1 Nathalie Aufauvre2

Central banks need to fulfil their monetary and financial stability mandate in the digital era, while accompanying innovation within a field of trust, says the director-general for financial stability and operations of the Banque de France.

Digitalisation has been transforming financial infrastructures and payment systems over the past few decades, particularly through the dematerialisation of assets and the automation of procedures. As such, digitalisation in its broad understanding is not a new phenomenon; however, it is currently reaching a new turn with the development of distributed ledger technologies (DLTs).

We have observed a growing market interest in DLT-based payment systems, alongside the emergence of tokenised versions of tradable assets (i.e. digital representations of rights circulating on a DLT network in the form of tokens), such as security tokens.

At the same time, new players — such as fintechs, ‘big techs’ and newcomers within the decentralised finance (DeFi) space — are entering the market for payments and financial services, or amplifying the role they already play on those sectors. The increasing interest in payments and settlements from those new players and the development of financial transactions based on DLT, far from being mutually exclusive, can intersect.

The Banque de France supports innovation and acknowledges that new technologies and approaches present significant potential to improve the functioning and efficiency of the financial system. However, those evolutions also come with new challenges and potential risks for users, consumers and investors, and for the stability of the financial system as a whole.

In navigating these new uncharted waters, the course for the Banque de France is clear: making sure we continue to effectively fulfil our monetary and financial stability mandate in the digital era, while accompanying innovation within a field of trust.

Overarching concerns

What are the top priorities in that perspective? First, central banks must preserve monetary sovereignty and ensure their ability to perform an effective and smooth transmission of monetary policy, which would be challenged if the use of other forms of money, such as private stablecoins or central bank digital currencies (CBDCs), were to become significant. And they must do so considering the present situation, but in a forward-looking way.

Second, the availability of central bank money remains essential: the presence of this safe and liquid settlement asset secures the large-value financial transactions and stabilises the whole financial system. This principle was clearly reiterated following the 2007–2008 financial crisis and transcribed in the Principles for Financial Market Infrastructures issued in 2012. Principle 9 recommends the use of central bank money to settle financial transactions to avoid credit and liquidity risks, where practical and available. As a consequence, if large flows of transactions were to move to tokenised systems, central banks would have to consider the issuance of money in a tokenised form.

Otherwise, the only available way to settle transactions of tokenised financial instruments directly on DLT would be to use private crypto-assets, such as stablecoins. This would endanger the stability of the system when considering not only their private nature, which necessarily generates credit and liquidity risks, but also (or even more) the significant regulatory, financial and operational uncertainties surrounding these crypto-assets, making them very risky for financial intermediaries to use at the current time.

And settling a tokenised instrument with existing forms of central money would not be efficient for market stakeholders, since they would need to branch out of the DLT environment to perform such a settlement with a non-tokenised form of central money, thereby incurring additional cost and complexities in the process. One of the main advantages of DLT is to be able to enter not only the ‘securities leg’ but also the ‘cash leg’ directly onto the ledger.

Central banks should promote innovation that brings the promise of stimulated competition, better services matching the evolving expectations from the users, and efficiency gains

Finally, central banks should promote innovation that brings the promise of stimulated competition, better services matching the evolving expectations from the users, and efficiency gains. But new offers cannot come at the cost of the soundness and safety of financial markets. They also cannot cause adverse side effects such as liquidity or operational fragmentation, which would be the consequence of an uncoordinated development of non-interoperable payment and settlement systems functioning in closed loops.

With this course set, it becomes clear that central banks must adopt a holistic approach to steering the ship. A first response is to act on the regulatory field, in a globally coordinated way, to ensure that new actors respect protective rules for financial stability and users, and are duly supervised. A second response is for central banks to develop innovations themselves, as is the case for the issuance of CBDCs.

Hands-on experience

The Banque de France is steadfastly committed to this approach. In March 2020, we launched a joint experimentation programme with market participants to explore the issuance and use of a wholesale CBDC that could be made available to financial intermediaries on a network in the form of tokens. This programme aims to go beyond the purely conceptual to produce concrete innovation. We want to combine this with a ‘learning by doing’ approach to innovation, to gain practical knowledge of new technologies and insights into their implications for the financial system.

Following a call for application, we initiated nine experiments focusing on the use of CBDC for wholesale payments, including cross-border and cross-currency payments, and securities settlement. We selected nine groupings for around 40 applications, covering a wide diversity of use cases, financial instruments and types of technologies. Participants involved financial intermediaries across the whole value chain, including large European and international custodian banks, central securities depositories, exchanges and fintechs, as well as institutional partners and public institutions.

The experiments were conducted within the existing regulatory framework to test different technologies in real-life conditions, and shed light on the technical limitations and regulatory challenges of the current framework. With most of these experiments completed, the Banque de France has already presented the main results of this programme.

First, this work has confirmed that new technologies, such as DLT underpinning the tokenisation of assets, can bring benefits to the financial system. These include: a smaller number of intermediaries, reduced processing times and costs, easier reconciliation of transactions, improvement of information flows, better tracking of the ownership of securities, reduced reporting costs and back-office burden, and the ability to support more secure and sophisticated products, such as smart contracts.

Second, the experiments highlighted how a wholesale CBDC could help secure the use of DLT by financial intermediaries for securities settlement. They showed how a wholesale CBDC could be used to settle tokenised securities in central bank money, and thus in a riskless way, under various configurations and for many asset classes, such as equities, bonds (both listed and unlisted) and fund shares. Experiments also looked at how conventional systems, such as Target services and DLT-based arrangements, could be made interoperable to ensure that money and assets can seamlessly move from one to the other, regardless of their underlying technology.

Finally, the experimentation programme highlighted how wholesale CBDCs could contribute to faster, cheaper, more transparent and inclusive cross-border payments. Wholesale CBDCs could be used to complete both cross-border and cross-currency transactions. As various jurisdictions may possibly issue a CBDC in the future, interoperable CBDC systems could help simplify and enhance the performance and accessibility of cross-border and cross-currency payments.

The experiments pursued this approach, comprehensively exploring the various possible types of multiple CBDC arrangements. Through these arrangements implemented on DLT, cross-border transactions, including cross-currency payments, could be settled safely in central bank money, and mitigate the current lack of interoperability between different jurisdictions’ real-time gross settlement systems. A reduction in the current frictions to cross-border transactions is therefore in reach, assuming central banks can efficiently co-operate on this matter and ensure interoperability between CBDC systems.

Beyond confirming the Banque de France’s belief that there is a case for a wholesale CBDC, this programme also raised a series of questions that set the stage for further work, particularly in relation to design choices and technical options. These include how to ensure and implement a seamless interoperability between CBDC systems and with other systems; how scalable the new technologies can be and to what extent they are able to perform rapidly and securely important flows of transactions; and how to integrate in the equation future assets and DeFi applications, to name a few.

Digital currencies are a key area of focus for central banks that want to ensure they have all the necessary tools to fulfil their mandate to preserve the soundness of the financial and monetary system in the digital era. The Banque de France has a strong conviction of the necessity of central money as an anchor for the entire financial system, which could imply issuing a CBDC to bring its safety and liquidity to the new systems if the financial markets transition towards a more decentralised set-up.

The Banque de France remains convinced of the importance of continuing this work on DLTs and CBDCs to address the many questions and challenges ahead; to take it further, in partnership with other private and public actors, to an international level, as interoperability could prove critical to enhance cross-border payments.

Nathalie Aufauvre is director-general for financial stability and operations at the Banque de France and chair of the Climate Change Centre. This article was written in collaboration with Paul Gardin, digital currency specialist at the Banque de France.

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