Below is a keynote address on central bank digital currency by Tao Zhang, Deputy Managing Director at the International Monetary Fund. London School of Economics, February 28, 2020.
It’s a real pleasure for me to be here for this conference on China’s Trade and Financial Globalization. I want to thank the Institute of Global Affairs of the London School of Economics for the invitation.
This afternoon, we’re going to take up a topic that everybody seems to be talking about these days – namely, central bank digital currency (CBDC). This is a “widely accessible, digital form of fiat money that can be legal tender,” and a recent BIS (the Bank for International Settlements) survey of central banks shows that 80% were exploring CBDC.
I’ll start by laying out what I see as some of the main pros and cons of CBDC, as well as their international implications. I’ll say a few words about a few recent pilot experiences with these currencies, and also about some variants and alternatives to CBDCs. Finally, I will close by sharing what the IMF is doing in this area.
Digital currencies issued by central banks can bring a number of benefits.
First, a more efficient payments system. In some countries, the cost of managing cash can be very high on account of geography, and access to the payments system may not be available to the unbanked, rural, or poorer population. CBDCs can decrease costs and enhance efficiency.
Second, enhanced financial inclusion. CBDC may provide a public digital means of payment without requiring individuals to hold a bank account.
Third, more stability and lower barriers to entry for new firms in the payments system. In some countries (such as Sweden and China), we observe an increasing concentration of payment systems in the hands of a few, very large companies. In this context, some central banks view having their own digital currency as a means to enhance the resilience of the payments system and increase competition in the sector.
Fourth, enhanced monetary policy. Some academic scholars have suggested that by promoting financial inclusion, CBDC can also enhance the transmission of monetary policy. Moreover, to the extent that cash use is made costly, CBDC could be used to charge negative interest rates and thus help alleviate the constraint on monetary policy transmission due to the “effective lower bound.”
And fifth, a means of countering new digital currencies. A domestically issued digital currency backed by a trusted government, denominated in the domestic unit of account, may help limit the adoption of privately issued currencies (e.g. stablecoins), which may be difficult to regulate and could pose risks to financial stability and monetary policy transmission.
Despite the potential benefits, risks from CBDC can emerge. Measures need to be taken to mitigate the risks by getting the design of CBDC right.
Let me start with the risk of banking-sector disintermediation. Individuals could move their money from deposits at commercial banks to CBDC holdings. Banks in turn might feel pressed to raise deposit rates or access more expensive (and volatile) wholesale funding, weighing on profitability and possibly leading to more expensive or lower provision of credit to the real economy. Such disintermediation risks could be mitigated with a CBDC that does not bear interest (at least in an environment of positive deposit rates), and with limits on CBDC holdings.
Another issue to consider is so-called “run risk.” In times of crisis, bank customers could flee from deposits to CBDC, which might be seen as safer and more liquid. However, credible deposit insurance should continue to dissuade runs. Moreover, if a run occurred, the central bank would be more easily able to respond to banks’ liquidity needs with CBDC. In addition, in many countries around the world, bank runs typically coincide with runs from the currency. Thus, independent of the existence of local-currency CBDC, depositors might seek refuge in a foreign currency.
Next, there are implications for central bank balance sheets and credit allocation. In case demand for CBDC is high, the central bank’s balance sheet could grow considerably. In addition, the central bank may need to provide liquidity to banks that experience rapid and large funding outflow. As a result, central banks would take on credit risk and have to decide how to allocate funds across banks, opening the door to political interference.
CBDCs also imply costs and risks to the central bank. Offering CBDC could be very costly for central banks, and it could pose risks to their reputations. Offering full-fledged CBDC requires central banks to be active along several steps of the payments value chain, potentially including interfacing with customers, building front-end wallets, picking and maintaining technology, monitoring transactions, and being responsible for AML/CFT [Anti-Money Laundering/Combating the Financing of Terrorism] issues. Failure to satisfy any of these functions, because of technological glitches, cyberattacks, or simply human error, could undermine the central bank’s reputation.
Policy makers around the world are actively considering the best way to address these issues, taking into account countries’ own circumstances.
Among all the options, one potential way for the central bank to mitigate some of these costs and risks while offering a safe alternative to cash would be to enter into a partnership with the private sector to provide a synthetic version of CBDC (or “sCBDC”). The private sector would issue coins fully backed with central bank reserves, under the supervision of the central bank.
Advantages relative to full-fledged CBDC include preserving comparative advantages, with the private sector to innovate and interface with customers and the public sector to regulate and provide settlement services and trust. This would be a two-tiered system not unlike current arrangements whereby banks provide payment services to customers but settle in central bank money.
In addition, sCBDC could be less costly and risky for the central bank. Consider the CB not having to run customer due diligence, nor being directly responsible for AML/CFT compliance. Also, the CB would not be responsible for technological glitches, designing the user interface, or answering customer service lines.
However, sCBDC would require additional oversight on the part of the CB and establishing clear criteria to obtain an sCBDC license and access CB reserves.
sCBDC also has advantages relative to privately issued stablecoins (including global stablecoins). Stablecoins seek to minimize price fluctuations by backing their issuance with assets (including globally used fiat currencies) or by managing their outstanding supply using algorithms. Global stablecoins are those that could scale rapidly by leveraging existing network of clients for other services or goods offered. Being backed by CB reserves and supervised directly by the CB, sCBDC could be safer than stable coins.
All that I’ve said so far relates to the domestic implications of CBDC, but there are important international repercussions as well, and as you can imagine, we at the IMF are extremely interested in those as well. On the one hand, a CBDC used as an international means of exchange could improve the efficiency of cross-border payments, which are currently costly, slow, and opaque. But at the same time, CBDC available across borders could increase the probability of currency substitution (“dollarization”) in countries with high inflation and volatile exchange rates and therefore reduce the ability of the central bank to conduct an independent monetary policy. Moreover, a CBDC used across borders could also have an impact on capital flow movements, the effectiveness of capital flow management measures, and the international monetary system.
I hope that all this discussion makes it clear that the decision to issue CBDC is an incredibly complicated matter, and there are lots of factors to be taken into account before proceeding. Whether the pros outweigh the cons will depend very much on individual country circumstances, and there are plenty of international spillovers to consider as well.
Countries differ substantially in the extent to which they are actively exploring digital currencies and in just how close they might be to issuing such currencies.
Some countries recently have launched pilots to develop experience with CBDC. Some countries have run or are preparing pilot projects to explore the feasibility and the implications of CBDC. To do so, they have increased resources allocated to CBDC and fintech research at the central bank, sometimes in partnership with private sector advisors. Several countries are also reviewing and revising legislation to support CBDC in the event it were to be issued. And they are actively studying the potential implications of competing CBDC designs. Some authorities are also engaging with the public and their legislatures to discuss the possibility of issuing CBDC.
Some other countries are investigating CBDC, though they are also exploring alternatives. Regarding CBDC, these countries mostly focus on undertaking analysis and doing some limited, hands-on testing of technology. A final group of countries do not see an immediate need to issue CBDC. They are focusing instead on improving existing payment arrangements and strengthening regulation. Some are exploring synthetic CBDC and yet others are thinking about other ways to improve payment systems (such as “fast payments”) without issuing CBDC at all.
Recently, we’ve seen an increase in central banks’ interest in CBDC following the announcement by Facebook of its Libra initiative. The G7 set up a working group on stablecoins that produced a report published in October 2019.
At the IMF, we have been ramping up our research, analysis, and overall thinking on CBDCs, and indeed, on Fintech in general. Together with the World Bank, the IMF produced the Bali Fintech Agenda, which offers a framework to guide policymakers in thinking about how to regulate Fintech in their jurisdictions. We also routinely publish Fintech Notes, Staff Discussion Notes and Working papers on issues related to Fintech and CBDC, specifically. In January, for instance, we came out with a note on “Institutional Arrangements for Fintech Regulation and Supervision” and another on the “Regulation of Crypto-Assets.” And we also collaborate with other international organizations and standard setters, such as the Financial Stability Board and Committee on Payments and Market Infrastructure. The Fund is also a member of the G7 Working Group on Digital Payments.
This is, as I’ve tried to emphasize, an incredibly rich area for policy experimentation and discussion, and I look forward to hearing your views during the remaining sessions this afternoon.
This speech first appeared on www.imf.org.
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