In response to current trends such as the decreasing use of tangible money (currency) and the rise of cryptocurrencies and stablecoins, central banks worldwide are considering the feasibility of creating a Central Bank Digital Currency (CBDC). This CBDC would represent a novel form of central bank-issued money aimed at improving the existing store of value and cashless payment options.
My article published in the Capital Markets Law Journal explains that private households, in all societies, are disadvantaged when it comes to accessing a comprehensive array of monetary options. The full range of options are reserved for a privileged group of legal entities, primarily commercial banks, which have exclusive access to central bank reserve money, which is currently the safest and therefore most attractive form of money. CBDC would grant the public access to intangible central bank money and therefore a default-proof type of store of value which would end the discriminatory practice of central banks that have so far limited the public’s options to currency and commercial bank money.
While this innovation appears promising for society as a whole, it may come with trade-offs. The banking industry, accustomed to accessing retail customers’ funds at a low cost, would face competition from CBDC and potentially have to pay risk premia for their store of value services. This could result in reduced liquidity within the banking system, potentially leading to decreased lending to various sectors of the economy. From a results-oriented perspective, some therefore argue that societies should reconsider their ambitions for universal intangible central bank money. Alternatively, CBDC could be introduced with various risk-minimizing features to mitigate these complications, an approach favoured by several central banks, above all the Eurosystem.
A notable paradox emerges in this narrative. Central banks’ strategies to minimize potential negative side effects of CBDC for the financial industry involve designing CBDC to be unattractive to the public, thereby encouraging retail customers to retain their funds in deposit accounts with commercial banks. However, this approach creates a fundamental contradiction: if CBDC is intended to enhance public trust and interest in the official monetary system, it becomes challenging, if not impossible, for an unattractive CBDC to achieve this objective, particularly when private issuers such as stablecoin schemes offer appealing alternatives for means of payment and store of value.
Furthermore, the article uncovers another weakness in the current CBDC discourse, namely the disregard for significant disparities among countries regarding monetary and banking systems, retail customers’ expectations, and central banks’ mandates. These factors are pivotal in determining the potential adverse impact of CBDC on the financial system. The decision to introduce CBDC by central banks and its subsequent impact on the banking sector are contingent on a multitude of specific factors, each warranting individual scrutiny. In comparison, the value of broad discussions centred on abstract evaluations of the advantages and drawbacks of CBDC is inherently limited.
The article therefore advocates for a thorough analysis of the critical question of which markets truly require CBDC and what the implications for the financial industry would be and suggests that the answer is contingent upon the specifics of the financial market infrastructure. Only when evaluated from a specific and nuanced perspective, it becomes feasible to address the genuinely pertinent question: which central banks should embark on the journey of introducing CBDC?
In well-established conventional markets, where banking industries thrive on retail deposits as their primary source of funding, the introduction of CBDC is unlikely to yield significant changes, except in scenarios where a banking crisis triggers runs on deposits. I have posited that the risks arising from large-scale conversions of deposits into CBDC during such crisis situations can be managed, and CBDC can expedite effective crisis resolution.
My conclusion, as of the time of writing, is that China has the most compelling rationale and the requisite capability to introduce a digital Renminbi. It appears highly probable that China is poised to lead the initial phase of the global CBDC race. China’s financial infrastructure diverges significantly from that of developed open market economies. Consequently, the introduction of a digital Renminbi not only carries manageable risks for China’s banking sector but also strengthens and consolidates the People’s Bank of China’s (PBOC) authority over China’s financial market and economy—a development likely welcomed by policymakers in Beijing.
Similarly, the euro area is a promising candidate for a digital euro due to the Eurosystem’s (long-term) inclination toward expansive monetary policies and their impact on the banking sector. During periods of extensive monetary easing leading to perplexing transformations in traditional bank funding models, as observed in the recent history of the euro area, CBDC may be perceived as a relief rather than a threat to the banking industry. Furthermore, CBDC can create additional channels for the transmission of monetary policies and allow central banks to react more swiftly and implement their policies more directly.
Countries characterized by low levels of financial inclusion stand to gain the most from CBDC. However, they may face financial constraints when it comes to driving CBDC development. Their best hope may lie in aligning themselves with progress made in wealthier regions of the world.
Keywords: Concept of money, Currency and commercial bank money, Stablecoins, Bank runs, Financial inclusion
AUTHOR INFORMATION
Associate Professor Christian Hofmann is the Head of Central Banking and Financial Regulation at the Centre for Banking & Finance Law and the Deputy Director of the Centre for Asian Legal Studies at NUS Law.
Email: lawch@nus.edu.sg