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The writer is a senior fellow at Harvard Kennedy School
The emergence of central bank digital currencies is inevitable. Research on CBDC design and implementation is under way around the world. China is seven years into the process and has pilot programmes for the e-CNY, or digital yuan. The European Central Bank aims to introduce one by 2025. The Bank of England and Federal Reserve, however, are moving more slowly. And I think they’re right. What’s inevitable isn’t necessarily what’s optimal.
The world’s financial ecosystem has been transformed over the past 15 years. Cryptocurrencies and fintech firms threaten to shift payments, deposits and loans out of the banking sector and into unsupervised networks. This could create a wild west for international finance, threatening sector stability and undermining central banks’ abilities to achieve their mandates. The only defence, CBDC proponents say, is for policymakers to retain ultimate control over financial transactions.
With CBDCs, businesses and individuals could hold accounts directly with the central bank. While that could provide efficiency, it would end the role of banks in financial intermediation. The core of bank business models is leveraging deposits to extend loans and collect a fee. With an unstable deposit base, this practice, and bank profits, will dwindle. Fewer loans would be made, a drag on overall growth. To make up for the lost fees, banks might charge more for payment services and accounts. So much for a cheaper and more inclusive financial system.
Politically, it would be very hard for a central bank to step in to fill a lending gap by assuming the role of credit allocator. It would also require a central bank to take on new operational tasks such as credit risk and know your customer (KYC) analysis. More likely, a system would have to be designed so that customers will hold CBDC accounts at a bank or other intermediary, which will provide the services.
This poses its own challenges. Since CBDCs are backed by the central bank, they are safer. In a crisis, that might lead to a run on banks as customers switch out of cash. Even if commercial banks offer a higher interest rate to savers than those on CBDCs, it probably would not be effective in a flight to safety. Limits on CBDC holdings would leave openings for unregulated cryptocurrencies and could undermine competitiveness vis-à-vis other CBDCs.
CBDC fans argue they would boost inclusion by enabling everyone to have a bank account. This ignores the problem of people who are not connected to the internet. Privacy is also a concern. Do customers want even a quasi-government agency knowing the details of their spending? A token-based system, akin to authenticating the cash rather than the owner, would allow CBDCs to be used anonymously. This might attract the 23 per cent of the unbanked US population that reports it doesn’t trust banks and wants privacy. But it would not fly with anti-money laundering or sanctions authorities.
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Central banks, meanwhile, are addressing speed of settlement concerns by developing immediate-payment systems. If CBDCs were interoperable, they might make cross-border payments faster and cheaper. But this would require central banks to establish corridors with agreed architecture and governance. In a world with 200 currencies, this would demand unworkable numbers of bilateral arrangements. The anti-money laundering efforts that have slowed down attempts to modernise cross-border payments would persist even with CBDCs.
The international financial system must be updated for the digital age, and central banks will take the lead. Distributed ledgers and other technologies have the potential to make payments and invoicing more efficient. But getting CBDC design right is crucial. Simply assuming that “if it’s digital, it must be better” is too simplistic. This is a case where speed is not of the essence, and the Fed and BOE are wise to proceed cautiously to get it right.