As countries around the world accelerate the development of retail central bank digital currency, the impact on commercial banks and their role in this endeavour remain uncertain. OMFIF’s Digital Monetary Institute convened a panel discussion to explore what a retail CBDC public-private partnership would look like and how this would shape banks’ business models.
The panel included Hanna Armelius (Riksbank), Henny Arslenian (PWC), David Birch, and me. We discussed the potential division of labour between central banks, commercial banks and technology companies, and assessed how non-bank providers’ participation in a CBDC roll-out could impact traditional banks’ strategy and operations, as well as wider implications for global banks if digital currency is adopted for cross-border payments.
Tellingly, at the start of the seminar 78% of the audience thought the benefits of CBDC would outweigh the risks posed to the commercial banking sector, but this had dropped to 61% by the end of the webinar.
The consensus view among panelists was that central banks could distribute digital currencies through banks, in a public-private partnership not unlike the way the distribution of physical cash is organised. This would be a less disruptive scenario for banks and for the financial system more broadly, although availability of deposits would remain an issue for the supply and pricing of credit to businesses and households. While preserving banks should never be a policy goal, preserving financial stability while introducing CBDC should be. This does not mean a no-go for CBDC but does imply a reality check, and a warning to proceed carefully.
Digital finance was already a fast-changing place before Covid-19. After the pandemic, expect more government intervention. A changing appreciation of data may have strong implications for finance as well.
The Covid-19 pandemic will eventually pass, but not before disrupting vast swathes of the global economy and making its mark on digital finance.
1. Bigger government role
The increased role of government in the economy and financial sector is likely to persist to some degree. Before Covid-19, the changing geopolitical landscape had already made policymakers aware of the strategic importance of vital domestic infrastructure, including communications and payments. Governments are now also looking into data, an area already identified as a strategic priority by the European Commission earlier. In finance, governments have quickly established huge guarantee schemes to see businesses through the crisis.
It will take years to wind down the increased public role in finance
Even in a best case scenario, it will take years to wind down this increased public role in finance and the broader economy. A renewed debate on the division of labour between public and private sectors in finance will likely flare up, once the dust settles.
2. Reduced foreign dependence
Calls for autarky (e.g. in producing face masks) may fade quickly, but both businesses and authorities will look for less complex cross-border supply lines and smaller foreign dependencies, as Covid-19 demonstrates their fragility, but also on national security grounds. At the same time, governments have also been made acutely aware of the need for high quality communications infrastructure, e.g. to facilitate working from home. Countries with leading positions in the required technologies (think China and 5G) will be aware of their good negotiating position.
Authorities realise digital platforms are playing useful roles in locked down societies.
Finance has grown into a business with complex cross-border linkages. This ranges from financial ties to IT outsourcing and supervision. These international, sometimes global linkages, were already critically scrutinised by authorities, a development that may intensify post-Covid-19. How bigtech’s endeavours in finance fit the revised picture, remains to be seen. National authorities e.g. in Europe were increasingly critical about bigtech before the pandemic struck, but also realise that major digital platforms have become an important part of daily life and are playing useful roles in locked down societies.
The switch to working from home has stretched across corporate and national network infrastructures. With resources reallocated to keeping the show on the road, this exposes businesses (and an already heavily burdened health care sector) to increased cybersecurity risks, such as ransomware attacks and data leaks, but also to things like fake news. We have to reckon with the possibility that bad actors use security gaps today to establish a presence, only to exploit this presence later on, when it suits them best. To counter this threat, cybersecurity may be expected to move up the policymakers’ agenda. Given that cybercrime knows no borders, it is best fought at the international level. In the EU, while there is an EU agency, there is no deep cooperation as in markets and finance, for example. That might change in the future.
4. Faster adoption of digital interactions in retail
On the retail end, we expect the adoption of digital finance technologies to accelerate post-Covid-19. Many people have had no other choice than to acquaint themselves with ways to do business digitally – ranging from video conferencing to exchanging documents securely by digital means, or paying contactless to minimise physical contact.
Identity verification via video call may become accepted practice rapidly
We expect identity verification via a video call to become accepted rapidly. In the medium term, this may provide a boost to digital-only financial intermediaries, and may accelerate the demise of brick-and-mortar financial shops.
5. Focus on inequality and financial inclusion
The pandemic has put new focus on inequality in society. Digital financial intermediaries may be asked to intensify their efforts towards financial inclusion, e.g. by improving access to financial products for groups such as the self-employed, temporary workers and small and medium-sized enterprises (SMEs). Access for these groups is hindered by the limited availability of financial data and the high costs of processing them. One way to go about this is to augment financial data with a diversity of non-financial data sources.
6. Changing attitudes vis-à-vis data
Until recently, data debates centred around things like privacy and the question of whether people are comfortable paying for platform services with their data. While people may not like the idea when they think about it, in practice they continue to use said services. Several European governments are currently considering tracking location, health and other personal data for Covid-19 control monitoring and personalised health advise (e.g. to self-quarantine). There are other examples where data sharing could be useful in a lockdown society. Acutely arising liquidity needs due to the lockdown have demonstrated the need for quick credit checks. In the absence of readily available financial data, alternative (platform) data may prove very valuable.
People may reconsider the potential gains of sharing data and the need to protect users and society at large from data abuse
While data protection and usage monitoring remain paramount, far-reaching data sharing may be temporarily acceptable to most given the challenge at hand. But after the pandemic too, people may reconsider the value of data, the potential gains of sharing this data and the need to protect users and society at large from data abuse. Such shifting views may in turn enable new business models such as data guardians (a function that prima facie banks might be in a good position to fulfil), and may accelerate the establishment of legal frameworks to govern data sharing and protection.
Conclusion: Don’t stop thinking a step ahead
The coronavirus pandemic is such a fundamental and monumental shock that it will have a lasting influence on digital finance. In particular, and in no particular order, we see shifts in the relationship between the public and private sector in finance, changes to global interconnectedness, the need for increased cybersecurity cooperation, an acceleration of digitisation, an increased focus on financial inclusion and shifting attitudes towards data. For both financial intermediaries and policymakers, it is wise to start thinking about these tectonic shifts too.
The Covid-19 pandemic took the world by surprise with an unprecedented political and economic shock. As a result, we’ve updated our outlook on digital currency attitudes and trajectories
CBDC – as we knew it
Two months ago, the factors that drove research and development into central bank digital currencies (CBDC) included:
Technology considerations: the possibilities unlocked by today’s tech to create e.g. programmable money and decentralised, even offline exchange infrastructures;
Efficiency and financial inclusion: the desire to develop payment systems and use them as a development tool for the rest of the economy (less of a driver in developed economies);
Geostrategic considerations: the dominance of the dollar in finance and trade, the emergence of China on the world stage and the role of US and Chinese big tech firms;
Monetary autonomy: the dystopian idea of a private sector global currency operator sharply reducing national central banks’ monetary degrees of freedom and efficacy;
The declining use of physical cash and the urge to develop public sector alternatives to private digital infrastructures;
The realisation that any CBDC is potentially highly disruptive and therefore has financial stability implications that need to be managed carefully.
Covid-19 will accelerate, not slow, CBDC developments
We don’t think that Covid-19 alone will be a good enough reason for central banks to suddenly adopt digital currencies. However, the pandemic is likely to accelerate the process.
Here are a few reasons:
The declining use of physical cash is likely to accelerate, as contactless payments are encouraged to reduce contagion risk. While this may not win over the staunchest physical cash fans, the forced introduction to contactless payments may convince a silent majority;
The role of government is likely to increase, as we discuss here. This may make it easier for central banks to obtain the necessary political mandate to introduce a digital currency;
The pandemic may clear the political way towards introduction of CBDC
The financial system will come under increased pressure from Covid-19. The financial stability concerns related to CBDC (mainly substitution from bank deposits into CBDC) will therefore be even more pressing. At the same time, so will be calls to insulate payment systems from pressures in the lending parts of the financial system;
The pandemic will reshuffle the cards on the geopolitical stage. Some countries may emerge with less economic damage, giving them a clear opportunity to flex their muscles;
This and de-globalisation may intensify attempts to establish “national champions” in digital payments, either private or public.
So what are central banks up to? Will Libra 2.0 host any CBDC?
The global Financial Stability Board launched a consultation on global stablecoins (such as Libra), however, that was already planned. The Dutch central bank stated this week it’s ready to test CBDC in the Netherlands, once CBDC is properly debated at the Eurozone level. Yet this statement too, like other communications about intensifying research and pilots starting, was already in the pipeline before Covid-19. In other words, it’s too soon to see a corona effect.
De-globalisation may intensify attempts to establish “national champions” in digital payments
Last week the Libra association updated their white paper and introduced “single-currency stablecoins” alongside the original multi-currency Libra coin. In this new version, they argue that if central banks were to create a digital dollar, euro or British Pound, the Libra association could host these on the Libra infrastructure.
This offer has put the ball firmly back in the central bankers’ court. It may sound like an offer central banks can’t refuse, but we doubt whether they will take it up. In principle, a central bank may like the idea of having its CBDC hosted on multiple private platforms, in addition to its own public infrastructure. Availability on widely used platforms is in fact necessary for broad CBDC acceptance. So from that perspective, hosting CBDC on the Libra platform may be fine. There are a few problems though.
The dreaded multi-currency original Libra is not off the table yet. Authorities will continue to regard this global stablecoin with suspicion
The biggest one is that, even though Libra added single-currency Libra’s and potentially CBDC to the mix, the dreaded multi-currency original is not off the table yet. Authorities will continue to look at this global stablecoin with suspicion, and will probably demand guarantees in some form that it does not threaten monetary autonomy. We doubt whether Libra is able and willing to give such guarantees. The best one, from the authorities’ perspective, is to have no multi-currency Libra at all. But even in this long-awaited version 2.0, Libra refused to bite that bullet.
Moreover, Libra 2.0, which still has the potential to quickly become a dominant payment platform, will not make the previously mentioned questions on financial stability any easier. The Libra association may feel it has addressed all authorities’ objections to its v1.0 proposal, yet it may face more stiff conversations with central bankers.
A new dynamic?
In the end, whether CBDC arrives or not, was never, and never will be, a purely technological question. It was and will primarily be about political acceptance and alignment with other political strategic goals, both domestic and international.
De-globalisation, bigger role of governments and close cooperation with the financial sector will guide CBDC discussions
In that respect, our initial assessment is that CBDC will be a more likely option post-Covid-19. The bigger role of governments and the close cooperation between them and the financial sector in combating the economic fallout will guide discussions about CBDC in the context of the role the financial sector has in serving society.
That said, CBDC will not be introduced overnight. Right now, authorities and the rest of society are in crisis-fighting mode. However, previous crisis episodes have shown us that the foundations for the post-crisis institutional framework are laid in crisis times. We expect the debate to start soon.
It’s been a few months since we heard from Libra. As it turns out, the consortium has been working hard on version 2.0 of its white paper. This time, its proposed digital currency has a serious chance of being acceptable to authorities
It turns out that Libra had a lot of homework to do. When the initial white paper was published in June, a storm of criticism followed. Authorities all over the world were afraid a global stablecoin with the userbase of Facebook would create a de facto global private central bank, reducing the monetary autonomy of existing central banks. Concerns were also raised about Libra’s governance and its compliance framework. It quickly became clear that Libra would not fly in its initially proposed form, simply because many authorities would outlaw it.
But the Libra Association paid attention, and their 2.0 plan contains a number of fundamental changes that should to a very large extent address the fundamental concerns raised. To name the most important ones:
Libra has introduced “single-currency stablecoins” alongside the “global stablecoin”. In other words: the original Libra will get company from EUR-Libra, USD-Libra etc. These local currency versions blend in much easier in domestic monetary, financial and regulatory framework, and do not pose direct threats to monetary autonomy. That said, a successful Libra network could still influence financial stability. While an important concern, this should not be a complete showstopper. We do see potential issues around the fact that the “global” stablecoin, the original Libra, continues to exist. Authorities will continue to regard this global stablecoin with suspicion, and demand guarantees in some form that it does not threaten monetary autonomy. In what was probably a well-timed coincidence, the Financial Stability Board issued a consultation about global stablecoins earlier this week..
Libra is attempting to bring its business participants clearly within existing regulatory parameters. For example, exchanges and wallet providers are to register as Virtual Asset Service Providers (VASPs), meaning they have to comply with global standards to counter money laundering and terrorist financing. This too is important, as it will provide regulators with the tools needed to monitor and enforce compliance.
The third important change is that Libra is giving up on a fully decentralised future. Doubts about the feasibility arose immediately on publication of the initial white paper. There was great uncertainty about how a decentralised Libra network would look, and how authorities and supervisors would interact with it. Libra has apparently not been able to provide authorities with a satisfactory sketch of a decentralised network that nonetheless can be supervised and controlled effectively, and has instead opted to let go of the decentralised idea altogether. This is a very important signal with wider implications. Various crypto-projects are still working on fully decentralised approaches. But they now have a hard question to ask: will a decentralised setup ever be acceptable to authorities, or will it cause the coin/asset to languish on the fringes of the financial system forever?
Libra has shown that those who gave up on the project, did so too quickly. Libra 2.0 is very different from the initial version and now has a serious chance of being acceptable to authorities, and actually come into existence. The biggest issue in our view remains that the global currency basket-version of Libra is not off the table enitrely. Moreover, even in its watered down local-currency form, Libra, in combination with Facebook’s vast userbase, would remain a strong disruptive power to existing payment systems and the financial system at large. Let’s see how Libra’s proposals are received this time round.
The way we manage our daily money is changing rapidly, both visibly and behind the scenes. Effects will go beyond the disappearance of plastic cards
Payments: striving for integration, achieving more fragmentation?
Payments are seen as the plumbing of the economy. If that seems dull, rest assured, it isn’t anymore. It combines cutting edge tech developments, geopolitical arm-wrestling, stiff competition and central bank strategic manoeuvring.
Take Facebook’s Libra, a new cryptocurrency which threatens to disrupt the global financial system. After a strong backlash from global politicians and central bankers, it is unclear whether Libra will launch as planned in 2020. But with tech giants pushing deeper into finance, and bigtech already taking over payments in China, the industry looks set to be transformed in ways that have yet to be fully recognised.
The geopolitical importance of payment infrastructure is clear. The central role of the dollar in international finance means the US can wield power over foreign financials – power the US has been increasingly willing to use. It prompted, for example, the European Commission and European Central Bank to advocate more strongly for the development of a European retail payment infrastructure (as opposed to the current system reliant on the US firms Visa, Mastercard and Paypal, with expanding US and Chinese bigtech payment front-ends), and to develop plans to promote the international role of the euro.
Given their potentially far-reaching consequences, digital currencies are rapidly turning into Boardroom material as well.
Libra, and the strategic importance of money and payments, has prompted some major central banks to perform a U-turn on central bank digital currencies (CBDC). Before 2019, CBDC was mostly a debate for monetary seminars, now, it’s a topic of key strategic relevance for central bankers. As the Bank for International Settlements puts it, 20% of the world’s population may be using retail CBDC in the next three years. Both private and central bank digital currencies could have disruptive implications for banks. Bank disintermediation changes the channels of monetary transmission and raises fundamental questions about the operational framework of monetary policy. Mitigation of consequences for the availability of bank lending might involve central banks extending funding to banks, or taking on a greater role in credit provision themselves. Neither of these options look very attractive from a central bank perspective. At an even more fundamental level, the emergence of new digital currencies may fuel the debate about bank money creation, involving a total rethink of the financial plumbing of our economies. Given these potentially far-reaching consequences, digital currencies are rapidly turning into Boardroom material as well.
Last year, an EU directive known as PSD2 entered into force. In the UK, this is known as “Open Banking”. The “APIfication” of payments opens up the system to all kinds of new non-bank players. Paradoxically, individual service providers aim to provide a seamless, integrated service to their clients. The ideal often mentioned is an all-inclusive “super app”, like WeChat or TaoBao, which caters for all the clients’ needs, and makes any other app superfluous. At the same time, research into new currencies, both private and public, and the suspicion about the role of global players could actually result in a more fragmented back-end.
What to expect in the years ahead?
For crypto-assets, the future is with those initiatives that embrace and work with regulation
We remain of the opinion that a niche role is the best that ‘legacy’ crypto-assets can hope for as long as they continue to try and work around regulation. The future is with initiatives that embrace and work with regulation. Moreover, the debate is moving towards digital assets, with the industry making further progress on asset custody solutions, and regulators playing catch-up quickly this year, especially (perhaps surprisingly) in Europe. France strengthened its regulatory framework by issuing the Pacte Act last year. This new legislation brings more clarity on primary digital assets issuance, and allows Digital Asset Service Providers (DASPs) to operate in secondary markets. It also imposes some prudential and anti-money laundering measures. Germany created a new licensing regime for digital asset custody. Europe is now one of the most active regions in developing asset tokens and their legal framework, with Switzerland, Germany and France leading the way. However, to avoid fragmentation across jurisdictions, coordination and standardisation are needed. This would also bolster cross-border activity, which in turn would strengthen Europe’s credentials as a digital market.
2020: digital asset regulation in full swing
Meanwhile, the CBDC debate and research are accelerating. We expect more progress on the wholesale front first, with a key focus on improving efficiency, speed and costs while reducing counterparty risks. At the same time, central banks have stepped up their research on retail CBDC, but given the potentially more disruptive nature, they are likely to be careful and take it slow. In the developed world, the RiksBank is definitely the most “progressive” central bank on CBDC research with its e-krona project, in the face of steeply declining cash use. Before issuing e-krona, however, the central bank needs to make sure that it has a clear mandate from the Swedish parliament, and so far, nothing has been decided. The People’s Bank of China is also doing some serious work, having filed over 80 patents, and we should be ready for some potentially ground-breaking announcements in 2020. The PBoC is looking to preserve and build on the well-developed domestic digital payments infrastructure, while issuing and controlling CBDC centrally.
As for Libra, Facebook has suggested it could drop its currency basket approach and instead build separate €-libra, $-libra currency tokens. While many of Libra’s corporate backers have walked away from the project following objections from regulators and central bankers, we still expect them to return with Libra 2.0. If Libra (or another bigtech, for that matter) is able to establish a globe-spanning payments infrastructure, coupled with a unified digital ID scheme, it would be a major threat for banks and existing payment infrastructures in general.
A globe-spanning payments infrastructure with a unified digital ID scheme would be a major threat to existing infrastructures
Could this mark the end of good old notes and coins? Lower acceptance of cash transactions might further marginalise the unbanked and may not be socially desirable. In the United States, for example, the city council of New York joined San Francisco and Philadelphia in forcing retail stores to continue to accept physical cash. Within Europe, usage of and attitudes towards the continued availability of physical cash vary markedly between countries.
Physical cash still dominant?
There were 90 billion non-cash payments in 2018 in the eurozone, or on average 2,854 every second. The latest eurozone survey on cash usage showed that in 2016, there were an estimated 129 billion cash transactions. Since 2016, non-cash payments increased by a cumulative 16%. It seems safe to assume that the number of cash transactions declined over that period, but that cash is still the dominant means of payment in the eurozone. We are probably not far off the turning point, though.
Euro area non cash payment services
The impact goes beyond the disappearance of plastic from your wallet
Policymakers have their work cut out for them in the years ahead: adjust customer due diligence and competition, privacy and digital ID frameworks, managing (geo)politics, and not least minimising the monetary and financial consequences. Central banks understandably want to take the time to think through all these aspects of digital currencies. The question is whether private sector initiatives allow them the time to do so.
Where might a retail-digital currency thrive? We ask as Facebook’s Libra was a wake-up call for central banks and global policymakers, and there’ll be at least one or two contemplating launching such a currency of their own. We’ve examined global indicators to discover what might be coming next, and where.
The concept of retail digital currencies is now being taken far more seriously, not least by us, for numerous reasons. They include financial inclusion and arguments about the public nature of money to efficiency and costs. And in this article we take a global perspective and ask ourselves where in the world could be most receptive to a digital currency infrastructure. We’re only providing broad-brush, tentative answers using the World Bank’s Global Financial Development Database. Crucially, a global perspective based on a limited set of composite indicators merely identifies countries where demand for more, better and cheaper financial services might be highest. That is not sufficient to establish a business case for launching a digital currency.
Financial inclusion 1: broaden access to digital money
Introducing a digital currency, not reliant on existing systems but built as a standalone infrastructure which preferably extends across borders, makes the most sense in countries where access to, and usage of, existing digital means of payment is limited. The world map below shows access to digital money, measured as use of bank accounts, cards, electronic and mobile payments. Access is relatively broad in most developed economies, look at China (thanks to Alipay and WeChat Pay), Kenya (thanks to the mobile payment system M-Pesa) and most of South America. Africa and southern Asia stand out as areas where access to digital money could be broadened.
Chart 1: Access to digital money
Financial inclusion 2: broaden access to credit
For businesses developing digital currencies, it may be attractive to offer (micro)credit as well. Platform companies have non-financial data on their consumers and suppliers, which they may use to assess creditworthiness fast and accurately. For less developed countries, improving access to credit may accelerate economic development. Most credit opportunities concentrate again on the African continent. In contrast, it is noteworthy that some countries in South-East Asia which score low on access to digital money, do offer relatively broad access to credit.
Scope for efficiency gains and business opportunities are bigger when the incumbent banking system is less efficient. The map below – though based on a small set of indicators whose significance should not be overestimated – shows that in most developed economies, the banking sector is relatively efficient. The Middle East and North Africa region also scores well, and thus lends itself less well to digital currency disruption from this perspective. Sub-Saharan Africa and Latin America show the weakest results.
Sending money home across borders can be an expensive business, and an integrated infrastructure next to the current correspondent banking system could offer a new, cheaper and faster channel. The remittance market is growing at an astonishing rate: if we exclude China, remittances now outpace foreign direct investment (FDI) flows. Moreover, the global average cost of sending payments currently stands around 6.84% of the sum sent. To assess the importance of this to a domestic economy, we look at the inflow of remittances over GDP. The map below highlights in green the countries for which remittances are a relatively important source of income.
What can we conclude from our highly abstract analysis? The general picture that emerges is that there is most scope for improvement across Latin America, sub-Saharan Africa and parts of southern Asia, although for different reasons. In Africa, access to credit is most limited. In South America, efficiency and cost of finance offer opportunities. In southern Asia and Central America, a cross-border digital currency infrastructure might primarily be in demand to facilitate cheaper remittances.
Yet whether the introduction of a digital currency would be a successful or even sensible next step in the countries concerned, cannot be determined just by comparing a few global indicators. Relevant domestic circumstances are, for example, poverty levels, trust in and acceptance of intangible payment instruments among both merchants and the public, the presence and reliability of power and communications networks, and the applicable regulatory framework, to name just a few.
The introduction of a digital currency really requires a country-by-country approach
From a technical perspective, a digital currency infrastructure can only thrive if it is connected to and integrated into domestic and international systems, against manageable operating costs. This requires cross-border coordination and harmonisation by regulators, for instance, to agree on a digital identification method. Technical standardisation is also needed to avoid creating a new infrastructure which may develop into another difficult-to-maintain legacy a few decades down the road.
To conclude, while global analysis yields insights in the possible use cases for digital currencies across regions, the introduction of a digital currency really requires a country-by-country approach, taking into consideration local needs, circumstances and policies. Nonetheless, we note that demand for digital currency is more likely to rise in those places where the financial system is less developed and more fragmented.
Mark Zuckerberg, de baas van Facebook, moet morgen voor het Amerikaanse congres verschijnen. Daar moet hij zijn digitale munt, de Libra, verdedigen. Sinds de lancering van de munt in juni is er veel kritiek op de plannen van Facebook. Gaat het Zuckerberg lukken om het congres te overtuigen dat de munt kan werken? En ligt er een rol voor Nederland weggelegd in dit verhaal? Wouter van Noort, tech-journalist van NRC en Teunis Brosens, econoom van digitale zaken bij ING, vertellen het in De Nieuws BV.