The Bank for International Settlements (BIS) produced a chapter in its annual economic report in June asserting that central bank digital currencies (CBDCs) are in the public interest. It concludes that CBDCs will likely have to work in a two-tier, account-based system, instead of being either token-based or held in direct accounts at the central banks.
This probably calls for a hybrid architecture where the private sector onboards all clients, is responsible for enforcing anti-money laundering regulations and conducts all retail payments. However, the central bank also records retail balances and acts as a backstop to the payment system. Should a payments service provider fail, the central bank has the necessary information to substitute for it.
The e-CNY, the CBDC issued by the People’s Bank of China and currently in a trial phase, exemplifies such a design.
The BIS cannot get away from the fact, however, that even with a two-tier system people will now have some kind of account-based claim on the central bank itself.
Limits
It will probably require negative interest rates and caps on how much CBDC people can hold to preserve bank funding. However, the BIS admits one problem with hard caps is that households or firms that have reached their limit could not accept incoming payments, resulting in a broken payment process.
Funds in excess of a cap would have to be transferred automatically to a linked commercial bank deposit account.
This all gets terrifically complicated very quickly, without settling concerns over the potential loss of deposit funding to banks in normal times – let alone in periods of stress – that may curtail provision of credit and destabilize the whole financial system.
Worries
There is another worry. The BIS claims retail CBDC will benefit people if it works on open payment platforms conducive to competition and innovation. But it admits the very same technology that can encourage a virtuous circle of greater access, lower costs and better services might equally induce a vicious circle of data silos, market power and anti-competitive practices.
Randal Quarles, vice-chair of the Federal Reserve, had his say a few days after the BIS.
The Fed is due to publish a discussion paper later this summer on a digital dollar, but Quarles points out that the dollar is already digital, that the dollar payments system works well and is improving. He is sceptical that a CBDC version of the dollar is needed, as is often claimed, to preserve it as the world’s leading reserve currency or to improve financial inclusion.
Quarles argues that imminent improvements in the existing payments system, such as FedNow, combined with the cross-border efficiency of properly structured stablecoins could make superfluous any effort to develop a CBDC.
As to financial inclusion, he argues a better step is to make cheap, basic commercial bank accounts more available. He also worries that a Fed CBDC might deter private-sector payments innovation by occupying and dominating the field.
Quarles concludes that the potential benefits of CBDC are unclear and the risks are considerable.
While excitement grows around CBDC, the mood may now be shifting. It could be one of those captivating concepts that just fizzles out.
