The Bank of International Settlements (BIS) and seven different central banks, including the Bank of England, Bank of Japan, European Central Bank, and U.S. Federal Reserve, published three new reports, which find that while a groundbreaking innovation to monetary policy, central bank digital currency (CBDC) pose many opportunities and uncertainties.
Digital currencies backed by central banks could cause significant disruption to private financial institutions, although risk to banks could be limited with the proper checks and balances, according to a report by a group of central banks.
The first report explores how private-public collaboration and interoperability can be designed into CBDC systems. In particular, policies about privacy and access to payment data would be key design elements to maintain public trust, the group concludes.
The second report focuses on how a CBDC could best serve people and businesses in a fast-changing technological landscape. Lessons from previous payment innovations compiled in the report show that success often requires harnessing network effects and not requiring users to obtain new devices.
The third report outlines the possible impact of CBDC issuance on banking systems, in terms of intermediation capacity and overall resilience. The preliminary analysis highlights the importance of allowing the financial system time to adjust and the flexibility to use safeguards to influence CBDC adoption.
The key concern is that CBDCs would eat into commercial bank profitability, as savers move their bank deposits into accounts held at the central bank. Banks typically rely on client deposits to make loans, meaning a reduction in deposits could affect the availability of credit throughout the economy.
“This could, under certain circumstances, affect bank profitability, lending, and the overall provision of financial services,” the report said.
One risk highlighted in the new report is the heightened potential for systemic bank runs. During an economic crisis, “reduced transaction costs of a CBDC could exacerbate bank runs” because these digital currencies might be “perceived as a safe haven.”
Eswar Prasad, senior professor of trade policy at Cornell University and author of a CBDC-focused book, “The Future of Money,” said bank runs are just one of many risks central banks need to consider when issuing their own digital currency. “A low-cost digital payment system provided by a central bank not only risks disrupting the banking system but could also discourage private-sector payment innovations,” Prasad told Yahoo Finance.
Nic Carter, Coin Metrics co-founder and current partner with Castle Island Ventures, said a digital dollar issued by the Federal Reserve could be used to effectively “nationalize the commercial banking sector.”
“I think the biggest threat to Wall Street and banks, and the commercial bank sector is actually CBDCs,” Carter told Yahoo Finance.
Prasad also warned that if nations move from cash to digital currencies, “confidentiality in financial transactions and privacy could be compromised.” On the other hand, the same low-cost efficiency that comes with digital cash would present the greater vulnerability of hacking and other cyber crime, he said.
Private-sector digital currencies known as stablecoins could also reduce people’s reliance on bank deposits. Indeed, one of the core arguments for CBDCs is that central banks are better placed than private technology companies to manage the disruption caused by digital money.
Policymakers, for instance, could limit the impact of digital cash on bank deposits by capping how much money could be held in a CBDC account. The BIS report also advocates for considerable private-sector involvement in any CBDC system, with financial institutions providing the customer-facing parts of the system, such as digital wallets.
“For central bank digital currencies (CBDC) to work effectively, public and private institutions need to cooperate to ensure integration with existing payments systems; to anticipate customers’ future needs; and to support innovation while preserving public trust, privacy, and stability in the broader financial system,” the authors of the BIS report wrote.
While the race to issue CBDCs first heats, the risks of doing so too quickly also come with costs.
“This will require extensive research and analysis,” Prasad said. “It is encouraging that major central banks are cooperating in undertaking extensive background research and experimentation before contemplating full-fledged rollouts of their CBDCs.”
Around the world, more than 80 central banks are thinking of launching their own forms of digital currency in response to a decline in the use of physical cash and the rise of digital currencies backed by large technology companies, such as Facebook. The fear among central bankers is that they could lose their place at the heart of the payments system defined by digital wallets and tap payments.