## ppea2020050

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### Executive summary — overview and key statistics
- Rapid progress in digital technologies increases prospects for adoption of new forms of digital money for domestic and international transactions, including central bank digital currencies (CBDCs) and global stablecoins (GSCs).
- International use of currencies reflects:
  - the economic weight of issuing countries;
  - broader geopolitical factors;
  - strong network effects and synergies across the three functions of money (unit of account, means of payment, and store of value): once a currency is dominant, it has tended to stay dominant.
- Digitalization could drive international currency use by:
  - lowering transaction costs through increased competition;
  - widening access to services and promoting financial inclusion via mobile devices;
  - enabling complementary services on social networking and e-commerce platforms of global scale.
- Stylized adoption scenarios are presented for exposition (not forecasts or value judgments).
- Quantified and sample statistics (preserve source figures):
  - Based on a sample of 112 countries, Bank for International Settlements (BIS) (2020, p. 84) reports that the average total cost of a US$200 bank-based cross-border remittance is over 10 percent of the remittance value.
  - Remittances to developing countries exceeded US$550 billion in 2019, surpassing FDI and portfolio flows.
  - The share of adults without access to a bank account stands above 50 percent in parts of the developing world, such as Sub-Saharan Africa, North Africa and the Middle East (BIS, 2020, p. 72).
- Definitions:
  - CBDC (retail focus): widely accessible digital form of fiat money that could be legal tender.
  - GSCs: stablecoins issued by “Big Techs” with potential for widespread adoption; stablecoins may differ from traditional e-money schemes and do not necessarily guarantee redemption at a pre-established face value denominated in the unit of account.

### Stylized adoption scenarios (expositional)
- Scenario 1 — Niche use for cross-border payments:
  - CBDC or GSC used for small value transactions (e.g., remittances); held mainly for duration of transaction; exchanged for local currency for domestic purchases.
  - Likely limited implications for monetary policy and financial stability unless it materially fosters currency substitution.
- Scenario 2 — Greater currency substitution in some countries:
  - Foreign CBDC or GSC pegged to an existing fiat currency induces extensive use in countries with high and volatile inflation; replaces domestic currency significantly as store of value, means of payment for many transactions, and commonly as unit of account.
  - Adoption intensity depends on credibility of local monetary policy, e-commerce/social platform incentives, and payment system development.
- Scenario 3 — Global adoption of a single GSC:
  - A GSC becomes commonly adopted in many countries, potentially an independent unit of account, used on global e-commerce/social platforms; issuer’s rules (e.g., price stabilization rule) preserve value.
  - Raises fundamental issues about entrusting macroeconomic policy influence to a private firm.
- Scenario 4 — Global adoption with multipolarity:
  - Competition between a few major CBDCs and GSCs; possibilities include “currency blocs” for CBDCs or “digital currency areas” for GSCs determined by platform boundaries.
  - Could hasten transition to a multi-polar world of reserve currencies.

### Benefits of cross-border CBDC/GSC adoption
- Conceptual benefits:
  - Make cross-border payments as easy as sending an email and reduce transaction costs, especially for small transactions.
  - Broaden access to cross-border financial services leveraging transaction data.
  - Potential to improve global risk-sharing in the longer term.
- Intrinsic adoption drivers:
  - Lower transaction costs by cutting intermediaries and simplifying compliance; potential to reduce costs in securities issuance and trading via tokenization.
  - Ease of access, especially in rural areas, overcoming infrastructure impediments.
  - Access to complementary services or bundling (e.g., social media, e-commerce, credit) from private platforms.

### Risks, macro-financial effects, and channels
- General risks and policy challenges:
  - Foreign CBDCs and GSCs could raise pressures for currency substitution and worsen currency-mismatch vulnerabilities.
  - Reduce ability of local authorities to run independent monetary policy and control domestic financial conditions.
  - Facilitate illicit flows and complicate enforcement of exchange restrictions and capital flow management measures (CFMs) without appropriate safeguards.
  - GSC-specific governance issues and potential for bouts of confidence crises if not independent units of account; independent-unit GSCs pose deeper global monetary and governance challenges.
- Monetary policy transmission:
  - CBDCs do not qualitatively change forces behind international currency use but could quantitatively reinforce currency substitution and internationalization incentives.
  - Currency substitution consequences: reduces control over domestic liquidity, limits direct influence on liquidity components, reduces stability of money demand, and weakens transmission of monetary policy.
  - Scenario-specific implications:
    - Scenario 1: probably no significant impact unless substitution increases materially.
    - Scenario 2: user country’s ability to absorb shocks depends on business cycle synchronization with issuer.
    - Scenario 3: countries subject to monetary stance of a private firm; issuer profit motives may conflict with stabilization objectives.
    - Scenario 4: competition and potential for CBDC issuers to offer swap lines or tailored policies; multipolar currency blocs may leave diverging-cycle countries worse off.
- Financial stability channels:
  - Easier access to foreign currency lowers transaction costs for speculative positions, raising funding and solvency risks from currency mismatches.
  - Disintermediation risk: CBDC/GSC use could crowd out bank deposits, elevating run risks and raising banks’ funding costs.
  - Operational and confidence risks: cyberattacks, custodian or wallet-provider failures, liquidity risk of GSC market makers.
  - Scenario effects on bank vulnerabilities:
    - Scenario 1: likely small effects; modest deposit declines and funding risk increases.
    - Scenario 2: higher funding and solvency risks; increased credit risk if loans denominated in foreign currency without matching earnings.
    - Scenario 3: domestic conditions driven by global factors; harder for local regulators to constrain boom-bust dynamics.
    - Scenario 4: currency competition may increase volatility; competition could induce risk-taking by GSC providers.
- GSC ecosystem risks:
  - Liquidity, market, credit, operational, cyber risks across wallet providers, exchanges, custodians; runs away from GSCs could break pegs and trigger cross-border volatility.
- Capital flows:
  - Adoption/use could affect gross cross-border capital flows by reducing transaction costs, lowering frictions, and improving access to foreign markets.
  - Risks of more atomized investor bases: increased noise trading and herd behavior.
  - Scenario implications:
    - Scenario 1: unlikely to affect capital flows significantly.
    - Scenario 2: could increase capital flow volatility and bypass exchange restrictions/CFMs.
    - Scenario 3: could enable more integrated international capital markets but also enable herding and panics via platform-bundled GSCs.
    - Scenario 4: potential for diversified international risk sharing but also fragmentation of liquidity and amplified volatility.

### Regulatory, legal, and AML/CFT considerations
- Legal definitions and implications:
  - Currency (legal concept) vs. money (broader legal concept); CBDC expressed in existing official monetary unit — likely a new means of payment, not a new monetary unit.
  - CBDC designs: deposit-based (book money) vs. token-based (digital token; legal status unclear).
  - GSC legal status unclear and likely sui generis; legal classification consistency across jurisdictions is crucial for wide use.
- Regulatory environment and risks:
  - Fragmented regulatory environment; regulatory uncertainty may prompt pushback unless clarity on financial stability impact and applicable frameworks exists.
  - In countries with exchange restrictions, CBDCs/GSCs could be used to circumvent restrictions.
- AML/CFT framework and supervision:
  - Effective implementation of AML/CFT frameworks is needed in all scenarios; FATF standards and virtual asset guidance are key.
  - Supervisory scope/intensity depends on scenario:
    - Scenario 1: relatively little impact on financial vulnerability → fewer regulatory changes.
    - Scenario 2 & 4: increased currency mismatches and different liquidity profiles for foreign CBDC deposits.
    - Scenario 3: maturity mismatch risks—may require higher capital charges, stronger underwriting, and enhanced liquidity risk management.
  - GSC service providers should be licensed/registered and effectively supervised; identifying a “home” supervisor for the GSC ecosystem is challenging.
  - FSB high-level principles recommend comprehensive regulatory requirements and international cooperation; limitations exist and call for more detailed international standards.
- Design considerations and enforcement:
  - Recipient countries can set legal boundaries on denomination and settlement in foreign CBDCs/GSCs.
  - Technological design choices (deposit-based vs. token-based) affect capacity to verify payor/recipient/payment purpose and enforce restrictions.
  - Token-based designs may struggle to support constraints without leakage; smart contracts and programmable features could facilitate compliance but raise implementation questions.
- Structural and competition policies:
  - Widespread GSC adoption raises welfare questions about privately issued monies at global scale; profit motives may not align with recipient-country stabilization needs.
  - Policies promoting contestability and interoperability can mitigate monopolistic risks:
    - data policy frameworks mandating portability of user data;
    - interoperability requirements on payments systems.
  - Consumer protection and disclosure requirements are essential given likely use by unsophisticated consumers.

### Policy responses and macroeconomic policy implications
- For countries facing incentives to adopt/use foreign CBDCs/GSCs:
  - Options include strengthening monetary policy credibility and/or restricting foreign currency use via legal/regulatory means.
  - When monetary policy is constrained, use integrated policy frameworks (IPF) combining fiscal, macroprudential policies, foreign exchange interventions and CFMs.
- CBDC issuance as a strategic response:
  - Issuing a domestic CBDC may not prevent currency substitution if monetary policy framework lacks credibility; ex-ante cost-benefit analysis and design choices are critical.
- Fiscal policy:
  - If monetary policy is ineffective and business cycles diverge, fiscal policy must play a larger stabilization role; sufficient fiscal policy space is necessary.
  - Digital money could complicate fiscal sustainability by facilitating evasion of financial repression.
- Financial stability and buffers:
  - Recipient countries should build capital and liquidity buffers and secure emergency liquidity arrangements (reserves, contingent lines, or swaps) with issuing central banks or GSC issuers in currency blocs/digital currency areas.
- For CBDC-issuing central banks:
  - Assess spill-back effects of nonresident access, possible sterilization challenges, seigniorage implications, and whether to act as lender of last resort to heavy foreign users.
  - Consider tiered remuneration structures to limit foreign demand interference with domestic monetary policy.

### Reserve assets and safe-asset implications
- Digitalization may speed changes in reserve currency composition by lowering switching costs and enabling rapid scalability via digital platforms and global wallet networks.
- Scenario impacts on reserves:
  - Scenario 1: limited implications for reserves.
  - Scenario 2: central banks may increase foreign reserves for precautionary motives; reserve holdings could shift toward CBDC/GSC units of account.
  - Scenario 3: tension between private issuer profit motives and global demand for safe GSC reserves; uncertainty over private issuer providing swaps or backstops.
  - Scenario 4: reserve diversification possible; outcomes depend on number and behavior of major issuers.
- Supply-side risk: shortage of safe assets if issuers do not accommodate global demand, with side effects such as depressed risk premiums and higher leverage.

### Annex I — current landscape of cross-border use of currencies (key stylized facts)
- The U.S. dollar dominates international transactions:
  - United States represents just 10 percent of global trade and 15 percent of world GDP, yet the U.S. dollar is the invoicing currency for 50 percent of global trade.
  - Two thirds of global securities issuance are in dollars.
  - 75 percent of cross-border bank claims and public debt by emerging markets and developing countries are denominated in the U.S. dollar.
  - U.S. dollar accounts for about two thirds of official foreign exchange reserves.
  - Around 45 percent of forex trading involves the U.S. dollar.
- Cross-border payments rely on correspondent banking; there has been a broad-based retreat of correspondent banking relationships in the past decade.
- Cross-border retail payments have high transaction costs due to fragmented data standards, AML/CFT compliance complexities, limited operating hours, outdated legacy platforms, and weak competition.
- A concerted global effort coordinated by the Financial Stability Board is underway to improve cross-border payments efficiency in part as a response to the rise of GSCs.

### Annex II — extent and dynamics of currency substitution
- Mechanisms:
  - Currency substitution depends on which functions of money (store of value, medium of exchange, unit of account) a foreign currency performs better than the domestic currency.
  - When domestic currency is a poor store of value, households and firms prefer foreign-currency financial assets/liabilities; this is the most prevalent form of substitution.
  - If substitution centers on medium of exchange, payment system adoption can drive unit-of-account use (example: Cambodia).
- Prevalence and dataset composition:
  - Analysis based on a sample of 154 (149) countries reporting foreign currency deposits (loans) shares.
  - In close to one third of countries, currency substitution exceeds 30 percent of deposits/loans.
  - Foreign currency use exceeds half of total deposits in 17 percent of countries.
  - Foreign currency use exceeds half of total loans in 11 percent of countries.
  - Countries with high currency substitution are emerging or developing economies.
  - Special cases in the dataset: Ecuador and El Salvador (foreign currency only legal tender); Liberia and Panama (both domestic and a foreign currency legal tender); Zimbabwe (foreign currency legal tender during sample period but no longer).
- Dynamics and persistence:
  - Currency substitution can happen rapidly after crises or political transitions: examples show foreign currency deposits rising from single digits to above thirty percent in two years.
  - Habit formation leads to persistence; average extent plateaus but does not revert over a ten-year horizon.
  - Correlation between deposits and loans is significant: foreign currency deposits’ share correlates with foreign currency loans’ share.

*September 22, 2020 — DIGITAL MONEY ACROSS BORDERS: MACRO-FINANCIAL IMPLICATIONS — ppea2020050*

### EXECUTIVE SUMMARY

### EXECUTIVE SUMMARY

### Overview
- Rapid progress in digital technologies increases prospects for adoption of new forms of digital money for domestic and international transactions, including central bank digital currencies (CBDCs) and global stablecoins (GSCs).
- The international use of currencies reflects:
  - the economic weight of issuing countries;
  - broader geopolitical factors;
  - strong network effects and synergies across the three functions of money (unit of account, means of payment, and store of value): once a currency is dominant, it has tended to stay dominant.
- Currency substitution (use of foreign currencies for domestic transactions) depends on monetary stability, legal frameworks, and regulation.
- Digitalization could drive international currency use in ways distinct from traditional dynamics by:
  - lowering transaction costs through increased competition;
  - widening access to services and promoting financial inclusion via mobile devices;
  - enabling complementary services on social networking and e-commerce platforms of global scale.
- The paper presents stylized adoption scenarios (not forecasts or value judgments) because adoption is difficult to predict.

### Stylized Adoption Scenarios (expositional)
- Scenarios range from:
  - niche use for small cross-border payments;
  - pervasive adoption in a subset of countries;
  - global adoption of a single GSC;
  - a multipolar world with intense competition between a few major CBDCs and GSCs.
- Purpose: illustrate possible implications for monetary policy transmission, financial stability, capital flows, and international reserves.

### Benefits of Cross-border CBDC/GSC Adoption
- Conceptual benefits include making cross-border payments as easy as sending an email and reducing transaction costs, especially for small transactions.
- Potential to broaden access to cross-border financial services leveraging big data from transactions.
- Could lead to improved global risk-sharing in the longer term.

### Quantified and Sample Statistics (preserve source figures)
- Based on a sample of 112 countries, Bank for International Settlements (BIS) (2020, p. 84) reports that the average total cost of a US$200 bank-based cross-border remittance is over 10 percent of the remittance value.
- Remittances to developing countries exceeded US$550 billion in 2019, surpassing FDI and portfolio flows.
- The share of adults without access to a bank account stands above 50 percent in parts of the developing world, such as Sub-Saharan Africa, North Africa and the Middle East (BIS, 2020, p. 72).

### Risks and Policy Challenges
- Foreign CBDCs and GSCs could:
  - raise pressures for currency substitution and worsen currency-mismatch vulnerabilities;
  - reduce the ability of local authorities to run independent monetary policy and control domestic financial conditions;
  - facilitate illicit flows and complicate enforcement of exchange restrictions and capital flow management measures (CFMs) without appropriate safeguards.
- GSC-specific challenges include governance issues and the potential for bouts of confidence crises if they do not represent independent units of account.
- If GSCs represent new independent units of account, they could have deeper impacts on global monetary and financial stability and pose global governance challenges because profit-maximizing issuers may conflict with public policy objectives.

### Macro-Financial Effects Identified
- CBDCs do not qualitatively change the economic forces leading to international currency use; they are digital forms of existing fiat currencies.
- Quantitatively, CBDCs could reinforce incentives behind:
  - currency substitution;
  - currency internationalization.
- GSCs that are not independent units of account are similar to CBDCs in monetary effects but may affect financial stability via confidence risks.
- Cross-border use of CBDCs could help issuing-country firms and households better manage risks (e.g., issuing debt denominated in their own currency), but greater financial integration without commensurate market and institutional development could increase issuing countries’ exposure to global shocks.
- Increased accessibility of foreign currencies via digital money could increase capital flow volatility and complicate the conduct of monetary policy in issuing countries.

### Policy Considerations and Responses
- Central banks could issue their own CBDCs as a strategic response, but issuing a domestic CBDC may not prevent currency substitution if the local monetary policy framework lacks credibility.
- Authorities may need to adapt fiscal and macroprudential policies when monetary policy effectiveness is impaired.
- Central banks issuing CBDCs might see their currencies internationalize or gain reserve currency status, but foreign use of their CBDCs could complicate domestic monetary policy by increasing capital flow volatility.
- Policy harmonization may be needed on legal and regulatory frameworks for:
  - data use and sharing;
  - competition policy;
  - consumer protection;
  - digital identity;
  - other digital-economy issues.
- RegTech and SupTech may empower regulation and supervision, but their effectiveness remains a work in progress.

### Definitions and Scope
- For this paper:
  - CBDC (retail focus) is defined as a widely accessible digital form of fiat money that could be legal tender.
  - GSCs are stablecoins issued by “Big Techs” with potential for widespread adoption; stablecoins may differ from traditional e-money schemes and do not necessarily guarantee redemption at a pre-established face value denominated in the unit of account.
- The paper treats stablecoins as a form of digital money for exposition, but this does not imply they are formally considered “currency” or “money” by IMF staff. Legal definitions are discussed in Box 1.

### Institutional Role
- The IMF, given its universal membership and mandate for safeguarding international monetary and financial stability, is positioned to consider macro-financial effects and policy implications in bilateral and multilateral surveillance and capacity development.
- This paper provides an initial analysis and an informal briefing to the Board; it refrains from making prescriptive policy recommendations and notes that normative policy discussions require further welfare analysis and broader public debate.

_September 22, 2020 — DIGITAL MONEY ACROSS BORDERS: MACRO-FINANCIAL IMPLICATIONS — EXECUTIVE SUMMARY_

### 10.      Ongoing progress in digital technology

### 10.      Ongoing progress in digital technology

### Overview: technological change and payments
- New forms of digital money can be cheaper and faster than traditional electronic instruments, especially for cross-border payments.
- Compared to credit cards, CBDCs and GSCs do not incur expensive interchange or foreign transaction fees, in part reflecting that they do not require the multi-layered clearance and settlement infrastructure behind credit card transactions.
- CBDCs and GSCs can be transferred over a peer-to-peer system in real time around-the-clock, essentially bypassing correspondent banking relationships.
- Analogy: before the internet, sending a letter domestically and internationally involved different infrastructures and pricing; in the internet age "a message is a message" and with CBDCs and GSCs "a payment might just be a payment" regardless of domestic or foreign recipient.

### Types of private digital money: characteristics and use
- First generation cryptoassets (example: Bitcoin):
  - Denominated in their own units of account.
  - Exhibit large price volatility, making them poor stores of value.
- Stablecoins:
  - Seek to minimize price fluctuations by pegging to fiat currencies or other assets, backing issuance with assets (including assets denominated in globally used official currencies individually or as a basket), or managing supply using algorithms.
  - To date, neither cryptoassets nor stablecoins have reached the level of use of cash or of established cashless payment methods.
- Global stablecoins (GSCs) issued by Big Tech:
  - Big Techs, benefiting from network effects and bundling, may issue stablecoins with potential for large-scale adoption.
  - Example noted: Facebook and partners announced intention to launch Libra, a blockchain-based digital money fully backed by assets denominated in reserve currencies.
  - Initial pegs to reserve fiat currencies could engender trust; over time GSCs might be de-linked and become an independent unit of account backed by user trust and credible issuer rules (amount and pace of issuance, interest or fees).

### Central bank digital currencies (CBDCs): interest and motives
- Survey result cited (Boar and others, 2020, BIS): approximately 80 percent of surveyed central banks are engaging in work related to CBDC and 40 percent have progressed from analytical studies to experiments or proofs of concept.
- Main motives for issuing CBDC (reported in the survey):
  - (i) Providing an alternative to cash and ensuring the public has access to a state-guaranteed means of payment.
  - (ii) Reducing the cost of handling cash in countries with vast or inaccessible territories.
  - (iii) Promoting financial inclusion, particularly for the unbanked population.
  - (iv) Improving the efficiency and safety of domestic, and especially cross-border, payments.
- Additional motives:
  - Potential global adoption of stablecoins issued by Big Techs could contribute to interest in CBDC.
  - In the wake of COVID-19, CBDC is being contemplated as a means to enable the swift disbursement of government support and as a more hygienic means of payment than cash (Auer, Cornelli, and Frost, 2020).
- Country example: Sweden—use of cash declined significantly; cash used in only 13 percent of payment transactions; Riksbank contemplating CBDC (e-Krona) primarily because of concerns about payment systems being completely in private hands.

### Legal definitions and implications (Box 1 summary)
- Currency (legal concept): official means of payment of a country denominated in its official monetary unit; currency status typically provided to banknotes and coins issued by a central authority; "legal tender" entitles a debtor to discharge monetary obligations by tendering currency.
- Money (legal concept): broader than currency; in many jurisdictions includes assets readily convertible or redeemable into currency, such as commercial bank "book money" (credit balances on accounts); no universally accepted legal definition.
- Payment instruments (cheques, bills of exchange, promissory notes) are legally used to effect payments but are neither currency nor money.
- CBDC legal categorization:
  - Expressed in existing official monetary unit, so CBDC would be a new means of payment, not a new monetary unit.
  - Could be deposit-based (transfer of a claim on a deposit account; deposit-based CBDC would be book money, and not currency in most jurisdictions) or token-based (transfer of a digital token between wallets; legal status unclear).
  - Token-based CBDC legal questions include: legal nature of a digital token, transfer and pledge mechanisms, protection of good faith acquirers, and applicable private international law rules.
- GSC legal categorization:
  - Monetary and private law status unclear; will depend on design and governing law.
  - GSCs would not be currency (nor a payment instrument) unless law otherwise determines; legal qualification likely to be sui generis and could range from money, electronic money, a commodity, a security, or a combination.
  - Legal classification consistent between jurisdictions is crucial for wide use; classification as securities would imply securities laws and regulations, raising obstacles to use as a cross-border means of payment.
  - Legal status affects rights of coin holders, status of issuer and intermediaries, and tax treatment.

### Factors affecting CBDC and GSC adoption and international use of currencies
- Two categories of cross-border currency use:
  - Use of a currency for international transactions (medium of exchange, store of value, unit of account for trade, finance, reserves).
  - Domestic use of foreign-issued currency (currency substitution).
- Factors explaining disproportionate international use of some currencies:
  - Safety, liquidity, trade links, financial connections, geopolitical factors.
  - Price stability and confidence in value (credibility of monetary authority) critical for role as unit of account and store of value.
  - More liquid and developed financial markets increase likelihood of other countries using the currency for interventions or to denominate assets.
  - Larger share in world output and trade raises likelihood of other countries using the currency due to economies of scale.
  - Geopolitical relationships influence adoption and use.
- Network effects and synergies:
  - Strong network effects reinforce international use: the private value of using a currency increases with number of other users.
  - Synergies across monetary functions (e.g., trade invoicing and international finance) reinforce dominance (self-justifying).
- Currency substitution drivers:
  - Typically occurs with unsound macroeconomic policies and lack of trust in policy institutions.
  - High and volatile inflation undermines domestic currency as store of value and can impair medium of exchange and unit of account functions.
  - Other contributing conditions: limited hurdles to foreign exchange convertibility, government guarantees on foreign-denominated liabilities, low foreign exchange transaction costs, absence of regulatory bounds on foreign exchange exposure for banks and corporates.

### Intrinsic attributes of CBDCs and GSCs that could drive adoption
- Lower transaction costs:
  - Potential to reduce costs of cross-border payments by cutting out intermediaries and simplifying compliance.
  - Could lower transaction costs in securities issuance and trading through tokenization of assets.
- Ease of access:
  - Foreign currency access is challenging in rural areas; CBDCs and GSCs can overcome infrastructure impediments and broaden access.
  - Private issuers may invest to reach broader user bases.
- Access to complementary services or bundling:
  - Stablecoins can be entry to wider platform services.
  - Example: China’s e-money providers bundle services—WeChat Pay integrates transfers with social media; Alipay links e-money to online retail and offers credit services.
  - Big Tech stablecoins could bundle social media and e-commerce with payment services.

### Legal and policy considerations affecting use
- Legal provisions will heavily influence CBDC and GSC use; countries can set boundaries through legal frameworks without stifling innovation.
- Recipient countries can determine degree to which denomination and settlement in a foreign currency or GSC are legally authorized.
- Treatment of foreign CBDC in a recipient country may depend on issuing country’s legal treatment (e.g., currency and legal tender status).
- Design choice: whether nonresidents are allowed to access the system where CBDC and transfers are recorded.
- Legal certainty needed for GSCs to operate cross-border: requires uniformity in legal characterization, clear definition of coin-holder rights, issuer and intermediary status, and resolution of private law issues.
- Tax treatment of GSC transactions should be substantially similar to equivalent transactions in fiat currencies, including cross-border transactions.

*Source: ppea2020050 - 10.      Ongoing progress in digital technology*

### 20.      Regulatory frameworks also have a crucial role in shaping the scale and scope of CBDC

### 20.      Regulatory frameworks also have a crucial role in shaping the scale and scope of CBDC

### Regulatory environment and risks
- The regulatory environment for new forms of digital money is fragmented.
- In countries with exchange restrictions, households and firms could choose to use CBDCs and GSCs to help circumvent some of those restrictions.
- Regulatory uncertainty about the treatment of GSCs, and concerns about overseeing and supervising the complete ecosystem involved in a cross-border CBDC or GSC, may prompt significant regulatory pushback against allowing these to operate in a jurisdiction unless:
  - there is clarity on their financial stability impact, and
  - there is clarity on the regulatory framework that would be applicable (G7 Working Group, 2019).

### Hypothetical scenarios (stylized examples to analyze macro-financial effects)
- Scenarios consider:
  - purpose/functions of money for which CBDCs and GSCs are used,
  - pervasiveness across countries,
  - degree to which they supplant the local currency,
  - type of issuer—public (CBDC) or private (GSC).

- Scenario 1: Niche use for cross-border payments
  - A CBDC or a GSC is used as the preferred means for small value transactions, such as remittances across borders, due to low cost and efficiency or due to legal and regulatory limits on purpose and amounts transferable internationally.
  - The CBDC or GSC would not be held for very long—in most cases for the duration of the transaction, and in some cases as a store of value.
  - The CBDC or GSC would be exchanged for local currency to make purchases domestically, and would not supplant the local unit of account.
  - Key points:
    - Convenience and easy accessibility make CBDCs and GSCs attractive as vehicle currencies versus opening a bank account holding balances of foreign currencies.
    - Peer-to-peer, around-the-clock transfers flatten multi-layered correspondent banking structures, shorten payment chains, reduce transaction time, and facilitate increased competition among service providers.
    - Cross-border payments could become cheaper and more inclusive, benefiting small value remittances.

- Scenario 2: Greater currency substitution in some countries
  - A foreign CBDC or a GSC pegged to an existing fiat currency induces greater use of foreign currency in countries with high and volatile inflation and unstable exchange rates.
  - Use is intensive and replaces the domestic currency significantly:
    - as a store of value (in and of itself, or to access assets in that currency),
    - as a means of payment for many but not all transactions (including some regional cross-border trade),
    - as a common (though not necessarily ubiquitous) unit of account.
  - In countries with credible policy frameworks, adoption of GSCs could still be significant if e-commerce or social platforms incentivize their use (e.g., lower prices on the platform if GSC is used).
  - Key point:
    - Macroeconomic conditions and degree of financial market development will matter greatly for CBDC and GSC adoption; in countries with less credible monetary policy, CBDCs and GSCs may exacerbate currency substitution due to better accessibility.
    - Countries with less developed payment systems could see higher adoption of foreign CBDCs and GSCs to leapfrog to better payment and settlement services.

- Scenario 3: Global adoption
  - A single GSC becomes commonly adopted in many countries and replaces the local currency as store of value, means of payment, and unit of account; and is also widely used for international transactions.
  - The GSC is an independent unit of account and is used as a means of payment on e-commerce and/or social platforms that span multiple countries.
  - Value could be preserved by the issuer committing to a credible set of rules or principles (example: target a “price stabilization rule” relative to a basket of products sold on the Big Tech’s platform).
  - Adoption dynamics:
    - Could arise if a global Big Tech platform launches a GSC to its large customer base; network externalities and synergies with other goods and services would drive rapid adoption.
    - Initially issued against assets denominated in existing reserve currency; as adoption reaches critical mass, the peg may no longer be needed and the GSC could become a fiat currency.
  - Note: This scenario could also contemplate global adoption of a CBDC, differing from Scenario 2 only in the number of adopting countries.

- Scenario 4: Global adoption with multipolarity
  - Competition between a few major CBDCs and GSCs that represent independent units of account.
  - Possibilities:
    - “Currency blocs” for CBDCs—countries choose one common CBDC for international and domestic transactions.
    - “Digital currency areas” for GSCs—use determined by boundaries of e-commerce and social platforms rather than geography; networks operate payment instruments specific to the network and/or use their own unit of account.
    - Currency competition between a few major CBDCs and GSCs.
  - This could result from strategic responses by central banks and Big Techs launching CBDCs and/or GSCs; interoperability could facilitate multipolarity by reducing interchange costs.
  - Multipolarity could hasten transition to a multi-polar world of reserve currencies, as historical periods have seen several major currencies play consequential international roles.

### Macro-financial consequences — Monetary policy transmission
- Foreign CBDCs and GSCs can affect monetary policy transmission by:
  - increasing currency substitution, and
  - reshaping patterns of business cycle synchronization.
- Currency substitution consequences:
  - reduces monetary authorities' control over domestic liquidity,
  - limits the component of liquidity the authorities can directly influence,
  - reduces stability of money demand (El-Erian, 1988),
  - weakens transmission of monetary policy (i.e., how policy-induced changes in monetary instruments affect macroeconomic variables).
- CBDCs and GSCs may intensify currency substitution due to easier accessibility and could facilitate economic activities organized around Big Techs, reshaping business cycle synchronization and reducing monetary policy’s ability to respond to shocks.

- Scenario-specific monetary policy implications:
  - Scenario 1 (niche remittance use):
    - Probably no significant impact on monetary policy effectiveness unless it fosters currency substitution.
    - If remittances grow due to reduced transaction costs or regulatory barriers, they could impact monetary policy in recipient countries because domestic availability of a foreign currency is closely linked to substitution into that currency (example: Cambodia during transition to democracy; citation: Kubo, 2017; Odajima, 2017).
  - Scenario 2 (extensive use of foreign currency/GSC):
    - Ability to weather shocks depends on whether the user country’s business cycle is in sync with the currency issuer.
    - If business cycles coincide, the issuer’s monetary policy could partially serve the user country’s needs; if not, substitution reduces the user country’s ability to use monetary policy to absorb shocks.
  - Scenario 3 (global adoption of a GSC):
    - Countries adopting a GSC as fiat currency would be subject to the monetary stance of a private firm—a fundamental issue about entrusting macroeconomic policy to a profit-oriented company.
    - A globally adopted GSC’s issuer could:
      - cross-subsidize the coin and offer an interest rate if profit from related activities exists,
      - charge a fee if demand from access to additional services is high,
      - adjust interest rates or fees to maximize profit rather than stabilize price and output in user countries.
    - Conflicts of interest especially large if issuer is a major credit provider; provision of credit could increase issuer risk and endanger coin value.
    - If the GSC follows a price stabilization rule relative to goods on a platform, optimal currency area notions based on business cycle synchronization could be challenged; platform-linked sectors could generate shocks to other parts of the economy.
    - Platform-linked GSCs might also offer benefits from tailored offerings and credit provision based on payment data (Brunnermeier and others, 2019b).
  - Scenario 4 (multipolarity):
    - If multipolarity is characterized by country currency blocs with each country adopting one CBDC or GSC, monetary policy implications mirror those of single-currency adoption.
    - CBDC issuers might offer ample swap lines or monetary policies that internalize externalities to attract countries and gain seigniorage.
    - If GSCs pay an adjustable rate of return, competitive forces could lead them to consider business cycle conditions in using countries, making currency blocs more similar to currency unions than to “dollarized” economies.
    - Monetary policy tailored to a bloc may not help countries whose business cycles diverge from the bloc average.
    - Multipolarity with domestic use of multiple currencies:
      - Domestic implications resemble substitution into a single currency, with two exceptions:
        - multiplicity could entail diversification benefits, and
        - multiple currencies complicate exchange rate anchoring if the domestic currency remains in use (private sector agents need to monitor several exchange rates and adjust price quotations).
- Cross-border use of a CBDC could affect the issuing country’s monetary policy:
  - On one hand, issuing central bank could increase seigniorage revenues.
  - On the other hand, swings in external demand for the CBDC could drive large movements in capital flows.
  - Challenges depend on the size and depth of the issuer’s financial markets; market liquidity could move significantly in response to global capital flows if financial markets are shallow relative to the economy or the economy is small relative to the global economy.
  - If sterilization fails to stop large swings in flows, a CBDC issuer could experience fluctuations in market liquidity and asset prices that mirror global demand for its currency.

*Source: IMF staff.*

### 35.      CBDCs and GSCs could create additional incentives for risk taking and raise

### 35.      CBDCs and GSCs could create additional incentives for risk taking and raise 

### Financial stability risks and channels
- Easier access to foreign currency via CBDCs and GSCs lowers transaction costs for taking speculative positions, potentially adding pressures to traditional currency substitution risks: funding risks and solvency risks arising from currency mismatch.
- Disintermediation risk: CBDC/GSC use could disintermediate banks in normal times and elevate run risks in stressful times.
- Operational and confidence risks include cyberattacks, failure of asset custodians or wallet service providers (e.g., crypto exchanges and/or authorized resellers), and liquidity risk of GSC market makers (FSB 2020).
- Host countries of GSC arrangements need to consider liquidity risks, market risks, operational risks of the GSC arrangement itself, interlinkages with local financial systems and spillover effects.

### Scenarios and expected effects on bank vulnerabilities
- Scenario 1 — Niche adoption of CBDC or GSC for cross-border payments:
  - Likely small effects on vulnerabilities of the balance sheets of financial institutions.
  - Users hold CBDC/GSC balances mainly for transactional purposes; some temporary limited use as store of value substituting for bank deposits.
  - Modest decline in bank deposits could lead to a moderate increase in funding risk as banks replace deposit funding with more volatile sources.
  - Banks that rely significantly on fees from cross-border payments could experience revenue reductions.
- Scenario 2 — Greater currency substitution:
  - Could add additional pressures on funding and solvency risks relative to partially “dollarized” economies.
  - CBDC/GSC can increase currency substitution by reducing frictions in access and transacting in foreign currency (e.g., foreign banknotes not freely available; CBDC/GSC availability limited only by technology).
  - Higher use as means of payment likely leads to higher use as store of value, increasing banks’ funding and currency risks.
  - Banks may face increased credit risks if they denominate loans in the CBDC or GSC, especially for borrowers with income or collateral in local currency.
  - Use of foreign CBDC/GSC could lead to higher run risks in stressful times if opening/transferring to a digital wallet is faster/more accessible than opening/transferring to an account abroad and lender-of-last-resort support from the issuing central bank may not be available.
- Scenario 3 — Global adoption of a single GSC:
  - Domestic financial conditions become more influenced by global factors and global financial cycles.
  - Global financial cycles could be associated with perceived changes in safety/soundness of the GSC ecosystem or interest rate changes by the GSC issuer.
  - Local regulatory authorities may find it more difficult to constrain boom-bust dynamics (experience from the euro area cited).
  - Systemic risks due to interconnectedness: pressures on any component of the GSC ecosystem could transmit quickly across borders via direct and indirect channels (e.g., reputational risk), potentially leading to breakdowns in the global payment system.
- Scenario 4 — Global adoption with multipolarity:
  - Currency competition within a jurisdiction could make local financial conditions more volatile due to low switching costs between CBDCs and GSCs.
  - Competition could foster better risk management to maintain attractiveness of privately issued money, but there is no consensus on whether currency competition improves or worsens financial stability.
  - Currency competition could incentivize GSC service providers to take higher risks to gain market share, potentially offering services at a loss to capture market share and later recoup through monopoly rents, raising systemic risk and creating new systemically important institutions with potential anti-competition effects.

### Box 2 — CBDCs, GSCs, and the Structure of Financial Intermediation (key points)
- CBDCs could disintermediate banks by crowding out bank deposits if sufficiently attractive (e.g., considered safer).
- Commercial banks perform maturity transformation and credit allocation more efficiently than central banks due to information frictions and monitoring; displacement of deposits may raise funding costs and depress lending.
- Domestic factors that attenuate adverse effects on bank lending:
  - CBDCs functioning predominantly as means of payment rather than store of value (users hold small balances if mainly transactional; deposit-based payments remain competitive; regulation limits CBDC holdings; central bank does not pay positive interest on CBDCs).
  - Increased competition reducing banks’ monopoly rents without raising lending rates; higher deposit rates may expand deposits and lending under certain conditions (Andolfatto 2019; Chiu et. al. 2020).
  - Banks making up for lost deposits with other cheap funding sources; central bank investments could re-cycle funds back to commercial banks (Bindseil 2019); monetary policy responses may limit rise in bank funding costs; theoretical conditions where automatic substitution keeps bank funding constant (Brunnermeier and Niepelt 2019a), though central banks may be reluctant given balance sheet and credit risk implications.
- How GSCs might affect credit intermediation:
  - Choice between bank deposits and GSCs depends on risk-return profile and services linked to the GSC.
  - Big Techs could extend credit leveraging personal data, potentially becoming “bank like” and thus subject to licensing and regulation.
  - Cross-border effects:
    - Foreign CBDCs and GSCs could lead to currency substitution in banking systems; some countries maintain both foreign currency deposits and loans, allowing banks to hedge currency risks but potentially transforming currency risk into credit risk if borrowers lack foreign-currency revenues.
    - Innovation could reduce cross-border financial frictions, deepen/integrate capital markets, enable asset tokenization and machine learning, and boost efficiency of financial services, potentially substituting bank-intermediated credit with direct financing through capital markets.
- Policy implication: Extent and overall impact on credit intermediation are unclear; policy responses must be country- and market-specific, balancing disruption to traditional intermediation with efficiency gains, and trading off credit market functioning with payment efficiency, financial stability, and other policy goals.

### GSC ecosystem risks
- Conventional risks (liquidity, market, credit, operational, cyber) and risks associated with GSC wallet service providers, exchanges and related market infrastructures can affect the value of the GSC.
- Realization of these risks could trigger runs away from the GSC into safer currencies/assets, potentially breaking the peg between the GSC and its currency of denomination, causing holder losses, raising cross-border capital flow volatility, and wider financial stability repercussions.

### Capital flows
- CBDC and GSC adoption/use could affect gross cross-border capital flows by reducing transaction costs and frictions in international capital markets.
- Digitalization of money/payments and asset tokenization can lower transaction costs and make foreign financial markets more accessible.
- GSCs bundled with big data from e-commerce/social networks could improve cross-border credit analytics and lower information asymmetries.
- For borrowers: reduced search/transaction costs could improve cross-border offerings by banks or reduce reliance on banks, improve access to international capital markets, and increase financial inclusion.
- For markets: a more atomized investor/borrower base could increase noise trading and herd behavior.
- Scenario implications:
  - Scenario 1 (niche use): unlikely to affect capital flows significantly.
  - Scenario 2 (greater currency substitution): could affect capital flow volatility as CBDCs/GSCs can be supplied directly by nonresident service providers, bypassing traditional payment systems and exchange restrictions/CFMs.
  - Scenario 3 (global adoption of a GSC): could lead to more integrated international capital markets by removing exchange and re-denomination risks and enabling improved hedging and risk management for households and small businesses; full integration requires more than a single currency.
  - Scenario 3 short-term risk: GSCs bundled with social media platforms could increase herding, panics and noise-trading due to noisier information and a class of investors prone to such behavior.
  - Scenario 4 (multipolarity): could create more opportunities for international risk sharing if CBDCs/GSCs are uncorrelated; new safe assets (e.g., triple-A rated bonds denominated in GSC units with embedded smart contracts) could emerge, but multiplicity could increase complexity, fragment liquidity backstop mechanisms, and amplify volatility.

*Source: ppea2020050 - 35.      CBDCs and GSCs could create additional incentives for risk taking and raise*

### 49.      Digitalization could facilitate cross-border use of currencies, reshaping the demand for

### 49.      Digitalization could facilitate cross-border use of currencies, reshaping the demand for

### Demand and supply implications for safe assets
- Digitalization could allow change in reserve currency status to occur more rapidly than previously envisioned.
- Demand-side drivers for reserve currency composition: the size and credibility of the issuers, the currency’s usefulness in trade and financial transactions (including foreign exchange intervention), and inertia reinforced by coordination of beliefs.
- Supply-side developments:
  - New digital platforms can achieve global scale quickly, offering alternative networks that digital money may tap into to spur adoption upon issuance.
  - Granting global access through a network of digital wallets could help credible CBDC issuers achieve scale and market liquidity previously not feasible.
- The key difference introduced by digitalization is potentially higher speed of scalability and lower switching costs out of existing dominant currency networks.

### How adoption scenarios affect reserve holders and issuers
- General point: Adoption and use of CBDCs and GSCs may alter incentives for both reserve holders and issuers; reserve issuers must trade off potential gains and risks from cross-border use.

- Scenario 1 — Niche adoption for remittances:
  - Most likely limited implications for reserves because the unit of account of trade and financial transactions would not change.
  - CBDC or GSC would serve as a conduit for completing cross-border payments; central banks would see little need to adjust reserve composition.

- Scenario 2 — Greater currency substitution induced by CBDC or GSC:
  - Central banks would increase foreign reserves for precautionary motives.
  - Increased adoption of a foreign CBDC or GSC in trade and financial transactions may shift reserves into the unit of account of the CBDC or GSC, especially if financial institutions are more exposed to exchange rate volatility.
  - Faster roll-out of CBDC or GSC might lower the inertia in reserve holdings observed so far.
  - Confidence in reserve issuers (e.g., cybersecurity, emergency liquidity provision) remains critical.
  - For issuers: If internationalization is a policy objective, issuers may accommodate higher demand; otherwise higher demand could lead to a shortage of safe assets, causing side effects such as depressed risk premiums and higher leverage in the financial system (Caballero, Farhi, and Gourinchas, 2017).

- Scenario 3 — Widespread adoption of a GSC with an independent unit of account:
  - Creates tension between profit motives of a private GSC issuer and global monetary and financial stability.
  - Central banks would want to hold safe GSC reserves, but the GSC issuer may face a conflict between supplying reserves that meet global demand and supplying an amount that maximizes issuer profits.
  - Unclear whether private GSC providers would offer swaps to act as lender of last resort or how a chronic shortage of safe assets would be prevented.

- Scenario 4 — A few CBDCs and GSCs become widely adopted and compete:
  - Reserve holdings could become more diversified.
  - With many reserve issuers, total issuance is high but individual issuance is low, protecting issuers’ domestic financial stability; with few issuers, coordination worsens and instability can ensue as investors substitute quickly between reserve assets.
  - A ‘synthetic hegemonic currency’ backed by a basket of CBDCs could generate confidence in underlying CBDCs and expand the supply of safe assets.

- Multipolar outcome:
  - Reserve composition could be diversified between or within countries depending on whether currency blocs form or currencies compete within each country.
  - Adoption of a single CBDC or GSC by a country would lead reserves to be mostly denominated in that currency bloc’s unit of account; multiple currencies used by residents could diversify reserves within countries.

### Policy implications — Macroeconomic policies
- Countries facing strong incentives to adopt/use foreign CBDCs and GSCs must decide whether to accept greater currency substitution or resist it by:
  - Strengthening monetary policy credibility and/or restricting use of foreign currencies.
  - Maintaining a sound fiscal position and safeguarding central bank independence, supported by legal and regulatory measures to disincentivize foreign currency use.
- When monetary policy is encumbered or ineffective:
  - Consider combinations of other policy instruments under an integrated policy framework (IPF) encompassing fiscal, macroprudential policies, foreign exchange interventions and CFMs to mitigate shocks.
- CBDC issuance as strategic response:
  - Some central banks consider issuing their own CBDC to counter foreign CBDC/GSC substitution, but issuing CBDC is unlikely to change a local currency that suffers from instability and provides a poor unit of account.
  - Decisions on CBDC issuance depend on country circumstances and require ex-ante cost-benefit analysis and critical design choices.
- Fiscal policy importance:
  - If domestic monetary policy is ineffective and business cycles are not synchronized with the currency issuer’s, fiscal policy must be used more for stabilization.
  - Local authorities need enough fiscal policy space to adjust revenues and expenditures while maintaining long-term fiscal sustainability.
  - CBDCs and GSCs could make fiscal sustainability more difficult by facilitating evasion of financial repression.
- Financial stability:
  - Recipient countries should build up capital and liquidity buffers and secure sources of emergency liquidity assistance.
  - Macroprudential policy should limit systemic risks from cyclical build-ups of vulnerabilities; adequate buffers can be released during large shocks.
  - Reserves or contingent liquidity arrangements with issuing central banks (in currency blocs) or with the GSC issuer (in digital currency areas) are needed for emergency liquidity support.
- For CBDC-issuing central banks:
  - Consider whether spill-back effects from cross-border CBDC use are consistent with domestic policy objectives and whether to act as lender of last resort to heavy foreign users of their CBDC.
  - Widespread CBDC use could allow central banks to lower policy rates below the effective lower bound, strengthening monetary policy efficacy in very low inflation environments (Bordo and Levine, 2018).
  - If external demand pushes yield curves near the effective lower bound, central banks may need to expand their monetary policy toolkit.
  - Consider tiered remuneration structures for CBDCs so foreign demand has less interference with domestic monetary policy implementation (Bindseil, 2020).

### Policy implications — Exchange restrictions and capital flow measures (CFMs)
- Some authorities may restrict the use of foreign CBDCs and GSCs:
  - Pre-emptive restrictions could occur in Scenario 1 to minimize currency substitution risks or as part of “de-dollarization” strategies in Scenario 2.
  - Countries without liberalized financial accounts may need to restrict foreign CBDC/GSC use if they are not ready for the capital flow liberalization implied by unrestricted use.
  - Even open-account countries may consider CFMs during capital inflow surges or large capital flight in near-crisis situations.
- Enforcement and circumvention risks:
  - Restrictive measures could target domestic transactions (e.g., licensing, bans) or cross-border payments to mirror existing payment or capital transaction restrictions.
  - Circumvention via nonresident service providers delivering services over the internet could undermine effectiveness.
- Technological requirements for enforcement:
  - Effective restrictive measures require technological support to verify payor, recipient, and payment purpose and to stop non-compliant payments.
  - Deposit-based digital money could address verification needs; token-based designs may struggle to provide constraints without leakage.
  - CBDCs/GSCs could be designed to facilitate compliance by building restrictive measures into design or programming through smart contracts (e.g., rejecting transfers if metadata or balances do not meet requirements).
- Legal consistency:
  - Authorities must assess whether restrictions on CBDC payments are consistent with international and bilateral treaty obligations, including the IMF’s Articles of Agreement.
  - A ban on use of a foreign CBDC for current international transactions would not constitute an exchange restriction under Article VIII as long as those payments are permitted in other convertible currencies.
  - Appropriateness of restrictive measures on capital transactions under the Institutional View (IMF, 2012) depends on country-specific conditions.
  - Additional implications may arise under other international, regional and bilateral agreements.

### Policy implications — Legal frameworks and AML/CFT
- Legal framework review:
  - Issuance and wide circulation of CBDCs and GSCs will likely require amendments to monetary, central bank, financial, contract, property, insolvency, and tax laws.
  - Changes should be analyzed and planned well in advance; recipient countries must review how foreign CBDCs/GSCs will be treated and decide on how accommodative the legal framework will be.
  - Legal changes should be coherent with broader exchange control legal frameworks.
- AML/CFT framework:
  - Effective implementation of AML/CFT frameworks is needed in all scenarios to mitigate risks of digital money being used for criminal activities.
  - Effective implementation of FATF standards on AML/CFT, including new standards for virtual assets, is key.
  - FATF standards include licensing/registration frameworks for professionals dealing with virtual assets and risk-based monitoring, and ensuring traditional criminal law frameworks apply to virtual assets.
  - Some AML/CFT measures (e.g., transaction monitoring) may be easier in a DLT context; others (e.g., identity verification of end users) may be more challenging.
  - AML/CFT obligations are broadly the same regardless of cross-border use, but intensity of measures varies according to risk; cross-border use may call for stronger measures.
- Design considerations for CBDC and AML/CFT:
  - For retail CBDC, AML/CFT measures will be implemented by participating commercial banks and service providers with little change to traditional frameworks.
  - For deposit-based CBDC directly operated by central banks, central banks may need to implement AML/CFT measures, including customer due diligence, requiring additional resources and expertise.
  - Cross-border adoption and use could further complicate effective implementation.
- GSC supervision:
  - GSC service providers will need to be licensed or registered and be subject to effective supervision or monitoring.
  - GSCs and their global networks could shift the virtual asset ecosystem and, due to mass-market use and person-to-person transfer offerings, could have serious consequences for AML/CFT; development and spread of GSCs must be monitored and regulatory responses adapted.

*International Monetary Fund — DIGITAL MONEY ACROSS BORDERS: MACRO-FINANCIAL IMPLICATIONS, paragraphs 49–68.*

### 69.      Changes to the AML/CFT framework are likely to be necessary and international

### 69.      Changes to the AML/CFT framework are likely to be necessary and international

### Regulatory Policies
- Changes to the AML/CFT framework may be necessary whether countries bring virtual assets into the AML/CFT regulatory fold or ban them; amendments may be needed "to designate the authority in charge of AML/CFT supervision and/or of sanctioning unauthorized activities."
- In cross-border contexts, dialogue amongst competent authorities—and in particular AML/CFT supervisors—will be key to ensure there are no regulatory loopholes and to combat misuse effectively.
- Under all CBDC and GSC adoption scenarios, regulations must preserve financial stability and ensure:
  - sound governance,
  - safety and integrity of payment infrastructure,
  - operational resilience,
  - consumer protection.
- Regulation must consider actual use and potential abuse of financial instruments and transactions to support AML/CFT and maintain market integrity.
- Scenario-specific supervisory implications:
  - Scenario 1: "relatively little impact on financial vulnerability" → no major changes in regulation and supervision required.
  - Scenario 2 and Scenario 4: borrowers and financial intermediaries could experience greater currency mismatches and increased exposure to foreign exchange market risk; deposits in foreign CBDC could have a different liquidity profile than traditional foreign exchange deposits.
  - Scenario 3: main risk is maturity mismatch (financial institutions may fund longer-dated GSC-denominated assets with short-term liabilities). Authorities may need to:
    - increase capital charges of the GSC-denominated loans,
    - enhance underwriting standards,
    - impose additional liquidity risk management standards given risks from GSC-denominated funding.
- Scope and intensity of supervision must consider how existing financial intermediaries could be affected by GSCs, especially where intermediaries are allowed to hold GSC exposures or intermediate entrusted GSC client funds; cases where GSCs include bank deposits as reference assets would intensify interconnectedness with the financial system.
- The Financial Stability Board (FSB) has developed high-level principles for regulation of GSCs:
  - recommends applying comprehensive regulatory requirements and relevant international standards to GSC arrangements;
  - authorities should cooperate and coordinate domestically and internationally to support respective mandates;
  - authorities should ensure GSC arrangements meet all applicable regulatory requirements of a jurisdiction before commencing operations, including affirmative approval where required.
- Limitations of current high-level recommendations:
  - FSB recommendations accommodate divergent regulatory approaches and sector-based coordination mechanisms; expanding coordination to be cross-sectoral requires further efforts by standard-setting bodies (SSBs) and members.
  - An overarching multi-sector effort to develop more detailed international principles or international standards would strengthen international consistency and contain arbitrage risks.
- Challenge of identifying a traditional "home" supervisor for the GSC ecosystem:
  - GSC ecosystems may comprise loosely connected specialist entities (issuers, custodians, authorized resellers, validators, wallet service providers) and may lack a single governing body exercising control.
  - Supervisor of the governance body would, in principle, be the "home" supervisor, but this can be difficult when governance covers only some elements or the ecosystem is very open.
  - Rights and responsibilities of a 'home' supervisor may be hard to determine.
  - May be necessary to identify home/host supervisors at each sub-entity level (e.g., exchange or wallet provider) and clearly spell out associated coordination arrangements.
- Significant challenges remain to achieve global consensus on regulating the GSC ecosystem:
  - divergence in regulatory treatment of issuers (extension of securities regulation vs. adjustment of payment providers regulation to capture GSC as e-money);
  - material gaps, inconsistencies and potential for regulatory arbitrage could remain unless more detailed international standards or guidance are agreed;
  - emergence of globally consistent regulations to cover other service providers (authorized resellers, exchanges, wallet service providers) will be equally challenging.

### Structural Policies
- Widespread adoption of GSCs raises welfare questions about privately issued monies at global scale:
  - In Scenario 3 and Scenario 4, recipient countries could be exposed to the monetary stance of private companies.
  - GSC issuers may not optimize for needs of recipient countries when adjusting interest rates or fees; unclear whether issuing firms’ objectives align with stabilizing prices in areas that use the GSC.
  - GSC issuers may lack incentives for robust governance and risk management, raising doubts that could lead to financial instability and volatile capital flows—risks could become acute if GSC issuers hold monopolistic global positions.
- Policies to promote contestability among Big Tech platforms could mitigate risks from lack of competition and uncertain governance of GSC issuers:
  - Effective competition among money issuers could alleviate conflicts of interest and enhance monetary stability (Hayek, 1976; Farhi and Maggiori, 2017).
  - Two key options:
    - data policy frameworks mandating portability of user data,
    - interoperability requirements on payments systems.
  - Without regulation, GSC issuers have sole control over users’ data, raising barriers to entry for competitors and motivating open banking–style initiatives to require incumbents to share customer data.
- Consider approaches to facilitate interoperability of payments networks:
  - Would counter network effects as barriers to entry by allowing competitors to offer tokens, including GSCs, on Big Tech platforms without building separate networks.
  - Implementation questions remain on balancing private interests of companies that invested in networks with public interest of competition and stability.
  - Important question: whether these requirements are enforceable on cross-border networks and whether international cooperation is needed.
- Consumer protection is essential to promote competition among new payment service providers:
  - Wide range of unsophisticated consumers likely to use new payment instruments—especially social media linked GSCs and retail CBDC.
  - Significant use requires consideration of adequacy of disclosure, anti-fraud protections, suitability requirements, etc.

### Conclusions
- Digitalization will keep international finance in flux; payments and financial services will become increasingly integrated with the digital economy.
- Rise of new forms of digital money could increase efficiency and global integration, but could affect monetary policy effectiveness and require sovereign governments to use fiscal, macroprudential policies, and capital flow measures (CFMs) to maintain monetary and financial stability.
- Robust legal frameworks are critical for instruments to acquire official status as legally accepted means of payment and majorly impact their use.
- Paper’s contributions and findings:
  - Focused on macro-financial implications of CBDCs and GSCs across borders and elaborated on the Bali Fintech Agenda.
  - Presented hypothetical stylized scenarios of CBDC and GSC adoption and use, analyzed macro-financial consequences, and discussed policy implications.
  - Finds that implications are scenario specific.
  - CBDCs do not qualitatively change economic forces behind international currency use but could quantitatively reinforce incentives behind currency substitution and currency internationalization.
  - GSCs that do not represent independent units of account are similar to CBDCs in monetary effects but could affect financial stability via bouts of confidence crisis.
  - GSCs that represent new independent units of account could have more fundamental impacts on global monetary and financial stability.
- For countries adopting foreign CBDCs and/or GSCs, main challenge is preserving macroeconomic and financial stability while realizing benefits of more efficient cross-border payments and better access to international capital markets:
  - Balance differs by country depending on business cycle synchronization, fiscal policy space, and availability of other stabilization tools.
  - Countries tightly integrated with a CBDC issuing country may not require independent monetary policy for stabilization.
  - Countries with larger fiscal space and capital and liquidity buffers can rely more on fiscal and macroprudential policies, tilting benefits toward financial integration over monetary independence.
- For countries adopting GSCs issued by Big Tech platforms:
  - They must ensure robust governance and risk management in GSC arrangements.
  - Need mechanisms to prevent GSC issuers’ profit maximization from jeopardizing monetary and financial stability.
  - Policies promoting competition among Big Techs and interoperability between GSCs could help but require further work.
- Issuing countries considering nonresident access to their CBDCs must weigh costs and benefits:
  - Nonresident access could help domestic firms and households manage risks and deepen financial markets.
  - But increased financial integration before sufficient financial development could raise exposure to global shocks.
  - Globally, CBDCs and GSCs could improve options for risk-sharing in the long term but complicate short-term policy coordination.
- Implications for the IMF:
  - CBDC and GSC issuance and cross-border use have spillover and spillback effects across IMF membership.
  - IMF’s universal membership and mandate position it to consider such effects in bilateral and multilateral surveillance and capacity development.
  - Questions for IMF services include whether it can play a role in enhancing cross-border payments and promoting safety and soundness of CBDCs and GSCs—requiring further research and stakeholder discussion.
  - Ongoing and planned staff work focuses on:
    - benefits and risks of CBDCs;
    - data policy frameworks;
    - regulation and supervision of stablecoin issuers and service providers;
    - role of digital money in fostering financial inclusion and its macroeconomic effects;
    - legal issues relating to the rise of CBDCs and GSCs.

### Annex I. Current Landscape of Cross Border Use of Currencies
- Key stylized facts:
  - The U.S. dollar dominates international transactions:
    - United States represents just 10 percent of global trade and 15 percent of world GDP, yet the U.S. dollar is the invoicing currency for 50 percent of global trade.
    - Two thirds of global securities issuance are in dollars.
    - 75 percent of cross-border bank claims and public debt by emerging markets and developing countries are denominated in the U.S. dollar.
    - U.S. dollar accounts for about two thirds of official foreign exchange reserves.
    - Around 45 percent of forex trading involves the U.S. dollar.
  - The U.S. dollar is also used for domestic transactions in some countries (currency substitution or "dollarized" economies), sometimes by policy choice (legal tender) or de facto displacement.
  - Cross-border payments rely on correspondent banking: correspondent banks hold deposits for respondent banks and provide payment and other services.
  - There has been a broad-based retreat of cross-border correspondent banking relationships in the past decade, reflecting higher costs associated with tighter AML/CFT requirements.
  - Cross-border payments have high transaction costs, particularly at retail level, due to:
    - fragmented data standards,
    - AML/CFT compliance complexities,
    - limited operating hours,
    - outdated legacy platforms,
    - high funding costs,
    - long transaction chains,
    - weak competition.
  - These frictions lead to high fees, slow speed and low transparency in cross-border payments.
  - A concerted global effort coordinated by the Financial Stability Board is underway to improve cross-border payments efficiency in part as a response to rise of GSCs as a solution to remove frictions (CPMI, 2020; FSB 2020b and 2020c).

*Source: ppea2020050 - 69.      Changes to the AML/CFT framework are likely to be necessary and international*

### Annex II. The Extent and Dynamic of Currency Substitution

### Annex II. The Extent and Dynamic of Currency Substitution

### Mechanisms: which functions of money drive currency substitution
- Currency substitution depends on which functions of money a foreign currency performs better than the domestic currency.
- When the domestic currency is a poor store of value, households and firms prefer to hold financial assets and liabilities denominated in a foreign currency. This is described as the most prevalent form of currency substitution and often includes domestic bank deposits.
- If banks on-lend foreign currency deposits, this results in credit denominated in the foreign currency, implying a significant correlation in the extent of currency substitution in terms of deposits or loans (see Chart B).
- If the attractiveness of a foreign currency stems from its value as a medium of exchange, currency substitution tends to focus on the payment system. Example: in Cambodia, currency substitution initially centered on the medium of exchange function.
- Extensive use of a foreign currency as a medium of exchange implies its use as a unit of account (local wages and prices set in the foreign currency); however, wage or price indexation can sometimes substitute for use of a foreign currency as a medium of exchange.

### Prevalence across countries and dataset composition
- Analysis is based on a sample of 154 (149) countries that report data on foreign currency deposits (loans) to total deposits (loans).
- In close to one third of countries, currency substitution exceeds 30 percent of deposits/loans.
- Foreign currency use exceeds half of total deposits in 17 percent of countries.
- Foreign currency use exceeds half of total loans in 11 percent of countries.
- The countries with high levels of currency substitution are all emerging or developing economies.
- Dataset composition notes:
  - 2 countries where a foreign currency is the only legal tender: Ecuador, El Salvador.
  - 2 countries where both the domestic and a foreign currency are legal tender: Liberia, Panama.
  - 1 country where foreign currencies were legal tender during the sample period, but are no longer: Zimbabwe.
  - Includes all SRF-reporting countries: 11 advanced economies and 143 developing countries.
- Chart A counts (currency substitution around the world; number of countries in given ranges) as presented: 63, 38, 26, 27, 77, 30, 25, 17.

### Correlation between deposits and loans
- Chart B shows a significant correlation between foreign currency deposits' share of total bank deposits and foreign currency loans' share in total bank loans.
- Dots in Chart B represent the most recent (annual) observation per country.

### Dynamics and persistence of adoption
- Currency substitution can happen rapidly, particularly in the wake of economic crises or major political transitions.
- Evidence from 25 country cases of currency substitution since 1975:
  - Countries where foreign currency use is initially limited can witness a rapid emergence: foreign currency deposits on average rising from the single digits to above thirty percent of total bank deposits in the space of two years.
  - Following an episode, habit formation among households and firms often ensues; the foreign currency becomes a vehicle of trust and provides insurance against recurrence of macroeconomic instability, implying high persistence.
  - All countries in the chart that experienced currency substitution episodes remain with a higher level of foreign currency use at the end of the ten-year period than at the outset.
  - The average extent of foreign currency use plateaus rather than reverts over the ten-year horizon.
- Adoption-dynamics chart: Line shows average foreign currency deposits in percent of total bank deposits; dots are country observations; starting year normalized to t.

*Source: Annex II. The Extent and Dynamic of Currency Substitution — ppea2020050*

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_Source: https://www.imf.org/-/media/files/publications/pp/2020/english/ppea2020050.pdf_