New Forms of Digital Money: Implications for Monetary and Financial Stability
IMF News, October 30, 2020
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- Published: October 30, 2020
Context and motivation: cross-border payments and COVID-era vulnerabilities
- Remarks by IMF Deputy Managing Director Tao Zhang, CAFIN Webinar Series on “Financial Risks, Innovation and Inclusion in a Post-COVID” World, October 30, 2020.
- Cross-border payments are central to the international monetary system and affect the most vulnerable populations.
- Key facts:
- Remittances still cost 7 percent on average, more than twice the target set by the U.N. Sustainable Development Goals.
- Correspondent banks—those providing access to cross-border payments—are 22 percent fewer since 2011.
- 1.7 billion people worldwide are unbanked.
- COVID-era impact concentrated in countries with:
- a higher share of unbanked population,
- greater reliance on remittances,
- lower access to correspondent banks,
- less liquid foreign exchange markets.
- Persistent frictions: slowness, opacity, high costs, inaccessibility, and collective-action underinvestment in interoperability and cross-border public goods.
What are CBDCs and global traction
- Definition: CBDCs are a digital form of fiat money issued by a central bank. Retail CBDCs are defined as a widely accessible digital form of central bank fiat money that is legal tender.
- Two variations of CBDC prototypes—wholesale and retail (general purpose)—discussion limited to retail CBDCs.
- Adoption status and experiments:
- No central bank has issued a retail CBDC at the time of the speech, but pilots underway in the Bahamas, the Eastern Caribbean, China, Sweden, and Uruguay.
- Some countries (the United States, Canada, Australia) are undertaking experiments as contingency.
- Recently, seven advanced economy central banks, including the U.S. Federal Reserve, issued a report articulating views on fundamental principles and core features of CBDC design.
- Rationale for cross-border CBDC use:
- Potential to lower transaction costs and increase accessibility/financial inclusion.
- Can be designed as a direct claim on the issuing central bank or as digital cash transferable peer-to-peer without going through a bank.
- Bilateral experiments demonstrate feasibility for cross-border payments.
Three scenarios for CBDC adoption in cross-border payments
- Scenario 1: Niche use for cross-border payments
- CBDC used for small-value transactions (e.g., remittances) due to low cost and efficiency or legal/regulatory limits.
- CBDC not held long; exchanged for local currency for domestic purchases; does not supplant local unit of account.
- Scenario 2: Greater currency substitution in some countries
- Foreign CBDC pegged to an existing fiat currency induces greater use in countries with high and volatile inflation and unstable exchange rates.
- CBDC replaces domestic currency significantly: as a store of value, as a means of payment for many transactions, and as a common unit of account.
- Scenario 3: Global adoption with multi-polarity
- Competition between a few major CBDCs representing independent units of account.
- Emergence of “currency blocs” within which countries choose one common CBDC for international and domestic transactions.
Macro-financial impacts across four areas
- Overview: Impacts concentrated in monetary policy; financial stability; capital flow management; and the international monetary system.
- 1) Monetary policy
- Primary concern: currency substitution/dollarization reducing monetary policy transmission.
- Currency substitution limits monetary authorities' control over domestic liquidity.
- CBDCs could enable faster and larger-scale substitution than traditional dollarization due to convenience and accessibility.
- If CBDCs used mainly for specific international transactions (e.g., remittances), direct impact may be limited, but indirect effects could arise if reduced transaction costs increase remittance flows.
- Empirical illustration: In Cambodia, U.S. dollar usage rose rapidly within a few years as large foreign aid flows provided ample dollar liquidity; dollars migrated from payments to store of value.
- If countries with weak fundamentals grant legal tender status to foreign CBDCs, monetary policy effectiveness could be significantly eroded.
- Multipolarity (Scenario 3) implications:
- Depend on whether multipolarity forms country currency blocs or currency competition within each country.
- Could complicate exchange rate anchoring and require monitoring of several exchange rates and frequent price adjustments.
- External demand for an issuing-country’s CBDC could complicate monetary policy in the issuing country if it results in large capital flows, particularly where financial markets are shallow relative to the economy.
- 2) Financial stability
- Effects depend on CBDC design, scale of adoption, and financial system structure.
- Greater currency substitution induced by foreign CBDCs could add pressures on funding and solvency risks beyond those in partially “dollarized” economies.
- CBDCs could increase substitution where foreign-currency frictions are reduced.
- Concerns include potential disintermediation in normal times and higher “run risks” in stress periods in issuing countries.
- IMF staff view: such effects depend on CBDC features and can be mitigated by design choices.
- In Scenario 3, currency competition within a jurisdiction could make local financial conditions more volatile; low switching costs could destabilize participation in currency blocs or digital currency areas.
- Competition could also foster monetary discipline to maintain currency attractiveness over time.
- 3) Capital flow management / Capital account restrictions
- Capital flow management measures and capital account restrictions could be circumvented by CBDCs, intensifying the “policy trilemma”: inability to have at the same time a fixed foreign exchange rate, free capital movement, and an independent monetary policy.
- CBDCs could complicate monetary and exchange rate policy conduct.
- Conversely, CBDCs might allow greater control of capital flows depending on design and issuer–recipient cooperation.
- 4) International monetary system
- Forecasting evolution of the international monetary system with CBDCs is difficult; changes likely slow because reserve currency adoption typically requires structural institutions: policy credibility, rule of law, and deep liquid markets.
- Longer-term possibilities:
- Widely available CBDCs and strong network externalities could accelerate shifts in reserve currency status.
- Digitalization could reshape demand for and supply of safe assets.
- Uneven technological advances, alternative cross-border payment “rails,” or shifts to trade-invoicing and financial intermediation denominated in a CBDC or global stablecoin could reposition reserve currencies.
- New digital platforms could emerge at global scale and offer alternative networks that CBDCs may tap to spur adoption.
- Reserve implications by scenario:
- Scenario 1 (niche adoption): limited implications for reserves; CBDC serves as payment conduit and would not change unit of account of trade and financial transactions.
- Scenario 2 (greater substitution): central banks may increase foreign reserves for precautionary motives; reserve holders may shift into the CBDC unit of account; faster roll-out of CBDCs might lower inertia in reserve holdings.
- Confidence in reserve issuers (e.g., cybersecurity, emergency liquidity provision) remains crucial.
- Supply-side: issuers’ incentives to supply more safe assets vary; lack of accommodation could lead to shortage of safe assets, depressed risk premiums, and higher leverage.
- Scenario 3 (competition among a few widely adopted CBDCs): reserve holdings could diversify; many reserve issuers yields high total issuance but low individual issuance protecting domestic stability; conversely, few issuers worsens coordination and may cause instability through rapid substitution across reserve assets.
- Multipolar outcomes: reserve composition could be diversified between or within countries depending on currency bloc formation or within-country currency competition.
- Broader payment ecosystem effects:
- Cross-border CBDC issuance could reduce demand for correspondent banking services and SWIFT international financial messaging and payment systems as countries transact separately.
Policy challenges and design considerations (drawn from international discussions)
- Realize benefits of CBDCs while mitigating risks requires attention to:
- CBDC design features (to limit disintermediation, manage run risks, and control substitution).
- Interoperability and public-goods investments across borders to address collective-action problems.
- Coordination among issuers and recipient countries to manage capital flow, reserve, and monetary policy implications.
- Ensuring policy credibility, cybersecurity, and mechanisms for emergency liquidity to preserve confidence in reserve issuers.
Remarks by IMF Deputy Managing Director Tao Zhang, October 30, 2020.