Central Bank Digital Currencies: 4 Questions and Answers

IMF Blog, December 12, 2019

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Central Bank Digital Currencies: 4 Questions and Answers

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Bibliographic details

• Authors: Tobias Adrian, Tommaso Mancini-Griffoli
• Published: December 12, 2019

IMF’s role around CBDCs

• Authors: Tobias Adrian, Tommaso Mancini-Griffoli; date: December 12, 2019.
• The IMF can help in three ways:
  • Informing the policy debate: investigating implications of CBDC available across borders; drawing on in-house experts; examining cross-border payments and international monetary system questions that relate to the IMF’s mandate.
  • Convening parties: fostering cooperation across countries and stakeholders (central bankers, regulators, investors, entrepreneurs, academics) using its universal membership and public-institution status; examples include bi-yearly meetings, yearly “fintech roundtable,” and ad-hoc research events.
  • Helping countries develop policies: through surveillance work, Financial Sector Assessment Programs, and technical assistance; IMF teams have worked with countries to modernize payment systems, advise on legislation related to digital payments, and review plans to issue CBDC; support can include regional workshops and bilateral technical assistance missions.
• Guiding principle: each country must weigh pros and cons of CBDC depending on its particular circumstances.

How the IMF views global development and implementation of CBDC

• Country approaches vary across three broad groups:
  • Active pilots and preparation: countries running pilot projects, increasing central-bank resources for CBDC and fintech research, partnering with private advisors, revising legislation, studying competing CBDC designs, and engaging publics and legislatures.
  • Scaled-up analysis and limited testing: countries that have increased resources for CBDC and payment-systems work but focus primarily on analysis and limited hands-on technology testing; CBDC remains an option but alternatives are also explored.
  • No immediate need: countries focusing on improving existing payment arrangements and strengthening regulation rather than pursuing CBDC now.
• Recent stimuli for increased interest: announcement of Facebook’s Libra initiative and reports of possible CBDC launch by the People’s Bank of China.

Potential benefits of CBDC (as highlighted by central banks)

• Cost of cash: CBDC could lower costs associated with providing a national means of payment in countries with high cash-management costs due to vast territory or remote areas (including small islands).
• Financial inclusion: CBDC may provide a safe and liquid government-backed means of payment that does not require a bank account, useful where cash use is diminishing and banking penetration is low.
• Stability of the payment system: CBDC could enhance resilience where payment systems are concentrated among a few large (sometimes foreign) companies.
• Market contestability and discipline: CBDC could offer competition to large payments firms and cap rents they extract.
• Countering private digital currencies: domestically issued CBDC denominated in the domestic unit of account could reduce adoption of privately issued currencies denominated in foreign currencies.
• Support for DLT-based markets: DLT-based CBDC could facilitate automatic “payment-versus-delivery” or “payment-versus-payment” using smart contracts; some central banks may provide CBDC only to institutional participants to develop DLT-based asset markets.
• Monetary policy transmission: academic views include that an interest-bearing CBDC could increase response to policy-rate changes and could be used to charge negative interest rates in prolonged crises, potentially breaking the “zero lower bound” constraint if cash is made costly.

Key challenges and risks (and design considerations)

• Banking-sector disintermediation: large-scale CBDC holdings could prompt deposit withdrawals from commercial banks, forcing banks to seek more expensive runnable wholesale funding or raise deposit rates, compress margins, or raise loan rates; competition with deposits in normal times depends in part on interest paid on CBDC.
• “Run risk”: in crises, depositors could shift to CBDC seen as safer and more liquid; credible deposit insurance, existence of safe liquid alternatives (government bond funds, state banks), and historical evidence suggest limited systematic runs toward such alternatives, but context matters; central banks would find it easier to meet withdrawals in CBDC than cash; in many countries, bank runs coincide with runs from the currency, so local-currency CBDC may not change flight-to-foreign-currency behavior.
• Central bank balance sheet and credit allocation: high CBDC demand could expand central bank balance sheets; central banks may need to provide liquidity to banks facing rapid funding outflows, taking on credit risk and making allocation choices that could open doors to political interference.
• International implications: reserve-currency CBDC available across borders could increase currency substitution (“dollarization”) in countries with high inflation and volatile exchange rates; these implications require further study; IMF staff are investigating.
• Costs and reputational risks: providing full-fledged CBDC can be costly and operationally complex—front-end wallets, customer interfacing, technology maintenance, transaction monitoring, AML/CFT responsibilities—with cyber, technological, and human-error risks that could harm central bank reputations.
• Design mitigation: some challenges can be attenuated by appropriate CBDC design choices.

Synthetic CBDC and public-private arrangements

• Synthetic CBDC model described by IMF staff:
  • Private firms issue digital coins to the public (accounts or tokens leveraging DLT) and manage innovation and customer interfacing.
  • Central bank provides trust by requiring coins to be fully backed with central bank reserves and by supervising coin issuers.
  • Outcomes: preserves comparative advantages of private firms and central banks, induces competition among private firms, limits costs and some operational risks to the central bank.

Alternatives to CBDC and complementarities

• Improved payment systems: several countries are improving inter-bank payment systems to achieve speed and convenience similar to digital currencies (example referenced: the Federal Reserve’s “FedNow” initiative for nearly instantaneous and low-cost settlement of inter-bank retail payments).
• Complementary reforms: public digital identities, common communication standards, open APIs, and data portability and protection standards can enhance payments and competition.
• CBDC complementarities:
  • DLT-based CBDC can spur DLT-based asset markets.
  • CBDC can operate outside the banking system and promote financial inclusion.
  • CBDC can provide competition to banks and encourage use of fast payment systems.
  • DLT-based CBDC could facilitate cross-border retail payments, complementing efforts to link traditional inter-bank payment systems.
• Recommendation: central banks should remain engaged in examining the full range of CBDC issues, including synthetic CBDC options, and deepen familiarity with new technologies.

IMF Blog entry from IMF staff.

References

• synthetic CBDC