Month: April 2021

Digitalization has thrown almost every part of the economy into disarray, and the payment system is no exception. Cash use has decreased significantly across developed and developing economies as customers have accepted the convenience and ease of digital payments. Privately run solutions have taken substantial market share. These range from well-established (debit and credit cards) to early stage (cryptocurrencies). According to Morgan Stanley, the failure of physical cash to play an effective role in the digital economy raises the risk that monetary authorities will fail to provide the population with a stable, accessible, and reliable means of payment. To protect their monetary sovereignty and mitigate financial stability concerns Central banks are on track to introduce their own digital currencies in the coming years that is Central Bank Digital Currency (CBDC).

Central Bank Digital Currency (CBDC) are a new form of money – digital cash, developed and backed by the central bank with the aim of facilitating digital transactions and transfers. CBDC would offer a new type of widely accessible, digitally issued money. Importantly, CBDC will not be a cryptocurrency, Cryptocurrencies are designed to work without a central issuing or controlling authority, have a fixed or system-determined money supply, and use distributed ledger technology to record and validate individual transactions using cryptography (blockchain). CBDC, on the other hand, requires none of these characteristics. The central banks retain complete control over the currency and its issuance and in most of the cases will track and certify transactions through a centralised ledger.

Central banks will have to make three main design decisions when developing their digital currency systems: Who has access to digital currencies issued by central banks? How are they going to be accessed? What type does a digital currency take in terms of technology?.86% of the world’s central banks are exploring the issuance of central bank digital currencies. The PBoC has already put its eCNY initiative to the test in three major Chinese cities. The ECB will release the results of its recently concluded public consultations and could announce its intention to develop a digital Europe by the summer. In the United States, Fed Chair Powell has described digital currency as a “high priority initiative,” with the Boston Fed preparing to launch one.

Morgan Stanley reported, even without a CBDC, India is an instructive example, Policymakers have taken the lead in developing the public data infrastructure that enables advanced and widely available payment solutions. The public sector has created a strong foundation for private sector innovation to promote payments and increase financial inclusion by providing a national identity verification system (Aadhaar), an instant real-time payment system at the central bank (United Payment Interface), and a comprehensive legal framework on data privacy. As a result, India now has a highly modernised payments infrastructure and has surpassed other emerging markets in terms of financial inclusion.

Morgan Stanley anticipates that central bank digital currencies (CBDCs) will help to strengthen monetary sovereignty and alleviate concerns about financial stability, but they pose a risk of disruption to commercial banks and the financial ecosystem. While central banks’ efforts at introducing CBDC are not intended to disrupt the banking system, it will likely have unintended disruptive effects. Banks will face disruption from three fronts; First, depending on the degree to which consumers can move their bank deposits to CBDC accounts, banks’ deposit bases can shrink. Second, CBDC’s technical framework could make it easier for new entrants to enter the payments market without having to rely on incumbent banks. Third, as more of the transactions move to CBDC, which are likely to include privacy safeguards, banks will have to compete harder for access to consumers’ spending data. The central banks’ design choices would have a significant effect on how much disruption occurs on all three fronts. The speed at which network effects take place in a CBDC system can determine how easily disruption occurs. The greater the acceptance of digital currencies, the more opportunities for innovation and the greater is the risk of financial system disruption.