When Facebook announced its intention last June to issue a digital currency, Libra, the official industry was put on hold in its initial response. Central banks could not be seen as being too overtly unwelcoming to innovation and new ideas, but also, the concept hit quite directly the sovereign privilege of issuing money. They also worried in private about the possible consequences for their conduct of monetary policy *.
Since then, central banks have remained largely silent. The main news on Libra were the resignations of the consortium supporting the project; Visa, Mastercard, eBay and PayPal, among others, have ended their involvement. This stripped the project of a lot of payments systems expertise, and while Facebook has found other companies to take its place, the consortium is now less balanced and much more clearly a Facebook-dominated operation.
But the authorities’ silence does not mean that they have ignored the subject or overcome their initial mistrust. Much research on digital currencies continues to be done by the central banking fraternity, and two issues in particular arise.
The first of these is the effect on the Orthodox banking system, in particular its role in the creation of money. In a split banking system, banks are able to grant loans (i.e. create money) that are a multiple of their deposits, keeping only a small portion of their balance sheet in assets. liquids such as central bank reserves. This process allows the money supply to expand and, in any modern economy, is a critical contributor to economic activity and growth.
But if digital currencies become an important part of the economy, that money creation will be halted. Calibra – the Facebook subsidiary that develops Libra – has made it clear that it has no intention of offering loans or overdrafts, as that will immediately make it a bank and therefore subject to banking regulation. But it does mean that any money customers take out of banks to place in their Libra accounts will be wiped out not only from banks’ balance sheets, but from the money creation process as well.
Indeed, the introduction of Libra threatens to split the banking sector’s currently unified balance sheet, shifting a significant proportion of customer deposits (i.e. banking system liabilities) to digital money issuers. , while leaving loans and overdrafts customers (the bank’s system assets) with the banks. The inevitable result would be to force banks to reduce the assets on their balance sheets to match the reduced liabilities, that is, to reduce their loans.
This would almost certainly lead to a significant credit crunch, which would be very damaging to economic activity. The threat that “narrow bank” (non-lending) digital institutions could reduce or even replace the role of existing commercial banks is of deep concern to central bankers. There is no precedent for a prosperous modern economy without commercial banks and their role in money creation.
Unfortunately, central banks don’t have an easy answer to this. Relaxing banks’ reserve requirements and allowing banks to offer more loans per unit of deposit would allow them to maintain the same volume of loans despite the reduction in their deposits, but would weaken banks and risk bank insolvency in the event of a loss. economic downturn. Alternatively, central banks could issue loans themselves directly (or guarantee bank loans, which would have a similar effect by removing the need to build up reserves against them) – but this direct involvement in the economy of the private sector is even less attractive to them. Not only would such a move run counter to all existing central bank theories, but in purely practical terms, it would open up the central bank to much more direct contact with the general public and therefore, almost inevitably, to oversight. much more political. No central banker enthusiastically envisions getting drawn into the world of the “three Cs” – customers, complaints and call centers.
The second issue that arises from the introduction of private sector digital currency is that of cost. Libra and any other digital currency rival will need a revenue stream to pay their costs (and provide feedback to consortium partners). How are they going to increase this income?
If they can’t generate an income stream from paid loans and overdrafts, they must come from user fees. In principle, these charges will be levied on the commercial service provider, not the retail consumer, but in practice they will inevitably be paid by the consumer in the end.
This raises important questions of efficiency and value for money. It is by no means clear that such a private sector payment system would cost less to operate than the existing banking system, even on the narrow point of cost per transaction, especially if, as seems likely, a currency digital quickly becomes dominant for the exclusion of competitors. But there is the larger question of whether society is benefiting from big tech that takes even more money out of the economy into an unaccountable, tax-free and often overseas giant.
The current trials of Libra may mean that its introduction has been delayed. Many consider it to be in no way guaranteed to work. But central banks are well aware that even if Facebook fails to make its plan a reality, sooner or later someone else will succeed and introduce a private sector digital payment system. And the problems and implications for the central bank, the commercial banking system, and the wider economy that their current research has highlighted will not go away.
John Nugée, former Managing Director of Reserves at the Bank of England, is Senior Advisor to OMFIF. This is an abridged version of an article published by Laburnum Consulting.
* See http://laburnum-consulting.co.uk/facebook-enters-the-digital-currency-world/ for a more detailed discussion of the initial reaction of central banks to Facebook’s announcement.
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