CBDCs could cause friction with commercial banks

Johan Javeus, chief strategist at SEB, explains to Finextra Research the tension that could emerge between central banks and commercial banks if the former circulates a digital currency directly to consumers.

Over the past few months, an array of central banks have announced plans to develop digital currencies, most likely in response to Facebook’s proposed launch of its own stablecoin, Libra.

It would be an understatement to say that governments, regulators and banks have been spooked by the idea of ​​a private company the scale of Facebook issuing a global digital coin and wielding such influence over the global financial system.

However, Johan Javeus believes that central bank digital currencies (CBDCs) would present their own problems that need to be addressed.

If a central bank were to circulate its digital currency directly to consumers, anyone wishing to use it would need to hold some sort of account with the central bank, putting it in competition with commercial banks to hold people’s money.

“Let’s imagine that the Swedish central bank issues a digital currency,” says Javeus. “Does this mean that every family and business will have an account at the Riksbank?

This would create an awkward standoff between central banks and commercial banks, which Javeus says could cause a crisis in the financial system.

“As a result, there is a question of stability in the system,” he adds.

“Of course, everyone will be rushing to put their money in the central bank, which would drain capital from traditional banks.”

Without the capital from customer deposits, commercial banks would be less able to extend business loans and consumer mortgages, which would naturally have detrimental ripple effects on economies.


Centralize or decentralize?

The question, however, is whether it would be in the interest of central banks to adopt this approach in the circulation of its digital currency.

The Bank for International Settlements (BIS) recently assessed the different paths central banks can take to develop and launch a digital currency, describing this direct CBDC or “retail model” as “appealing for its simplicity,” given that central banks would not. depend on commercial banks as intermediaries.

However, this model requires central banks to build the necessary infrastructure to deal with regulatory burdens related to KYC and AML, as well as more rudimentary tasks related to customer service, system outages, etc.

“That would be a huge project for a central bank to undertake,” says Javeus.

“There are a lot of potential issues that would need to be resolved, and we don’t yet know how they would be resolved.”

Therefore, central banks are more likely to take an approach that uses commercial banks and other intermediaries as circulation channels, outsourcing the aforementioned burdens to them in the process.

This “wholesale model”, however, has the disadvantage that the central bank depends on intermediaries for information about individual claims on the currency. It would bring in various oversight and regulatory processes that exist in different forms under the system we have now.

Libra to the rescue?

That being the case, it seems more likely that central banks would follow a “hybrid model” to develop a digital currency, which combines elements of the other two. The BIS proposes that this would involve a central bank distributing the currency, with intermediaries like commercial banks handling retail payments. However, the central bank would periodically record retail balances to exercise greater control than in the wholesale model.

The hybrid model then has the advantage of being simpler to propose for the central bank, but at the cost of requiring a more complex infrastructure. It is then likely that central banks will turn to technology companies with the capabilities to provide this.

This may suggest that there is still hope for Libra. Central banks will know that Facebook can provide the infrastructure necessary for a digital currency to work at sufficient scale much better than them.

“I don’t think central banks have quite decided how they’re going to go about it, because of these potential issues with issuing a digital currency,” Javeus says.

Painful as it may be then, central banks may decide their best bet is to work with Facebook to bring a form or Libra to market and use it as the basis for their own digital currencies.

Javeus adds: “Facebook and its peers are huge companies with resources and know-how at their disposal that far exceed those of any central bank.

“So if Facebook is able to remove regulatory hurdles and get the green light to launch Libra, it would be difficult for central banks in any country to compete with such a currency.”

Central banks could then decide that they would rather Facebook and other Big Tech companies spit inside the tent than outside.

See the Finextra long read on Libra, CBDCs and more on Welcome to the era of stablecoins.

About Ruben V. Albin

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