What CBDCs mean for private sector banks and financial inclusion

By Puja Sharma

To try and forestall such developments, central banks in all the world’s major economies and most of its lesser ones are exploring the creation of digital currencies, and a handful of emerging economies have already launched their own

The world’s central banks understand that the future of money is digital. As payments shift online, the use of cash declines and the fortunes of crypto assets rise and fall, central bankers realise that their ability to command the use of money in their economies could weaken and that the financial exclusion of un- and underbanked citizens could be cemented. To try and forestall such developments, central banks in all the world’s major economies and most of its lesser ones are exploring the creation of digital currencies, and a handful of emerging economies have already launched their own.

The widespread introduction of central bank digital currencies (CBDCs), especially in the world’s major economies, is not imminent. But the groundwork being conducted in this area is detailed and in-depth, such that many central banks will be ready to launch when their governments deem the circumstances to be right. Before that time comes, central banks have choices to make about the design of their CBDC systems, particularly those earmarked for retail use. We spoke with two experts to understand what some of those options are and how the choices made may have an impact on financial inclusion and the role of private sector banks in this new payments landscape.

A boon to inclusion

Bringing the unbanked into the financial mainstream is one of the principal advantages that a CBDC offers—particularly, as noted earlier, to less developed countries with large percentages of unbanked in their population. A key feature of many retail CBDC projects is the ability of individuals to access a digital currency account offline as well as online. “This is important as it effectively decouples financial inclusion from access to the internet,” said Laboure. Thus, people will be able to make CBDC transactions over basic mobile devices, using stored value cards, for example, or even text messages.

The financial inclusion benefit is not a given warns Perumall. “To lay claim to this feature, the system for a CBDC needs to be designed with inclusion in mind,” says Perumall.  Offline access is one such design element, but there are more. For example, the system must be interoperable with the diverse payment mechanisms used in an economy, and it must be accepted by merchants. It also requires simplified KYC (know-your-customer) and AML (anti-money laundering) processes.

Where the private sector fits in

Implicit in the above—and an altogether new departure in the history of banking—is the existence of a direct relationship between individual citizens and their country’s central bank, in which the former hold a CBDC account with the latter. In some countries’ designs, citizens may use a mobile app to access that account directly, but it is more likely that private sector banks will play the role of intermediary in a two-tiered digital banking system.

There are nevertheless concerns that central banks could compete with retail banks for CBDC transactions, especially if the former opted to offer interest-bearing accounts. While not excluding that possibility, Perumall downplays disintermediation concerns. “Private sector banks not only provide the mechanism for distribution of money into an economy,” Perumall said, “but they also provide the services and the management of such services that go along with it—things that no central bank has the capacity to do.”

Concerns also exist that CBDC accounts could exacerbate a banking crisis if customers began shifting funds from their retail banks to the safer haven of the central bank. In Perumall’s view, however, the two-tiered system of most CBDC designs, along with non-interest-bearing accounts and limits on CBDC holdings, provide a safeguard of sorts against the possibility of bank runs.

Laboure similarly sees no CBDC threats to financial stability due to the same factors: their two-tiered design, zero interest accounts and caps on holdings. “Moreover, looking at countries where CBDCs are live, current adoption rates are low,” Laboure adds.