• Tue. May 28th, 2024

Impact On Financial Inclusion, Private Sector Banks

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Central bank digital currencies are being considered by a raft of countries. They bring, so advocates say, all kinds of pro-innovation benefits. They are also privacy concerns, however, to be taken into account. This article takes a look.


The article is part of the law firm’s “The Next Decade in
Fintech” series, and the editors of this news service are pleased
to share this. This publication has already examined central bank
digital currencies (CBDCs), such as their implications for
financial innovation, privacy and concerns about their
use in surveillance. 


We are grateful to Baker
McKenzie to be able to republish this material. The
usual caveats apply and to respond, email [email protected]


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.


The state of play

As of June 2023, 11 countries or their currency unions had fully
launched digital currencies, 21 had embarked on pilots, 32 had
them under development and another 46 were at earlier stages of
researching them. Some initiatives are exclusively for retail
CBDCs (including the 11 already launched), some for exclusively
wholesale ones, and several large economies (such as China
(1), the US, and the eurozone) are exploring the launch of
both.  



Except for Nigeria, all of the 11 that have launched CBDCs thus
far are small economies in the Caribbean region. Why their speed
to launch? According to Marion Laboure, senior strategist at
Deutsche Bank Research and co-author of a recent white paper on
digital currencies, a major motivation for them is to expand
financial inclusion, as most have large numbers of un- and
underbanked citizens. For Nigeria, says Ashlin Perumall, a
partner in Baker McKenzie’s Johannesburg office, an additional
impetus is to shore up the use of its own currency in domestic
payments, thereby reducing the use of the dollar, as well as
increasing the visibility and traceability of money flows.
“There and in other African countries, CBDCs could solve problems
that aren’t currently being solved,” Perumall says.  


There is currently less urgency in larger, wealthier economies to
move towards a CBDC launch. Singapore is a case in point. After
completing a pilot in late 2022, its central bank, the Monetary
Authority of Singapore (MAS), stated: “The use cases for a retail
CBDC are unclear, given that electronic payments…are pervasive,
and households and firms … are already able to transact digitally
in a fast, secure and seamless manner today.” Speaking of wealthy
economies more broadly, Perumall also cites the travails of
cryptocurrency markets as a reason for central banks to hold off.
“Crypto threats to sovereign liquidity have receded somewhat in
the past year,” he says.


The experts we interviewed nonetheless expect several major
economies to launch CBDCs this decade. “It’s a question not of if
but of when,” says Laboure.


  


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,” says 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 says, “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.


Preparing for the day

As the example of Singapore suggests, the possibility of an
extended wait for the widescale introduction of retail CBDCs is
real. There is, after all, ample scepticism among politicians,
and even some central bankers, about the very need for CBDCs. “A
solution in search of a problem?” is a recurring question about
CBDCs asked in recent months and years by authoritative sources
who posit the view that a digital currency offers more risk than
reward.


Private sector banks should not, however, assume that launches
will be delayed indefinitely. Singapore’s MAS, for one, has made
clear that it could bring forward the launch of its digital
currency if “innovative uses emerge or there are signs that
digital currencies not denominated in [Singapore dollars] are
gaining traction as a medium of exchange locally.”


Retail banks will need to make preparations. That means, for
example, readying their technology systems to be able to process
CBDC transactions at scale; creating electronic wallets or other
end-user interfaces so that their customers can begin making CBDC
transactions; and developing ideas for new services associated
with the management of CBDCs. It is not too early for banks to
begin taking such steps.

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