CBDC Policy Considerations

CBDC Policy Considerations

Sabrina Rochemont

25 years: Digital payments specialist

The introduction of central bank digital currencies (CBDCs) pose a number of questions around how CBDCs might impact the stability of the financial system. There are several proposed policies that might address the risk. In this video, Sabrina will introduce some of these policies. Sabrina will also outline the impact on monetary policy and privacy. The question around new technologies surrounding digital currencies and the existing central bank infrastructure will also be discussed.

The introduction of central bank digital currencies (CBDCs) pose a number of questions around how CBDCs might impact the stability of the financial system. There are several proposed policies that might address the risk. In this video, Sabrina will introduce some of these policies. Sabrina will also outline the impact on monetary policy and privacy. The question around new technologies surrounding digital currencies and the existing central bank infrastructure will also be discussed.

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CBDC Policy Considerations

15 mins 52 secs

Overview

In this video, Sabrina Rochemont analyses how central banks might implement CBDCs and how they might affect the financial system. Sabrina explores the impact of CBDCs on fractional reserve banking, as banks are currently the main creators of money. One of the concerns around CBDCs is that they might reduce the ability of banks to create money, in turn reducing the loans banks can offer and inadvertently increasing the interest rates bank charge. Sabrina outlines several policies that she thinks may combat these risks to the traditional banking system.

Key learning objectives:

  • Understand the impact CBDCs might have on the traditional banking system

  • Recognise how policies could be used to mitigate the risk to the traditional banking system posed by CBDC implementation

  • Identify the arguments for and against the use of a retail CBDC in an advanced economy

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Summary

What are some of the potential impacts of CBDCs on the traditional banking system? 

A retail CBDC may be deposited directly with a central bank, or with an intermediary, such as a payment service provider (PSP). Whichever architecture is chosen, a share of deposits will inevitably be redirected away from commercial banks. If deposits are shifted away from commercial banks, then the ability of these banks to create money to lend out will be reduced. It will challenge their ability to lend to core retail, consumer and business customers and therefore narrow the commercial banking system. This threat to commercial banks could lead them to charge higher interest rates and ultimately undertake riskier lending. 

Will CBDCs have an effect on monetary policy?

A central bank’s main purpose is to maintain financial stability. A CBDC should not impact this objective. However, a CBDC may provide an opportunity for central banks to introduce new monetary policy tools, or, deliver existing monetary policy tools more easily. 

There is a potential for a CBDC to offer an additional monetary policy tool to a central bank in the form of negative interest rates to CBDC deposits. This would be most effective in the total absence of physical cash. The effectiveness of such a policy would be directly related to the volume of physical cash available. In times of crisis, a central bank may elect to change the conversion rate from a CBDC to cash; this would remove the assumption of 1:1 convertibility into cash, and introduce a temporary negative interest rate.  

A CBDC may become a new instrument for central banks to deliver monetary policies without having to influence commercial banks’ economic behaviour.  One creative potential for CBDCs is for the direct delivery of welfare through helicopter money drops. A CBDC would introduce a mechanism for the government to deliver welfare payments or potentially a universal income directly through CBDC accounts. 

Why is privacy a key concern of CBDCs?

Privacy has long been a popular feature of cash. Due to regulatory constraints, central banks will likely have to opt for account-based retail CBDCs - this type of CBDC requires all transactions to be recorded and traceable. Single-tier systems will require consumers to hold their CBDC balance at a central bank, ruling out privacy. Two-tier systems would use an intermediary between the consumer and the central bank (a PSP). The two-tier system could provide consumers with some level of privacy from  central bank visibility as the PSP could hold transaction data while the central bank would only have visibility of the account balance. 

Which new technologies are being considered to facilitate CBDCs and is there associated risk?

Whether central banks opt for a wholesale or a retail CBDC, there will need to be an upgrade to the current infrastructure and technologies currently used by central banks. Blockchain is likely to be deployed by central banks due to its potential benefits, which include its architecture. Blockchain architecture allows it to monitor activity for compliance purposes as well as facilitate programmable money (rules that can be applied to money so that it acts in a certain way e.g. tokens/money can only be spent on food instead of betting). Blockchain is still a young technology and may not be mature enough to be used for critical economic functions and may also be challenged by the scale of a CBDC project. Ultimately, introducing new technologies introduces new risks. There must also be consideration of how a CBDC would operate offline. It is vital central banks get these elements right the first time. 

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Sabrina Rochemont

Sabrina Rochemont

Sabrina Rochemont is an experienced IT Service Management Professional. She has been researching the digitisation of payments and the possible evolution toward a cashless society for a working party. She is co-author of several papers on the topic of cashless societies including "A cashless Society - Benefits, risks and issues”, published in 2018 and “Understanding Central Bank Digital Currencies”, published in 2019. She’s also co-authored several other papers covering many aspects of the topic such as the environmental impact of payments.

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