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Data on the Data

Episode 10: The rise of central bank digital currency

In this week’s episode of Data on the Data, Sachin Somani, Global Director of Customer Proposition at Refinitiv, outlines the desire for central banks to develop their own digital currency to complement their existing offerings, reduce the reliance on coins and notes, and compete with private coins in the crypto space. Sachin outlines the drivers of adoption, the designs and models that will be implemented, and the implications for the commercial banking system. Will central bank digital currency compete with, or complement, the privately developed crypto?

  • Speaker 1 [00:00:06] The rise of cryptocurrencies has become a flashpoint for many investors, but there is a parallel development going on at the moment by many central banks of their own digital currencies to complement existing fiat currencies in the systems that they already have. And eventually these are going to replace traditional fiscal currencies such as coins and notes. And the central bank digital currencies, they're going to compete for attention with a multitude of private coins. Refinitiv's Sachin Somani outlines the drivers of adoption for central bank digital currency, the different designs and models, and what these implications could be for commercial banks as well.

    Speaker 2 [00:00:45] There are many drivers that central banks today consider or different countries, they consider while exploring the central bank digital currencies. The first and foremost is to ensure that the general public and financial institutions, they have access to a legal tender should these countries or central banks decide to move away from fiat currency. We all know that the use of cash in the economy today, globally it is reducing. And this is primarily due to the fact that we see more and more economies and consumers adopting digital transactions via credit cards, the payment gateways and so forth. Now what has also happened, or the second driver, as I see is the efficiency in the payment system is increasing. Now, the payment systems are broadly in two aspects or two categories. One is the retail, which is the general public, which is what you and I would use, but also the efficiency in the wholesale payment systems. Now, when we look at this efficiency, it implies two aspects. One is with respect to the wholesale efficiency rules in payment efficiency, it will reduce the time for cross-border payments, the settlement time and also the extended period that people could settle their debts. The other thing I've noticed is more so in the developing economies, the central banks or the, or the or these countries could benefit from the removal of low-value coins from the system. It is difficult to maintain these, it is also a costly affair, and with the central bank digital currencies, these economies could definitely benefit from it. I would also say that one of the drivers that most, many of the central banks are also seeing is the competition from private e-money. Now, if, for example, the e-private money is more widely accepted than the central bank, digital central bank issued digital currency, then it could mean that people who are receiving or the state subjects who receive benefits from the government would be at a disadvantage than the general public who is accepting the privately issued e-money. These are some of the major drivers which are prompting central banks across the globe to consider and explore digital currencies which are being backed by them or the liabilities lie on these central banks.

    [00:03:32] There are three main design considerations for the central bank digital currency. Number one is who should be given the access to or granted the access to? The number two is the degree of anonymity. And the third is will the central bank issued digital currency have an interest bearing characteristics? Now, when the central bank they want to go and issue a digital currency, then it should have all the features that of a fiat currencies. For a central bank to act as the central counterparty it also means that there should be interoperability between the fiat currency and the central bank digitally issued currencies. Now, central bank digital currency, there are a few characteristics, or what I call as the models. One is they need to be widely accepted, so the interoperability between the fiat currency and the central bank digital currency, that should exist. It should also be recognized as a legal tender in that country. Secondly is the central bank should guarantee at part and operability between the existing fiat currency and the digital version of it. Third but not really the last point is more towards the fact that the holder of the digital currency, the central bank, should not allow that person to issue lending facilities or provide the lending facilities. So these are the three what I call as the design consideration and the model considerations for the central bank issued digital currencies.

    [00:05:21] There are many implications when we consider central bank digital currencies on the commercial banks and also for the non-bank financial institutions or corporations. For one, there  would be transfer of deposits from the commercial banks to the central banks, central bank digital currency, as a result of which you would see the aggregate size of the balance sheet in the banking sector reducing. This means implications on the banking sector as a whole as we speak today. Likewise, you know, like any any any business, when the commercial banks, they come under competitive threat, they will do or they would innovate and they would have to remain competitive so as to sustain their business. My view is they would offer competitive interest rates on the bank deposits. But to do that, it would also mean that they would have to perhaps look at some cost reduction exercise. All of this could also mean that the lending rate, the rate at which they would lend to the general public and to the smaller businesses, it might increase. Now, this would impact these MSMEs and the private individuals who have a very low price sensitivity. So these are some of the implications I see on the commercial banks. Now, what I also see is the commercial bank. There is a likelihood that they would, they would borrow from overseas to fund their operations and therefore it would also mean that these commercial banks, they would expose the banking sector in a specific country to external factors. So these are the four areas or the forward implications, which I feel would be more prominent when we go live, or most countries go live on the central bank digital currencies.

    [00:07:24] Many challenges, you know across the spectrum. So for one, the central banks, they have to decide on the monetary policy. So while certain countries, they have taken the lead in terms of how they would like to implement, whether it is a centralized in terms of the technology, whether it would be distributed ledger technology or centralized databases, you also have the banks who would have to consider to how they are going to ramp up the infrastructure. The infrastructure that is required for the digital currency is quite different from that which is existing today. The banks, they would have to or the institutions would have to consider how these two different infrastructure, they seamlessly merge with each other. So these are some of the major challenges that I foresee for both the industry as well as the regulators and the central banks.

    [00:08:25] If you go back, if you take a step back, why did the central banks in the first place consider talking about the digital version of the fiat currency? And the reason being is they were cryptocurrencies, people were interested in them, it meant a lot of applications in the real life. For one, the cross-border payments, they could be settled faster. The cost of the settlement for cross-border payments it could be reduced significantly. And as I explained, it could also have implications for financial inclusions in many of the emerging economies. Now having said that, there exists no reason or there is no foreseeable reason. I see where both the cryptocurrencies  and a central bank digital currency cannot coexist. The question remains is when you have a privately issued cryptocurrency, the counterparty risk is quite high and it is up to the general public and to the regulator to understand those risks and to forge their monetary policies accordingly. So that's my view in terms of you know, how and if the cryptocurrencies as well as the central bank digital currencies could co-exist in a country.

    Speaker 1 [00:09:50] Central bank digital currencies are going to be in many countries in the very near future, and the infrastructure that will be needed will be based on many of the existing distributed ledger technologies that have been developed on behalf of the private coin space and also obviously decentralized finance. And these coins, these digital coins from central banks are going to coexist with the existing private coin space. And many of the fears that people have with regard to fiat currencies are not going to go away when they become digitized. Many of the real issues or many of the real adoption issues for digital currencies are very much the same ones that we see in the existing private coin space. It's going to be things based around trust, do you trust your central bank, digital currency and the government behind it? What are the operational costs and what are the transactional speeds? Which are often very much the issues at the heart of the private coin space. But one thing is for absolute certain, is that we are going to see digital currencies, central bank digital currencies adopted by governments coming to a country near you in the very near future.