By Tobias Adrian and Tommaso Mancini-Griffoli
Central Bank Digital Currencies (CBDC) is a complex and multidisciplinary topic requiring active analysis and debate. It raises questions related to monetary policy, central banking operations, and payment systems—as well as financial stability and legal foundations and regulation.
Below are some of the most pressing questions and answers on the topic.
What is the IMF’s role around CBDCs now and in the future?
The IMF can help in three ways: by informing the policy debate, by convening relevant parties to discuss policy options, and by helping countries develop policies. Because CBDC is a novel topic, the IMF has mostly been active in the first two areas, but it is gradually moving into the third area as member countries consider CBDC options and seek advice.
First, the IMF can help inform the policy debate. The IMF is currently investigating implications of CBDC available across borders. Other institutions, such as the Bank for International Settlements and the Committee on Payments and Market Infrastructure, among others, have also contributed to the topic. The IMF is well-placed to study CBDC, because it can draw on its in-house experts. Moreover, a potential world with multiple CBDCs could raise important questions about cross-border payments and the international monetary system, which are at the core of the IMF’s mandate.
Second, the IMF is well-positioned to help foster cooperation across countries and relevant parties. The IMF can draw on its universal membership to share information about rapidly evolving developments across advanced and emerging market economies. Moreover, because the IMF is a public international institution, it can bring together central bankers and regulators, as well as investors, entrepreneurs, and academics from around the world for an open dialogue. It has done so repeatedly at its bi-yearly meetings, in its yearly “fintech roundtable,” and in its ad-hoc research events.
Third, the IMF can help countries evaluate policies regarding CBDC as well as investigate alternative means to improve payment systems. The IMF can do so through its surveillance work, its Financial Sector Assessment Programs, and its technical assistance, which it has a long tradition of providing. IMF teams have already worked with countries to modernize payment systems, advise on legislation related to digital payments, and review plans to issue CBDC. The IMF can help countries think through the implications of CBDC and its attendant potential benefits and risks, including through regional workshops leveraging knowledge in central banks at the frontier of CBDC development, and bilateral technical assistance missions.
How does the IMF view global development and implementation of CBDC?
Countries differ substantially in the extent to which they are actively exploring digital currencies and in their proximity to issuing such currencies.
Some countries are actively running pilot projects to explore the feasibility of CBDC. To do so, they have increased resources allocated to CBDC and fintech research at the central bank, sometimes in partnership with private sector advisors. Several countries are also reviewing and revising legislation to support CBDC in case it were issued, and are actively studying the potential implications of competing CBDC designs. Some authorities are also engaging with the public and their legislatures to discuss the potential to issue CBDC.
Some other countries have also scaled up resources dedicated to CBDC and payment systems, although they mostly focus on undertaking analysis and more limited hands-on testing of technology. Although CBDC remains an option for these countries, they are also actively exploring alternative solutions.
A third set of countries do not see an immediate need to issue CBDC, and focus instead on improving existing payment arrangements and strengthening regulation.
Recently, we have seen an increase in central banks’ interest in CBDC following the announcement by Facebook of its Libra initiative as well as reports of a possible launch of CBDC by the People’s Bank of China.
What are the potential benefits and challenges related to CBDC implementation?
Central banks highlight a number of potential benefits of CBDC. These include:
Cost of cash: In some countries, the cost of managing cash is very high due to an especially vast territory, or particularly remote areas including small islands. CBDC could lower costs associated with providing a national means of payment.
Financial inclusion: CBDC may provide a safe and liquid government-backed means of payment to the public that does not require individuals to even hold a bank account. Some central banks view this as essential in a digital world in which cash use is progressively diminishing, especially in countries where banking sector penetration is low.
Stability of the payment system: Some central banks are concerned by the increasing concentration of the payment system in the hands of few very large companies (some of which are foreign). In this context, some central banks view CBDC as a means to enhance the resilience of their payment system.
Market contestability and discipline: Relatedly, some central banks view CBDC as potentially offering competition for large firms involved in payments, and thus as a means to cap the rents they can extract.
Countering new digital currencies: Some central banks view CBDC as healthy — potentially necessary—competition against privately issued digital currencies, some of which may be denominated in foreign currencies. These central banks believe a domestically issued digital currency backed by the government, denominated in the domestic unit of account, would help reduce or prevent the adoption of privately issued currencies, which may be difficult to regulate.
Support Distributed Ledger Technology (DLT): Some central banks see the virtue of DLT-based CBDC to pay for DLT-based assets. If these assets proliferate, DLT-based currency would facilitate automatic payments when assets are delivered (so-called “payment-versus-delivery,” or “payment-versus-payment,” which could be automated using smart contracts). Some central banks are considering the option of providing CBDC only to institutional market participants in order to develop DLT-based asset markets.
Monetary policy: Some academic scholars view CBDC as a means to enhance the transmission of monetary policy. They argue that an interest-bearing CBDC would increase the economy’s response to changes in the policy rate. They also suggest that CBDC could be used to charge negative interest rates in times of prolonged crisis (thus breaking the “zero lower bound” constraint), to the extent cash were made costly.
Despite these potential benefits, various challenges could emerge. Some of these can be attenuated by the appropriate design of CBDC.
Banking-sector disintermediation: Deposits could be withdrawn from commercial banks, should people decide to hold CBDC in significant volume. Banks would have to raise more expensive and runnable wholesale funding, or raise interest rates on deposits to retain customers. As a result, banks would either experience a compression of margins, or would have to charge higher interest rates on loans. The extent to which CBDC will compete with commercial bank deposits in normal times will depend in part on interest rates paid on CBDC, if at all. A non-interest bearing CBDC would come closest to simply replacing cash.
“Run risk”: In times of crisis, bank customers could flee from deposits to CBDC, which might be seen as safer and more liquid. However, in many jurisdictions, credible deposit insurance should continue to dissuade runs. In addition, safe and relatively liquid assets already exist in many countries, such as government bond funds, or state banks. Though evidence and country coverage is limited, academic studies do not point to systematic runs towards these alternative assets in crisis times. Moreover, if a run occurred, the central bank would be more easily able to meet deposit withdrawal requests with CBDC as opposed to cash. In addition, in many countries around the world, bank runs typically coincide with runs from the currency. Thus, whether or not local-currency CBDC existed, depositors would seek refuge in a foreign currency.
Central bank balance sheet and credit allocation: In case demand for CBDC is high, the central bank’s balance sheet could grow considerably. In addition, the central bank may need to provide liquidity to banks that experience rapid and large funding outflow. As a result, central banks would take on credit risk, and have to decide how to allocate funds across banks, opening the door to political interference.
International implications: CBDC of reserve currency countries available across borders could increase currency substitution (“dollarization”) in countries with high inflation and volatile exchange rates. These prospects need to be studied further, along with implications for the international financial system. IMF staff are currently investigating these questions.
Costs and risks to the central bank: Offering CBDC could be very costly for central banks, and it could pose risks to their reputations. Offering full-fledged CBDC requires central banks to be active along several steps of the payments value chain, potentially including interfacing with customers, building front-end wallets, picking and maintaining technology, monitoring transactions, and being responsible for anti-money laundering and countering the financing of terrorism. Failure to satisfy any of these functions, due to technological glitches, cyber-attacks, or simply human error, could undermine the central bank’s reputation.
In summary, each country will have to weigh the pros and cons of the case for CBDC depending on its particular circumstances.
Countries may consider the option of public-private partnerships that may achieve many of the same benefits of CBDC, while potentially reducing central bank involvement and operational risks. IMF staff have coined this solution “synthetic CBDC.”
More specifically, the synthetic CBDC model envisions private sector firms issuing digital coins to the public (which can either be accounts or tokens leveraging DLT). These firms would thus be responsible for doing what they do best: innovating and interfacing with customers. The central bank, instead, would provide trust to the system, by requiring that coins be fully backed with central bank reserves, and by supervising the coin issuers. This arrangement preserves the comparative advantage of each participant—whether it is a private-sector firm or a central bank—and induces competition among private-sector firms to offer attractive coins and interfaces. At the same time, it limits costs to the central bank, as well as some of the risks.
What are the alternatives to CBDC?
Several countries are working on improving existing payment systems to match the speed and convenience of digital currencies. For example, we understand from published sources that the Federal Reserve is developing so-called fast payments, allowing nearly instantaneous and low-cost settlement of inter-bank retail payments (the Federal Reserve’s “FedNow” initiative). In other countries, similar systems have improved payment services and injected competition in payments, especially if paired with other reforms, such as public digital identities, common communication standards, open application programming interfaces (“APIs,” which allow banking applications to interoperate and to be extended by third-party developers), and data portability and protection standards.
While improved inter-bank payment systems will bring many of the potential benefits discussed above, CBDC could be complementary, especially in some jurisdictions. Central banks have raised the following arguments: First, CBDC (or its synthetic version) can be DLT-based and thus potentially help spur the development of DLT-based asset markets. Second, CBDC can be designed to work outside the banking system and may thus favor financial inclusion. Third, CBDC could provide competition to banks and induce these to fully leverage the advantages of fast payment systems. Fourth, DLT-based CBDC could facilitate cross-border retail payments, thereby complementing the not-so-easy task of linking traditional inter-bank payment systems.
We generally think that central banks should remain engaged in examining the full range of issues associated with CBDC, including the potential to offer synthetic CBDC, and deepen their familiarity with new technologies.