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CBDC - the waking giant

Just about a decade ago, banks worried about fintechs taking away 'some' of their businesses. Some years ago, banks worried about cryptocurrencies taking away 'more' of their businesses. Today banks need to worry if central banks would take away 'most' of their businesses.

Welcome to CBDC (Central Bank Digital Currencies) - the dragon Dracarys of the new financial world.

At the outset, CBDC looks like a mechanism with meager intentions to resolve some of the basic yet important deficiencies in the current financial system in the areas of financial inclusion, ease of use of cash, transparency, creation and dispensation of physical notes and coins, tax management and etc. However underneath the hood of CBDC lies immense potential that can transform the payments world in a way unrecognisable.

Domestic Payments :

Of course CBDC starts with retail accounts of petty people but over time it would have wholesale accounts, and will start to draw more monies into these so called 'tokenised' accounts via deposits, due to interest on cash, ease of transfer and central bank's trust. Interoperability of CBDC system with domestic payment systems (RTGS, ACH) means that money can move instantly and seamlessly across CBDC accounts and regular accounts within commercial banks. This in combination with interfacing (possibly API) for third parties and fintechs to access the CBDC ledger and initiate payments makes the CBDC available for large variety of commerce.

So where does it leave us as far domestic payments are concerned. CBDC makes all domestic transfers in the country a simple book transfer in its ledger. Suddenly banks and the transfer systems seems like barriers, isnt it?

Cross-border payments :

CBDC offers immense potential for cross-border payments, making way for faster, scalable, cheaper payments network with a far larger reach - all of which are big deficiencies in the current transfer systems. Cross border payments via CBDC means payment exchange and FX settlement occur together within the CBDC ledgers of the respective central banks. Bank of International Settlements (BIS) is working on models where national CDBCs can be interlinked such as to enable this.

Now that you have a gist, I leave you to realise the potential CBDC has, imagination is the only limit. With the ever-increasing global datasphere and the gigantic increase in international financial transfer volumes, current payment infrastructures such as SWIFT have proven to be inadequate to meet the needs of the future.

CBDC arrives just-in-time!

Why banks needs to be worried?

CBDC can go beyond payment services. Digitalisation of assets using  technologies like blockchain associated with digital identities of its owners means that CBDC system can allow secured loans, just the way banks today instantly swaps securities for loans between RTGS and Securities settlement systems. Other common needs such as account statements, demand drafts or scheduled payments etc can be built into CBDC system as well with a little innovation on overlaying layers of software.

The rewards are too compelling for public. Imagine end customers enjoying central bank interest rates and FX rates.

Central bankers and government are in so much astonishment. Taking banks off some of these private money creation schemes allows them for better control on the liquidity and monetary policies. Examples from the US and Europe today illustrate these policy mismanagement problems very well - with low economic growth yet surplus liquidity in the banking system, and rising stock markets.

In year 2031, in an eventuality of banks maintaining an near empty ledger, does it not suffice for fintechs to do the front end and some customer data management jobs as service bureaus' for the central bank?     

Effect on world economies :

As central banks starts to be linked each other via CBDC systems, it gives them opportunity to hold currency of fellow nations that it trades with in a much more effective way. This isn't intuitively possible today and hence central banks resort to maintain reserves in very limited set of global trade currencies.

Interlinked CBDC system means there is no need for nations to hold a single reserve currency and incur its risk, instead spread the risk across multiple nations - with acceptable bilateral limits of course. The timing of CBDC is again just perfect when we find the world's leading reserve currency, the US Dollar is just about losing its steam.

Impact on Cryptocurrencies :

This is the easy one. I'm not a crypto fan, and I can't see them more than being another betting instrument. The whatever little e-commerce features it is offering is just a facade, to give the impression that it has 'value' - only to get more investors into it, so betting can get bigger.

While I won't argue with them on the point of intrinsic value (as I don't have a currency to defend with that has it) given all its other negatives, I don't believe cryptos has the ability to drive common man to do normal transactions irrespective whether CBDC kicks in or not.

So - cryptos may remain in the sideline for some exotic people to do exotic stuff.

Summary

Just when you think innovation in payments have ended, there is just another bigger one popping up. This time for a change, its driven by central bankers, willing to trust and shoulder with new technologies.

CBDC is a tough and long journey, just as was the early life of Drycarys. Unless there is a Daenerys, CBDC wouldn't reach its full extend. There could be things to lose for the reigning 'lords' of financial messaging world who can come on the CBDC way. I hope - they would just agree to walk with the proponents. 

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Shaju Nair

Shaju Nair

Payments Consultant

Temenos

Member since

30 Jul 2008

Location

Bangalore

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3

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This post is from a series of posts in the group:

Innovation in Financial Services

A discussion of trends in innovation management within financial institutions, and the key processes, technology and cultural shifts driving innovation.


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