Just when we all thought that cash management could not get any more complex central banks have begun introducing a new type of money – Central Bank Digital Currencies (CBDCs).
CBDCs are a form of electronic money issued by a central banks like the Bank of England (BoE) or European Central Bank (ECB). Currently there are three types of money:
- Physical money or cash which is money in the form of notes and coins
- Commercial bank money which is electronic money people and businesses hold in their accounts at banks such as HSBC, Société Générale or Citi Bank
- Central bank money which is electronic money that commercial banks hold in accounts at central banks to enable movements of money between banks.
The difference between a CBDC and the existing electronic central bank money is that the existing electronic central bank money is only available to financial institutions such as direct participants in the payment system, whereas a CBDC would be available to businesses or individuals.
Money is interoperable. This means £10 in an individual’s bank account can be converted to a £10 note at an ATM. Similarly paying for a coffee worth €3 can be made with a contactless debit card or euro coins and the cost is the same. A CBDC would be another form of interoperable money. Therefore, £100 held in a commercial bank account would be worth the same as £100 held in a BoE issued CBDC.
Central bank money (such as a CBDC) is a safer form of money than commercial bank money (the money held in a bank account). This is because a central bank can always create more money if it needs to, whereas a commercial bank can go bust.
So, if a business has a CBDC deposit account, then as the central bank has the liability for the CBDC this money is completely safe. As a result, there is a risk to the commercial banking system from introducing CBDCs. If they are introduced, and they are safer than commercial bank money, then there is a risk that people and businesses will simply withdraw money from commercial banks and deposit it with a central bank. This could lead to a run-on commercial banks, particularly in the event of a banking crisis.
Even if the introduction of a CBDC does not trigger a run on a bank, the movement of money from commercial bank accounts to a CBDC would have an impact on the commercial banking system. If a bank has less deposits it needs to look to other sources of funding for its loans. As a result, loans could become more expensive following the introduction of a CBDC. For this reason, central banks are looking to have a zero-interest rate on CBDC balances (effectively making them digital cash) to dissuade individuals using them as a store of value.
Given the downsides, why are central banks introducing CBDCs?
The main reason is that central banks are worried about losing control of the monetary system. With the rise of stablecoins and other forms of cryptocurrencies, there is a danger that individuals and businesses will stop using national currencies and instead use other forms of money. For example, the People’s Bank of China want to avoid commercial companies, such as Alipay and TenCent, dominating retail payments. Similarly, Big Tech companies such as Facebook are looking at introducing their own stablecoin, which could become systemically important and disintermediate national payment rails. An alternative business case comes from the Eastern Caribbean Bank who have introduced DCash, a CBDC equivalent to the Eastern Caribbean Dollar, as a financial inclusion project, allowing citizens who may not have bank accounts access to digital money.
One important use case for CBDCs is cross border payments. Settling cross border payments in CBDCs through direct connections on a blockchain would avoid the delays and costs associated with cross border payments being processed through a correspondent banking network. In fact, a recent paper from the BIS Innovation Hub on Project Inthanon-LionRock suggests that using a CBDC for cross border payments could reduce the transfer speed from multiple days to seconds – effectively introducing real-time cross border settlement in a fiat currency.
How do CBDCs affect cash management?
Obviously if a CBDC balance attracts a zero interest then it would not be useful as a long-term investment or deposit position. Indeed, it may be that commercial banks need to increase the interest rates they offer on deposits to ensure they have sufficient funding for their loan positions, so keeping cash in a commercial bank makes sense as a medium- to long-term investment.
However, there are advantages both in speed and cost in using CBDCs for payments. Therefore, it looks like using the best of both worlds would mean keeping money deposited at a commercial bank to enable the best return but exchange that for CBDCs when moving the money to reduce the time and cost of payments.
As a result, corporate treasurers will be looking for commercial banks that can automatically switch from a position that attracts a return to an equivalent CBDC amount when making a payment and of course when receiving a payment in CBDC moving this to an asset where the corporate customer can get a return on their balance, be that a deposit account, fund position or some other asset.
Most central banks are at an experimental stage with CBDCs. So, it is not yet time for corporate treasurers, or their commercial banks, to make any long-term plans. However, given the potential impacts of CBDCs, it is a subject both banks and their customers need to keep under review.
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