The space race of the 1960s was a thrilling battle for supremacy, occupying the finest minds of the time. Whether they know it or not, a whole host of institutions across the financial services sector are now firmly in a sprint of their own. Almost 70 different countries are either researching, developing, or piloting their own Central Bank Digital Currency (CBDC). But despite this, the impact they will have on the financial and economic system is still relatively unknown.
To provide a sense of scale, the cost of cash is now about three percent of GDP. It is one of the biggest industries in any country and permeates everything. According to the Bank of England, RTGS settles over £700bn on an average day.
In response, commercial banks, payment providers and others are clamouring for data on how CBDCs will impact them. The central banks fear it may disintermediate banks and the subsequent stability problems this might bring, while payment providers fear losing their seat at the table. Commercial banks, meanwhile, are similarly concerned.
Knowledge is power
CBDCs may be closer than anyone thinks – and those who have insight will be able to shape their introduction. Commercial banks need to act now to inform themselves on how they want this brave new world to be built. Currently, there are lots of opinions flying around. Often very well structured and sensible opinions, but lacking quantification and evidence. Commercial banks recognise they will be far better placed to create the future of money in their own image and to take advantage of the opportunities it brings. In-depth modelling and simulation are the only real ways to do it, changing opinion into qualitative results.
CBDCs may feature prominently in many central bank strategies, but they need to deploy simulation technology to fully understand the economic, liquidity and financial stability implications of introducing them – the same way many governments’ pandemic response policies were informed by epidemic modelling and simulations.
Why does this matter?
The financial crisis highlighted how interconnected the global economic system is. Impacts in one sector create a ripple effect that has the potential to cause significant damage. Failing to understand this is now longer an excuse.
As we have seen from the Bank of England’s own data, introducing a CBDC presents significant risks not just to the balance sheet of commercial banks, but monetary policy transmission and the smooth functioning of payment systems. Simulation provides clarity on the impact on commercial bank deposits and adoption rates as well as the optimal design and configuration of the CBDC itself, and on strategies to foster its adoption by consumers and merchants.
It is therefore essential that a bank’s CBDC configuration takes this and other economic factors into account. For example spending limits, balances caps, interest rates, and adoption paths all need modelling and testing.
It is very possible that an adoption scenario might involve a high volume of debit and credit card payments as well as cash payments moving to a CBDC may require a more resilient payment architecture. A better understanding of the risks and implications this brings, through testing of various scenarios, allows for quicker decision making and ultimately, a more successful and safer introduction of digital currencies.
It is important to understand that everyone has a stake in this. Banks, card companies, cash-in-transit companies, ATM vendors, the Bank of England, the Treasury and more. Some may form consortiums to understand the impact of CBDCs, while some might want to keep the findings closer to their chests. But the implications are huge.
Commercial banks and card schemes have rightly been jolted into action – and understand the need to undertake modelling and simulation to help shape the future of money. The best way to go forward is when industry, consumer groups, and the government are aligned on the best way forward. Simulation is a tool to bring everyone together. One thing is for sure – we are moving from the theoretical to the practical when it comes to the introduction of CBDCs.