What CBDCs Could Mean for Us and Banks?

 According to the Atlantic Council, over 65 countries are in advanced stages of developing their Central Bank Digital Currencies (CBDCs) and twenty central banks have launched pilots. Though emerging markets were developing faster to begin with, an increasing number of developed countries have quickened efforts. As one example, even in the midst of war, Ukraine’s Deputy Prime Minister, Mykhailo Fedorov, has demonstrated his support by saying that he'd be taking his salary in e-hryvnia, Ukraine's CBDC.

Which begs the question, why the rush? Also, how could the change impact life as we know it, and banks as we know them. I’ll start by explaining what CBDCs are and are not.

What are CBDCs?

As its most basic, CBDC’s are nothing but a digital form of currency issued and backed by central banks. For example, if the Euro is the currency in the European Union, its CBDC will be the digital Euro.

Considering many of our current transactions are already cashless, one might ask how the digital dollar differs from the electronic dollar that you just spent when renting a film from Amazon Prime or tapping your watch at the train station.

I believe the simplest way to understand this distinction is to view your current fiat currency as physical money held in an electronic form, because technically, that dollar you hold, is fungible. What I mean is that a dollar in hand is the same as a dollar on your app or card.

Digital money, on the other hand, isn’t convertible into cash and will always remain in digital form. Running on digital ledgers, it'll be similar to cryptocurrencies in that we won’t be going to cash machines to withdraw Satoshis, any time soon.

However, what one needs to bear in mind is that CBDCs are effectively the central bank's response to decentralized digital money. Though CBDCs may look like cryptocurrencies, when it comes to control and central oversight, they're the opposite. While cryptocurrencies are issued by independent entities, CBDCs are on central bank owned and managed ledgers, and any partners they might choose to work with.

I suppose given the central backing, CBDCs may be less volatile than cryptocurrencies, yet, they aren’t designed to support anonymity or decentralization. They are in fact connected to the idea of control, central oversight and single digital identity for every person. To understand this better, you might like to have a read through a recent statement by ECB President Christine Lagarde, in which she admits some control over the digital Euro, albeit limited.

To appreciate this point fully, we need to understand the concept of programmable money. CBDCs are programmable, which means that they can have inbuilt controls that prevent money laundering and so on. Yet, what this also means, is that central banks could also pre-determine what you can and can't do with your CBDC. For example, CBDCs could be programmed such that they can only be spent on certain items and places. As a comparison with your life today, this might be the same as mandating something such as that you must only buy local produce or that you can't spend money on items made in, say for example, India.

I'll be a little creative and take this concept further by combining the concept of unique digital identities with programmable money. What this could mean is that not only could you be told where you can and can't spend, the rules for you could be configured based on your identity and therefore, be different to the others, such as your family. For example, on one hand, money may be programmed such that it stops children from spending on alcohol, yet, a more regressive government could programme their CBDC such that women are unable to spend on education.

While these are extreme examples, my aim is to show you both sides of this picture. Suffice to say that CBDCs could impact everything from our day-to-day lives to cyber security, privacy, regulation and financial markets.

How Adoption Could Work?

While techniques to drive adoption will vary, one particular example making headlines appears to be the roll out and adoption of Nigeria's eNaira.

The Central Bank of Nigeria (CBN) introduced E Naira as early as October 2021. Following launch, CBN was struggling with adoption and in fact, even a year after launch, as little as 0.5% people had adopted the ENaira.

However, in March 2023, the uptake suddenly spiked by 63%. This drastic surge was driven not by collective will, but by a cash shortage caused by a note replacement programme.

A point to note is that while cryptocurrencies are an option, CBDCs could be mandated - if not be law, then by making it difficult for people to operate without them. If you need an example of how that works, think of digital vaccine certificates.

What This Could Mean for Banks and other Financial Service Providers?

Before we go into the role of banks, I’d like to distinguish between the two layers of banking as we’ve experienced over the past 250 odd years. That is, central banks and commercial banks. In this construct, central bank are the apex banks that take care of macroeconomic aspects, and commercial banks are the institutions that initiate deposits, loans and so on. Therefore, when managing our money, including everything from deposits and loans to mergers and acquisitions, we're dealing with commercial banks.

In terms of the impact of CBDCs on commercial banks, these are few points to consider.

1. The Impact on Fractional Banking Model

Traditionally, banks make money by using fractional-reserve model which involves using idle deposits to create new money through lending. Central banks control the demand and supply of money through levers such as interest rates and Cash Reserve Ratios (CRR).

However, if all our money was converted to CBDCs and the role of commercial banks was significantly reduced, this could lead to the collapse of the fractional-reserve model because banks wouldn't have deposits to finance loans.

2. The Role of Commercial Banks May Vary Based on What Central Banks Decide

When it comes to CBDCs, the role of banks (i.e. commercial banks and financial service providers) remains unclear because a lot depends on how each central bank will partner with the rest of the ecosystem; and how authority and responsibility will be split between all involved parties.

In the case of Nigeria, it appears that the central bank didn’t involve commercial banks and payment processors, and that’s believed to have been a key cause of slow adoption. However, other countries plan to leverage banks and their customer base, and therefore, scenarios will vary. For example, in the UK, the digital Pound will be issued by the central bank, which will provide its value and assure authenticity, yet, it's expected that distribution will be done via banks and other service providers.

3. The Ownership of Risks Might Change

I’d assume that since CBDCs will be programmed upon issuance, there'll be shared responsibility models, such that the central banks may be accountable for some inbuilt controls. For example, controls to manage money laundering, or prevent the use of CBDCs in sanctioned countries could probably sit with central banks. I believe this will also bring central banks within scope for some regulations, such as those associated with privacy, preventing financial exclusion, possibly even creating vulnerability markers within the CBDC and so on.

4. Banks Could Use the Opportunity to Build New Products and Services

While it’s yet to be ascertained how much of our money we’ll be holding in traditional money Vs digital money, assuming banks remain part of this transition, my belief is that banks will begin to play a different yet expanded role. As service providers to the CBDC, they’ll be able to build new products and propositions with CBDCs as they do with fiat currencies.

Conclusion

The current economic system, which has been in place since centuries, continues to face disruption.

It's believed that the ongoing development of cryptocurrencies can jeopardize central banks' ability to conduct economic affairs via monetary policy. In response to this, central banks are developing their own digital currencies to adopt the technology and also build a direct relationship between them and end consumers. Several countries are in advance stages of development and sooner or later, CBDCs will make their way into our ecosystem.

There's little doubt that the presence of CBDCs, coupled with digital identities and the concept of programmable money, will impact how we live and work.

While it’s fair for individuals to worry about control and loss of privacy, central banks will be mindful that excessive regulation could tip the balance towards decentralized currencies, which CBDCs are trying to compete with in the first place.

Commercial banks, on the other hand, fear disruption yet again, and this time, the threat has arisen from within the banking system. However, my belief is that commercial banks can play a huge role given their existing infrastructure and deep understanding of customers and criminals. Done right, this could be an opportunity for commercial banks and other financial service providers to view central banks as an ecosystem partner of sorts, and serve customers with a wider range of offerings, which could be a mix of traditional money, digital money and cryptocurrencies.  

ABOUT THE AUTHOR

Vinita is a versatile and impactful financial services leader with credible reputation. With 25 years of corporate experience, Vinita and has held substantial leadership roles in operations, strategic thinking, learning and risk. Some of her past roles include Head of Conduct at Barclays Wealth, Head of Risk at HSBC Commercial Bank and Global Head of API governance, also at HSBC in London.

Vinita is also an EMCC accredited coach, a prolific writer and public speaker. She’s authored three books and manages a biweekly newsletter on LinkedIn. It’s titled ‘Let Success Make the Noise.’

If you enjoyed this piece and you wish to connect with Vinita for further engagements, you can reach out to her via LinkedIn or write to her on vr@vinitaramtri.com.