More countries seek to develop digital currencies as consumer preferences change

Central banks must balance CBDCs’ innovation potential against their disruptive effects, Moody’s says

Central banks across the world want to develop digital currencies amid the growing popularity of cryptocurrencies as an asset class among retail and institutional investors. Photo: Getty

The number of countries developing central bank digital currencies has dramatically increased when consumers pivoted to digital payments during the coronavirus pandemic, according to Moody’s Investors Service.

However, central banks must balance CBDCs’ potential to solve specific problems against their disruptive effect on existing financial market infrastructure, particularly banks, the ratings agency said in a report on Tuesday.

“Benefits from the adoption of CBDCs would vary across jurisdictions, and CBDCs can be geared towards addressing specific idiosyncrasies,” Farooq Khan and Melina Skouridou, vice presidents at Moody’s, said.

“A CBDC could provide a systemically safe, state-sponsored payment alternative to existing payment rails. In emerging markets, increasing financial inclusion thereby reducing informality, as well as lowering costs of existing inefficient payment systems are additional compelling arguments for developing and launching CBDCs.”

Central banks across the world are looking into the development of digital currencies amid the growing popularity of cryptocurrencies as an asset class among retail and institutional investors.

The rapid development of CBDCs could help boost financial inclusion and stability, but they pose a threat to banks and could weaken their ability to lend, according to Fitch Ratings.

They would also help to speed up cashless payments and could “bring underbanked communities into the financial system” in many emerging markets, the credit ratings agency said in a report in May.

China was one of the first major economies to develop plans for a CBDC in 2014 and has already begun limited trials through mobile apps. Other major economies are following suit.

The Bank of Japan began a year-long series of experiments for a digital yen in April and the UK Treasury and Bank of England set up a joint task force to develop a CBDC, nicknamed the “Britcoin”. The Bahamas introduced the “Sand Dollar” CBDC in October last year.

In June, US Federal Reserve chairman Jerome Powell said that he has not made up his mind on the pros and cons of a CBDC, but would want authorisation from Congress before taking action to create one.

G7 finance ministers and central bank governors have also pledged to work together on CBDCs to develop an understanding "on their wider public policy implications".

The Eastern Caribbean became the first currency union central bank to issue digital cash in April. The so-called DCash is being initially rolled out in four of the eight member countries of the Eastern Caribbean Currency Union, according to Bitt, the Barbados-based company which led its development. The pilot includes Antigua and Barbuda, Grenada, Saint Kitts and Nevis, and Saint Lucia.

In February, the Central Bank of the UAE said it was participating in a central bank digital currency project with the Hong Kong Monetary Authority, the Bank of Thailand and the People’s Bank of China to investigate the use of CBDCs in cross-border payments.

The advancement of CBDCs has also been driven by the rise of stablecoins – digital assets that are linked to the US dollar or other currencies – and the acceleration of digitalisation, while financial inclusion, security costs of cash, reducing informality and improving payment efficiency in emerging markets are other catalysts, according to Moody’s.

As consumers increasingly prefer faster, easier and cheaper digital payments, central banks favour the least-disruptive choices as they design their digital currencies, the ratings agency said.

“The preferred choice for the CBDC model is the two-tier retail CBDC, in which banks and other financial intermediaries will maintain client-facing roles, while end-users see little change in terms of interacting with their current financial institution,” Moody's said.

Although CBDCs are not meant to compete directly with bank deposits, they would provide a risk-free alternative, attracting retail deposits, which are the predominant funding source of banks, Moody’s said.

This would create heightened disintermediation risks for banks, higher funding costs and fee income loss, it added.

The Bank for International Settlements teamed up with the central banks of Australia, Malaysia, Singapore and South Africa this month to test the use of CBDCs to settle cross-border payments. As part of a new initiative named Project Dunbar, the global body for central banks will develop a prototype of shared platforms for cross-border transactions using multiple CBDCs.

The BIS has long expressed its support for CBDCs, saying they contribute to an open, safe and competitive monetary system that supports innovation and serves the public interest.