Is CDBC the key to unlocking financial inclusion?

Gonzalo Santamaria and Jens Seidl from Currency Research discuss the potential CBDCs hold to create new opportunities to individuals that had previously declined financial access

While the payments industry is making great strides at driving innovation and new technologies, very few of the new products and services being developed are helping to drive financial inclusion on a large scale. Mobile payments are perhaps the most obvious and promising exception, but they typically are not interoperable, resulting in a wide range of competing services that don’t play or interact well with each other. Can central bank digital currency (CDBC) be the key to changing that? Let’s take a brief look at how we got here.

Considered the first widely-known peer-to-peer electronic cash system, Bitcoin recently blew out its 12th birthday candles. This crypto-asset lay the grounds for many ideas and innovations in digital currencies, including distributed ledger technology (DLT) and blockchain. By design, it lacks government backing (it was indeed created in the aftermath of the financial crisis in 2008 as ‘the people’s money’, independent of central and commercial banks) and its innovative technology also included some design flaws that resulted in high volatility, energy-intensity, transaction delays and costs, rendering it useless as a high volume, mass-market payment instrument.

Enter stablecoins. After several iterations, it was not until the whitepaper released by Facebook’s Libra in June 2019 that an awakening truly arose amongst the central banks and regulatory compliance community. Stablecoins reduce volatility and provide trust by means of pegging one or more currencies or other tangible tradable assets, such as oil or gold, effectively introducing an intrinsic value to the crypto asset that Bitcoin lacks. Libra opted for a representative currency basket including USD, EUR, JPY, GBP, and SGD, and add to this a market reach of 2.7 billion captive users, eyebrows suddenly raised, and ears had perked. Financial stability was potentially at risk and the alarms sounded globally.

CBDC, a concept that had been discussed for quite a while in the central bank community, was suddenly pushed into the spotlight, lauded by some as the best way to counter the Libra threat (other than through restrictive regulations, of course). CDBC is not a particularly well-defined term; it is a new form of electronic central bank fiat money that can potentially be accessed directly by consumers, typically a privilege that only commercial banks and other financial institutions enjoy through reserve and settlement accounts. In that regard, it can have a lot in common with cash, the only central bank money currently accessed by the public. Some central banks have experimented with CDBC as a wholesale settlement instrument, which provides a safe environment to get familiar with the technology – it does not however provide the perceived ‘game-changing’ aspect of direct access by the public.

A survey issued by the Bank for International Settlements reported that 80% of the 66 central bank respondents were either exploring, researching, or indeed planning to issue a CBDC in the near future. This figure is sure to rise in the coming months. A recent survey commissioned by Currency Research in collaboration with Lipis Advisors shows that the majority of central bank respondents believe that COVID-19 will accelerate the launch of CBDC globally.

Developed nations contemplating issuing CBDCs are apparently doing so primarily for financial stability and monetary policy reasons. However, a stronger case can arguably be made for the issuance of CBDC in developing economies. According to Jean-Michel Godeffroy, Chairman of the Central Bank Payments Conference and former Director General of Payment Systems and Market Infrastructure at the European Central Bank, ‘in many developing countries there is insufficient competition between banks, as well as a very loose network of bank branches and little or no deposit insurance. The business case of CBDC in developing countries is probably stronger than in most developed countries; in these parts of the world, the issuance of CBDC in parallel to banknotes could enhance economic growth and financial inclusion’.

With bank deposits being uninsured and depositors risking their savings (should commercial banks become insolvent), not to mention the costly barrier of commission fees, many citizens consciously ‘opt’ to remain excluded from financial services. Providing access to risk-free reserves via a CBDC can therefore create new opportunities to individuals that had previously declined financial access. Furthermore, many use cases suggest that the widespread global adoption of mobile phones can be a key to resolving many of these issues. A great majority of citizens in countries across the globe, including those in emerging economies, now own mobile devices—and in some regions, these include a healthy proportion of smartphones. A CBDC can easily be distributed via these channels, removing the need to use cash to move money in and out of a closed-loop mobile payments system, or even the need for a commercial bank account.

In parallel, ‘network effects’ such as those described in the International Monetary Fund’s Designing CBDC working paper*, can cause mass disruption in the usage of payment instruments. An example is the declining cash use in many countries, accentuated over the recent months by pandemic-related commercial lockdowns. Banks may reduce branches/ATMs and in some markets, retailers even refuse to accept cash, all of which are resulting in a decline in cash availability. Determining whether this remains a punctual disruptor or a true shift/change in habits is yet to be seen. However, these network effects may cause some payment instruments to disappear, or indeed fall below a critical usage threshold, thus affording a CBDC further incentive and justification, with Sweden’s e-krona initiative perhaps being the best example.

Currency Research and Enryo recently launched a global initiative, ‘Universal Access to Payments’ or UA2P, recognising the need to both understand such effects and to implement plans that will proactively address potential issues. UA2P seeks to help further financial inclusion by providing access to new digital payment instruments, while ensuring that access to cash will not suffer as a consequence.

An opinion often discussed is that CBDC should be issued in partnership with commercial banks in order to avoid the potential disintermediation of the established banking infrastructure. The scenario of a ‘super bank run’ has been repeatedly described in the CBDC literature, wherein a financial crisis similar to the one experienced in 2008 would lead consumers and even corporates to abandon the commercial banking system and convert all their funds into central bank-backed CBDC, effectively leaving the commercial banks with only debt. While the logistical challenges of cash make such a bank run less likely (we would argue impossible, as in most countries there would not be enough cash in circulation to fulfil such extreme demand), real-time access to CBDC may just open that Pandora’s Box.

If the approach taken by developing countries is to distribute CBDC through commercial bank partners, will the central bank’s role as the lender of last resort be perceived as a sufficient benefit for those that currently do not use a commercial bank? Or is the key to financial inclusion to develop distribution channels for CBDC outside the commercial banking systems? What functionality does a CBDC have to provide to drive financial inclusion and how will that influence the technology implementation? And finally, how different will a CBDC designed to drive financial inclusion in a developing country be from one that is intended to provide a digital alternative to cash in a mature market where cash usage is declining year on year?

Recognising the need to debate such questions, share knowledge and learn from experience already gathered, Currency Research is launching the new Digital Currency Conference in 2021, providing a platform to help shape a critical element of the future payments landscape—and hopefully, a more inclusive one.

* WP/19/252 IMF- Designing Central Bank Digital Currencies by Itai Agur, Anil Ari and Giovanni Dell’Ariccia

This Expert Opinion was published in our ebook Central Bank Digital Currencies for Dummies – A Quick Guide into CBDCs.

About Gonzalo Santamaria

Gonzalo Santamaria, with nearly 35 years of cash & payments industry experience, has held the VP Payments position at Currency Research since 2013 and has successfully led the business development of the flagship Central Bank Payments Conference (CBPC), the e-publication Central Bank Payments News (CBPN), the regional Global Payment Summits (GPS), and the Digital Currency Conference (DCC).

About Jens Seidl

Jens Seidl has been in the industry for 30 years with senior management roles in sales and marketing, operations, customer service, business development, and general management. Throughout his career, his work spanned across cash and payments, including leading highly complex automation projects, transformation programs and highly profitable global business units. Jens joined CR in 2018 as Vice President, Business Development and Consulting. In November 2020, he was appointed as President/CEO.

About Currency Research

Currency Research’s mission is to inspire and progress industry dialogue and efficiency across cash and payments through their core initiatives of Conferences, Consulting, Communication and Community. CR has successfully positioned itself as the leading global resource for central banks, their suppliers, and the related supply chain for currency and payment systems. CR has published a number of research-driven reports considered mandatory reading by the industry, publishes the monthly Central Bank Payment News, and provides consulting services with a focus on strategy and policy to central banks, regulators, and commercial organisations. To learn more, visit our website.