Navigating Terra Nova: The role of commercial banks in a future CBDC ecosystem

The global payments landscape has seen a dramatic transformation over the past ten years. Mobile payments have exploded in many markets with increased smartphone usage, while the entry of fintech companies and other non-bank financial institutions has led to numerous innovations and the application of new technologies. Dozens of central banks are now considering issuing Central Bank Digital Currency (CBDC), a new form of digital cash, for widespread use by households and possibly also businesses. 87 central banks are now actively exploring CBDC issuance, including the world’s largest economies, a dramatic shift compared to just a couple of years ago. Industry interest in the topic has naturally peaked in response, with potentially significant implications for payments ecosystems everywhere.

A major question that has emerged from an end-user point of view is how to ensure that CDBCs will have the same characteristics as cash, with the need for anonymity or privacy being a key concern. This is also reflected in a recent statement by Fabio Panetta, Member of the Executive Board of the European Central Bank, on the ongoing evaluation of the digital euro project: ‘…a greater degree of privacy could be considered for lower-value online and offline payments. These payments could be subject to simplified AML/CFT checks, while higher-value transactions would remain subject to the standard controls.’

Another relevant point is the question what the issuance of retail CBDCs could mean for the role of commercial banks, which have been the key institutions behind the creation of money and the provision of credit for hundreds of years. Even though the Bank for International Settlements (BIS) has espoused ‘do no harm’ as one of three foundational principles for CBDC design, that does not mean that the introduction of CBDC will have no impact on the role of banks. Introducing a new form of digital central bank money to the public via issuance of a retail CBDC could introduce changes in the traditional model for financial intermediation. And while central banks have been clear that they do not intend to disintermediate commercial banks nor offer the types of customer services that banks have traditionally provided, there is still ambiguity about the value proposition of banks in a future CBDC ecosystem.

Imagining commercial banks’ value proposition

There are several key areas where commercial banks could offer compelling value propositions in a future CBDC ecosystem. First, commercial banks’ history and experience with identity verification, fraud detection, and KYC/AML compliance will be a key area of expertise with respect to CBDC, regardless of the type of user access model. There will also likely still be a need for custodial or depository services for businesses or other institutions, an area where commercial banks have a strong record. Moreover, the rollout of a CBDC would generate large amounts of transaction data that could open opportunities for analysis and new real-time economic insights as other types of digital payments have shown. Customer privacy and data security are already key concerns for users in some markets such as the euro area, and banks already have high levels of user trust in this area. Lastly, with the potential for CBDC to facilitate programmable money, commercial banks are likely to be able to provide liquidity management for corporates with a new level of flexibility and utility. There could also be new opportunities for commercial banks to add value in terms of innovation and product development in ways that cannot yet be conceived.

Remaining relevant vis-à-vis non-bank competitors

With innovation and competition being two of the key public policy principles for retail CBDC as established by the G20, central banks are likely to explore the notion of expanding access to non-bank financial entities, such as payment and electronic money institutions, and beyond, such as fintech companies, large corporations, and others. Doing so is seen as an opportunity to level the playing field and foster inclusiveness with financial services, which in turn could drive market competition and foster financial innovation, with greater choice and better services for end-users.

Surging growth in mobile payments and Open Banking has already forced banks to contend with the rise of non-bank payment service providers by developing new business and technology strategies, reassessing their offerings, and developing new services (or risk being left behind). They have made large investments in client services and the development of online and mobile banking channels. Many have undergone significant infrastructure modernisation and outsourced certain functions to external providers, allowing them to shorten time-to-market. They have embraced new business models, such as developing partnerships with non-traditional players. These strategies are likely to remain highly relevant for banks to successfully compete in a future CBDC ecosystem.

Central banks need to think carefully about the underlying business model

It is already clear from looking at current CBDC implementations that central banks face significant challenges in designing a viable business model to support CBDC adoption. As part of these business model considerations, central banks should, for example, think about how to maintain a level playing field for all stakeholders involved. Currently, it is not clear how different stakeholders would be compensated for any responsibilities they might take on in the distribution and servicing of CBDCs.

Take for example, the e-CNY, which reportedly already has over 260 million users, or one-fifth of the country’s population, according to the People’s Bank of China. The e-CNY system architecture relies on a tiered approach, in which there are two types of authorised intermediaries. The first tier is a small group of large commercial banks that are responsible for opening customer accounts, providing e-CNY exchange services and ensuring KYC/AML compliance; the second is a broader group of commercial banks and other financial institutions that can develop and provide new payment and retail services to users. While commercial banks are clearly being given an important role in the e-CNY ecosystem, it is not entirely clear how the first-tier banks can monetise their investments, or how e-CNY usage will be incentivised, particularly given the multitude of existing easy-to-use and convenient digital payment solutions in the country.

Nonetheless, keeping investment costs low for commercial banks is an important part of making the CBDC business model compelling, with interoperability between CBDC systems and existing payment rails and infrastructure being of key importance. In the euro area, a system like TARGET Instant Payment Settlement (TIPS) could be used to facilitate digital euro transactions in an account-to-account context. Should interbank payments make use of the digital euro, they could be processed via banks’ settlement accounts and funded using commercial bank money. While current rules and processes regulating payments transactions would have to be updated and revised, which would take time and resources, commercial banks could leverage investments they already made in existing infrastructure to offer digital euro-based services.

Conclusion

Navigating a new territory such as a future CBDC landscape will be no easy task for any participant in the payments space. In assessing their potential value proposition regarding CBDC, commercial banks are largely in a position of wait-and-see as they monitor the central banks’ key design decisions that will ultimately determine their future role within the CBDC ecosystem. With the roles between central banks and commercial banks in financial intermediation having been clearly defined for so long, it can be difficult to imagine how these may shift. Although the fundamental banking services that commercial banks offer are unlikely to change, expanded access to central bank digital money will lead to increased competition from an ever-growing and dynamic group of non-bank financial institutions. Banks should be prepared to leverage their existing areas of expertise and comparative advantages and strategise ways in which CBDC can be integrated into their suite of product and service offerings.

About Tino Kam

Tino Kam, Head of Product Management Transaction Banking at Nordea, is the chair of the EBA Cryptotechnologies, Smart Payments and Stablecoins Working Group. He has 20+ years of leadership experience in transaction banking and payments through roles at Nordea, Capco, ABN AMRO and RBS.

About Daniel Szmukler

Daniel Szmukler, Director at the Euro Banking Association, has been in his current role with since 2012. Responsible for innovation, bank relations and strategic engagements, Daniel runs the EBA’s thought leadership, events and education streams and manages the EBA’s innovation working groups, the EBA schools, as well as the annual payments conference EBAday.

About Euro Banking Association

The Euro Banking Association (EBA) is a practitioners’ body for banks and other serviceproviders. We foster dialogue and experience exchange amongst payments industry practitioners towards a pan-European vision for payments. The EBA has over 160 members from the European Union and across the world.