Bank of Lithuania on the potential of central bank digital currencies

Central Bank Digital Currency (CBDC) is digitally issued central bank money, the equivalent of cash in digital form (in a standard retail CBDC case). Commercial banks already have access to digital central bank money through reserve and settlement accounts, but the idea is still novel for non-financial companies and private individuals.

CBDC is currently enjoying a great deal of attention in the academic and central banking communities. Naturally, central bankers are particularly interested in the potential effects of CBDC on monetary policy. In this arena, high hopes are coupled with real concerns. There are hopes that CBDC could strengthen the pass-through of monetary policy. For example, it is expected that CBDC could help to overcome the zero lower bound, strengthen monetary policy pass-through due to the possibility of applying interest rates on CBDC, setting a hard floor on money market rates and even retail deposit rates, or by greater financial inclusion. At the same time, a more conservative approach fears the potential of CBDC to induce structural bank disintermediation and stimulate bank runs in stress situations due to the provision of an asset for digital runs. Heated discussions on the topic continue, as does the search for the cost-benefit balance of the CBDC impact on monetary policy and financial stability more broadly.

Should everyone get excited about CBDC?

The excitement in the general society about the innovativeness of CBDC idea seems to be less intense. In the age of online and mobile banking, with all the banking potential being available at the touch of one’s phone, the idea of digital money is hardly something to get excited about. Therefore, the question arises: is there is a reason for everyone to be as excited as central bankers about the possibility of CBDC?

The answer depends on several factors. First, where is this question being asked? For countries with low financial inclusion and an underdeveloped banking system, CBDC can be a key to the digital money world. In remote areas, where the local ATM regularly runs out of banknotes or is hard to reach altogether, CBDC can become ‘cash 24/7’. For those who live outside their home countries and pay high fees for remittances or businesses with cross-border activities, CBDC can help bring down cross-border costs and increase payment efficiency.

Second, how much trust does one place in one’s bank? Ultimately, CBDC and commercial bank’s digital money part ways on the risk the money holder accepts. CBDC, just as cash is, would be a safe asset - a liability of a central bank. At normal times, one rarely wonders about risks his or her money holds; however, a bank run, when depositors rush to withdraw their deposits due to doubts in bank’s credibility, is a perfect illustration of the diverse levels of risks (perceived and actual) that different money entails and that money holders are willing to accept. For individuals with access to a highly credible banking system and deposit insurance schemes, the increment in safety when moving from the private money to central bank money would be less motivating than for those without such access. In the most extreme cases, without the introduction of CBDC, societies with strong trust in their financial systems might choose the convenience of digital money while allowing the cash in circulation to decrease significantly. Those in the opposite situation would likely continue to prefer cash money as a safe means of payment and store of value. Ironically, such a preference is an obstacle to further financial digitalisation, hindering these very consumers from fully availing themselves of the convenience of digital finance.

Where the CBDC discussion is heading

Going forward, CBDC clearly has the potential to impact the financial system in a significant way. Currently, there is no consensus on the CBDC cost-benefit balance. This is true regarding both the discussion on the effect of CBDC on monetary policy and financial stability more broadly, and the optimal CBDC design to pursue given policy objectives. Once there is more clarity on the course to be taken with CBDC (if any), the central bank can choose the CBDC design that is most likely to mitigate potential unintended side effects and to strengthen desired outcomes.

Central banks around the world have been making vigorous efforts in this direction.  The work on CBDC began as one of mostly individual-country interest. For example, China is believed to be far ahead in CBDC work, Swedish Riksbank has been exploring the idea of e-krona, and Lietuvos bankas has launched blockchain-based LBChain and LBCoin projects which provide valuable insights for the CBDC discussion. Recently, joint action has been devoted to the idea: the Eurosystem has announced a taskforce to determine specific goals for CBDC, and the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Sveriges Riksbank, the Swiss National Bank, and the Bank for International Settlements have formed a working group to assess CBDC use cases and design choices.

The time for CBDC discussion stage is constrained by external developments. The global financial system has witnessed significant shifts and new trends in recent years and shows a strong potential for further changes, with the private sector demonstrating a willingness to innovate in this area (as, e.g., illustrated by the emergence of private sector stablecoins). This impulse of the private sector to address perceived inefficiencies in the financial system is quite understandable. Nonetheless, it is the task of official institutions to be at the frontlines of such changes and ensure systemically sound courses of action that bring about the greatest possible benefit to society. Whether this will take the form of an active provision of solutions by central banks or cooperation with the private sector and regulatory adjustment remains to be seen in the near future.

About Aistė Juškaitė

Aistė Juškaitė is principal economist at the Market Infrastructure Department, Bank of Lithuania.

About the Bank of Lithuania

The Bank of Lithuania (BoL) is a central bank (part of the Eurosystem) and a supervisory institution. Alongside other standard central bank and supervisory functions, the BoL ensures the stable and efficient operation of payment and securities settlement systems. Striving to be an innovative, proactive and open Eurosystem central bank, the BoL avidly seeks to implement cutting-edge solutions that benefit society.