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Central banks can shape the future of digital finance

Like all other major central banks, the Federal Reserve is engrossed in the economic impact of a pandemic. So far, managing unprecedented supply shocks is our first business. But another issue, albeit quieter, is paying close attention. Over time, it emerges from bystanders and is very important and concerns all aspects of central bank policy. To be precise, what is the future of money?

In pondering this question, the Fed and its counterparts are not leading the revolution enough to keep up with it. Technology has transformed the monetary system at an accelerating pace in recent years. Banknotes are becoming obsolete as consumers are drawn to more convenient electronic payments using bank accounts, credit cards and other online systems.

As a result, developed countries are becoming cashless, regardless of Bitcoin or other cryptocurrencies. Banknotes were used in about 40% of US consumer transactions in 2012. By 2019, that percentage had dropped by about a quarter. In 2020, the market share fell to 19% as pandemics boosted e-commerce and some retailers in physical stores began refusing cash.

While there are certainly many benefits to this transition, there are undeniable risks. It provides valuable backup even if cash is no longer the primary means of closing transactions. Regulators may do everything they can to ensure that private payment systems are robust, but problems can still occur.

One potential answer to this dilemma is known as the central bank’s digital currency. Retail CBDC is electronic cash, held by businesses and individuals in central bank accounts, run on a strong and independent network, and supported by the full trust and credit of the government like banknotes. They are still (for example) vulnerable to energy and data system shutdowns, but without them they could move towards filling empty space with physical cash.

In fact, they can be significant improvements. In its role as a financial backup, the CBDC can be used in a much wider range of transactions, including e-commerce. They have the potential to spur new payment systems and put competitive pressure on existing businesses, thereby increasing efficiency and lowering costs. It could also meet the demand for innovations such as stablecoin (a cryptocurrency allegedly backed by other assets) without threatening financial stability.

Finally, the CBDC can serve purposes not possible with regular cash by creating new channels for monetary policy. Instead of indirectly affecting interest rates, central banks can adjust interest rates paid to the CBDC’s retail balance by managing reserves held by banks and other financial institutions.

Of course, all these opportunities have potential downsides. The benefits of the CBDC as a payment system may initially be great enough to drive existing systems out of business. In that case, there will be less competition and innovation. In addition, the greater the perceived benefits of new electronic cash, the less likely it is that a company or individual will hold banknotes or commercial bank deposits. Such “disintermediation” can have a significant impact on how banks raise their own funds, potentially reducing or increasing the lending of commercial banks.

Alternatively, if the central bank chooses to expand its own balance sheet and support the supply of credit by directing alternative funds to commercial banks, the central bank will more than ever make the choices they do not want. You will be drawn deeply. Independence, already under stress, will appear more and more suspicious.

None of this is easy. With full involvement, this debate could make the policy issues raised by the pandemic look simple. But discussions cannot be avoided. For some reason, a cashless society is coming. The central bank needs to decide that: Will it just make it happen, or will it seize the opportunity to shape the future of finance?

https://gulfbusiness.com/central-banks-can-shape-the-future-of-digital-finance/ Central banks can shape the future of digital finance

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