Just when we all thought that cash management could not get any more complex central banks have begun introducing a new type of money – Central Bank Digital Currencies (CBDCs). This is an extract from The Future of Digital Banking in Asia 2022 report.
CBDCs are a form of electronic money issued by a central banks like the Monetary Authority of Singapore (MAS) or Reserve Bank of India (RBI). Currently there are three types of money:
- Physical money or cash which is money in the form of notes and coins
- Commercial bank money which is electronic money people and businesses hold in their accounts at banks such as ICICI or Citi
- Central bank money which is electronic money that commercial banks hold in accounts at central banks to enable movements of money between banks.
The difference between a CBDC and the existing electronic central bank money is that the existing electronic central bank money is only available to financial institutions such as direct participants in the payment system, whereas a CBDC would be available to businesses or individuals.
Money is interoperable. This means ₹500 in an individual’s bank account can be converted to a ₹500 note at an ATM. Similarly paying for a coffee worth S$1.50 can be made with a contactless debit card or with coins and the cost is the same. A CBDC would be another form of interoperable money. Therefore, ¥10,000 held in a commercial bank account would be worth the same as ¥10,000 held in a Bank of Japan issued CBDC.
Central bank money (such as a CBDC) is a safer form of money than commercial bank money (money held in a bank account). This is because a central bank can always create more money if it needs to, whereas a commercial bank can go bust.So, if a business has a CBDC deposit account, then as the central bank has the liability for the CBDC this money is completely safe. As a result, there is a risk to the commercial banking system from introducing CBDCs. If they are introduced, and they are safer than commercial bank money, there is a risk that people and businesses will simply withdraw money from commercial banks and deposit it with the central bank. This could lead to a run-on commercial banks, particularly in the event of a banking crisis.
Even if the introduction of a CBDC does not trigger a run on a bank, the movement of money from commercial bank accounts to a CBDC would have an impact on the commercial banking system. If a bank has less deposits it needs to look to other sources to fund its loans. As a result, loans could become more expensive following the introduction of a CBDC. For this reason, central banks are looking to have a zero-interest rate on CBDC balances (effectively making them digital cash) to dissuade individuals using them as a store of value.