Recent technological innovations and increasing demand for convenience and security have expedited the shift to digital systems, including financial systems. This has become the catalyst for people and businesses to find new ways of interacting and conducting transactions digitally.
As a result, central banks have shown increasing interest in the central bank digital currency (CBDC) concept to accommodate this demand. Central banks see CBDCs as not only meeting evolving needs of their constituents, but also as a way to drive financial inclusion, thereby levelling the financial playing field.
Additionally, the emergence of cryptocurrencies and stablecoins has highlighted digital currencies’ potential benefits – as well as their drawbacks and central banks are keen to consider the role that CBDCs could play in the broader financial system. Central banks want to be relevant in the digital world with their “brands” such as Dollar, Euro, Sterling, as it provides a digital answer to Crypto payments. The European Central Bank (ECB) is no exception and has been exploring the use of blockchain technology and CBDCs to improve the speed and efficiency of its payment systems.
Innovation in Payments
In recent years, the European payments industry has undergone significant changes, driven by advances in digital technology, the emergence of new payment providers and increasing consumer demand for faster, more convenient and more secure payment options.
In response, European authorities and financial institutions have been working to create an environment that fosters innovation in the payments sector while also striving to ensure the safety and stability of the financial system.
The European Commission has been supporting innovation in the payments industry through initiatives such as the Payment Services Directive (PSD2), which aims to create a more open and competitive market for payment services in the European Union.
Whilst the European Union has yet to issue a digital euro, it is exploring the possibility of doing so as a way of ensuring the euro remains a stable and trusted currency in the digital age. The ECB, in leading this exploration, is doing so in a way that a CBDC would complement, not replace, cash.
According to the ECB, which expects to introduce a digital euro across its 27 member states by mid-2023, “Central bank money is a risk-free form of money that is guaranteed by the state”. That said, the EU still needs to address the change of status of legal tender so as to lay the ground for mass acceptance.
CBDC spurring financial innovation for local startups and the regional economy
Implementing a CBDC could help spur financial innovation and financial inclusion in several ways.
Improved access to finance as a CBDC could make it easier for local startups and small businesses to access the funds they need to grow and innovate. This is particularly beneficial in situations where access to traditional forms of finance, such as bank loans, can be limited by a lack of historical financial data.
As long as allowances are built to safeguard users’ privacy and digital identities, an individual’s CBDC account and profile data could be distributed even to providers of traditional financial instruments. For instance, the individual’s CBDC credit information could be shared with lending platforms to supplement traditional credit information like income history, debt, and repayment records – the sort of information unbanked people might otherwise not have access to.
Another benefit is lower transaction costs. CBDCs could reduce the costs of making and receiving payments, particularly for small businesses and underserved consumers, who currently pay disproportionately high fees for using traditional payment systems for domestic and cross border transactions.
The implementation of CBDCs could also promote financial inclusion for marginalised individuals and communities by making it easier for underserved or unbanked populations to access financial services by creating digital financial identities. A digital wallet could allow unbanked or lesser-banked individuals to have access to money movement and credit, establishing a track record of lending in the process if required.
CBDCs could further enable new business models and financial products that are not currently possible with existing payment systems. For example, a classic role of central banks has been to eliminate or reduce credit and get legal tender flowing within their economy. CBDCs encourage this role by making it easier to create liquidity, where physical assets like property can represent by a digital marker on the blockchain and can be moved around or used as collateral to secure a loan.
Monetary policy could also be potentially improved as CBDCs could provide central banks with additional tools to manage the economy and support financial stability. This could assist in economic growth and support the development of local startups and the regional economy.
Finastra’s expertise in financial technology and payments is well-suited to support this technology’s future growth. The company will continue to monitor and adapt to developments in CBDCs and may explore opportunities to offer solutions and services that support the implementation and use of CBDCs in Europe and other regions.
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