With a good amount of responses to Finextra’s introductory short read, ‘What is CBDC?’ we follow up to address the prevailing commentary: “What would be
the main purpose of introducing digital currency?”
The answer to this can be given in terms of the benefits of central bank digital currency (CBDC). In this article we respond to our community by proposing 5 key advantages.
But there is a nuance to be underlined at the outset. This list will be different (or perhaps far shorter!) for each type of institution asked. For the sake of vividity, we tackle this question from the
perspective of the central bank.
1. Financial inclusion
One of the top comments on Finextra’s preliminary article pointed to the existence of digital wallets as the most obvious means to serve end-users who may not have access to traditional banks – a common scenario in developing regions. The commentor went
on to note that CBDCs, on the other hand, may require wallets “linked with your bank account”. So, why the need for CBDCs specifically? A valid question.
Of course, Fintechs may well become the entities that give consumers access to CBDCs, but for some banks – the Bank of England (BoE) particularly – the recourse of relying on and working with private digital wallet and payment interface providers is very
much strategic. In a contributed
long read for Finextra, Vladimir Krasik, global head of internal treasury, Revolut, pointed out that “according to the BoE, this [arrangement] is intended to limit a central bank’s access to personal data and thus to boost the public’s confidence in the
CBDC.”
This means that central banks are happy for members of the public, underbanked or otherwise, to facilitate CBDC models compatible with third-party digital wallets. This is because everyone is a winner in that scenario: the underbanked customer gets a wider
choice of financial services, the fintech gets access to a bigger customer base, and the central bank advances closer to its goal of familliarising the public with the digital currency concept.
Financial inclusion, as enabled by CBDCs, is a strategy
endorsed by the World Economic Forum.
2. Improved homogeny and infrastructure
In part to address the financial inclusion issue, the European Central Bank (ECB), among
other institutions, has been working on developing the digital euro – a CBDC that would function as an electronic equivalent to cash in the EU. As yet,
progress has been stilted.
Earlier this year, EBAday challenge speaker David Birch suggested that there would be numerous benefits to implementing an
EU CBDC, such as having a pan-European payments scheme and the political aspects of domestic sovereignty. This would go some way to addressing the landscape’s interoperability issues.
The BoE’s
position on this matter is in alignment, claiming that CBDCs have the potential to “support a more resilient payments landscape…allow households and businesses to make fast, efficient and reliable payments… [as well as] provide a building block for better
cross-border payments in the future.”
Of course there are still economic and social
concerns around inclusion and sustainability that need to be addressed.
An additional consideration is that the rise of CBDCs could create problems for “card issuers and acquirers, as CBDC payments are meant to be faster and cheaper than those processed via standard gateways,” says Krasik. For the central bank, however, this
would be a positive, with CBDCs shaping up to be the preferred payment method for merchants – as they can be built to be free of all the hidden customer fees charged by card schemes and acquirers.
3. Fraud prevention
At the end of 2023 were confirmed
plans under the Payments System Regulator (PSR) for the mandatory reimbursement of victims of authorised push payment (APP) scams. These were due to come into effect in Q4 2024, though there may now be delays of at least 12 months.
The rules mean that reimbursements to victims will occur within five business days and will be split 50:50 between the sending and receiving banks – thus ramping up the pressure for institutions.
In an
interview with Finextra, Gilbert Verdian, CEO of Quant, said that a system built around CBDCs would enable fraud to be handled more effectively than the incumbent method. “Fraud happens very quickly and the system we have in place can only deal with fraud
after it happens. It’s always reactive, we’re always catching up…”
He continued by outlining that the new CBDC system would give banks a better view to control fraud: “When you step back, and you look at the whole aspect of fraud, you see these patterns, you see these trends, you see these anomalies, they can easily identify
as fraud, and you can actually tackle it properly.”
The answer to the question ‘why CBDCs?’ is about coding logic into money itself. Better fraud prevention is better for everyone in the transaction chain.
4. A competitive edge
Once again, we must look at CBDC benefits from the issuer’s perspective.
Krasik notes that “CBDC development is driven by a number of considerations, including…competition with cryptocurrencies.” This is a
big plus for central banks, which are seeking to maintain influence on monetary policy.
Krasik goes on to point out that in the face of possible fragmentation from the virtual currency boom, “some central banks see CBDCs as alternatives to the existing payment processing solutions, namely Swift. So, at this point, the version of the future
where central bank digital currencies do not become a part of the financial system, seems rather unlikely.” Is it just a matter of time before the CBDC conversation pivots from the “why” to the “how”?
Retail CBDCs could also be regarded as a solution that would help banks compete with fintechs – a concern that is moving higher up the priority list as they approach the
PSD3 deadline.
5. Simplifying compliance
This (by no means exhaustive) list of how banks can realise the benefits of CBDCs would feel incomplete without a pit-stop at the perennial issue of compliance.
It is Krasik’s belief that CBDCs could actually “make compliance obsolete.”
A big claim – though it can be substantiated. In 2020, UK-based developer of API platforms, Salt Edge,
showed that on average, 50% of banks did not respond to connection requests and 38% of all bank APIs did not meet regulatory standards. “APIs on a CBDC basis would eliminate these issues,” Krasik argues.
Focusing on an API system is the path the BoE took with the experimental
Project Rosalind – a joint initiative with the Bank for International Settlements (BIS) to develop an API for a retail CBDC.
Why overhaul existing infrastructure?
There is a counter argument that should be preempted before close: Why not avoid the massive overhaul of existing infrastructure with CBDCs and simply look to improve the current system’s capacity for homogeny, fraud prevention, financial inclusion and compliance?
Well, it transpires that banks’ incumbent systems – created 30 years ago – may not be up to the job, in an increasingly digital world. It is time to consider infrastructures that are modern and can flex to meet both our demands for today and our demands
for tomorrow.
The best candidate is still CBDCs.