EP9 - CBDC and Regulated Stablecoins: Friend or Foe? Part 2
A New Era of Digital Finance
The emergence of Central Bank Digital Currencies (CBDCs) and regulated stablecoins presents a groundbreaking shift in the global financial landscape. These digital currencies promise to revolutionize how money is managed and transferred, posing significant implications for traditional banking systems. But the big question remains: Are CBDCs and regulated stablecoins a boon (friend) or a bane (foe) for the future of banking as we know it?
(Note: The CBDC in this article refers to Retail CBDC)
Understanding the Dynamics
CBDCs are digital versions of national currencies, backed and issued by central banks. They aim to provide an official, secure, and digital means of payment alongside physical cash, for now. Some believe that CBDC are designed to ultimately replace the existing national currencies as legal tender to enable and promote the digital economy. Regulated stablecoins are similar in their stability but are usually pegged to existing currencies or commodities and are issued by private entities, subject to regulatory oversight.
CBDCs are a direct liability of the central bank, while regulated stablecoins are liabilities of their private issuers, not the central bank.
Impact on Commercial Banks
Commercial banks have traditionally created money through the lending process and have controlled various aspects of payment systems. With the introduction of CBDC this could change:
- Direct Access to Central Bank Money: CBDCs allow consumers and businesses to hold digital currency that is a direct claim on the central bank, potentially reducing the demand for commercial bank deposits. This could reduce banks’ influence over the money supply and their role in the financial ecosystem.
- Disintermediation Risk: As CBDCs provide a safer digital store of value, commercial banks may see a decline in deposits, affecting their ability to lend and fund their operations.
- Reduction in Systemic Risk: As people start to understand the difference between central bank money and commercial bank money, they might opt for the safety of CBDCs, which are direct claims on the central bank. Commercial banks may see a decline in deposits, affecting their ability to lend, the question being asked is if there is a “disintermediation risk” or a reduction of the rampant “systemic risk”?
- Increased Competition: CBDCs and stablecoins could make it easier for new entrants to compete with traditional banks in payments and financial services.
The question of whether a central bank digital currency poses a disintermediation risk to commercial banks or reduces systemic risk in the financial system is complex without a straightforward answer.
Disintermediation Risk
Many experts highlight the potential for CBDCs to lead to a decline in commercial bank deposits as people opt for the safety of central bank money over commercial bank money. This disintermediation could negatively impact banks’ ability to lend, as deposits are a key source of funding for bank lending. The risk is particularly acute during times of financial stress, when the flight to safety from bank deposits to CBDCs could be destabilizing, akin to a digital bank run.
Reduction in Systemic Risk
However, another view is that a well-designed CBDC could actually enhance financial stability and reduce systemic risk. By providing a safe, liquid, and universally accessible form of central bank money, CBDCs could reduce the economy’s reliance on potentially unstable private money creation by banks.
Central banks would also have greater visibility into monetary flows, allowing for quicker detection and response to emerging financial stability risks.
Design Choices
The ultimate impact likely depends on CBDC design choices. Features such as holding limits, tiered remuneration, and the degree of private sector intermediation in CBDC distribution could mitigate disintermediation risks while preserving benefits. Ongoing dialogue between central banks and commercial banks will be key to striking the right balance. In summary, while the disintermediation risk to commercial banks from CBDCs is real and deserves careful analysis, it must be weighed against the potential for an appropriately designed CBDC to reduce systemic fragilities in the current monetary system. The question is not clear-cut, and the answer will depend on jurisdiction-specific factors and policy choices. Central banks will need to carefully navigate these tradeoffs as CBDC projects advance.
Opportunities Through Innovation
However, viewing CBDCs and regulated stablecoins purely as foes would overlook the potential benefits they bring to commercial banks:
- Innovation in Financial Products: Banks can develop new financial products that integrate the unique features of CBDCs, such as programmable and efficiency of digital currency for automated transactions.
- Enhanced Payment Systems: CBDCs and stablecoins could enable faster, cheaper, and more inclusive payment systems domestically and across borders.
- Transparent Lending Process: The risk involved in the lending process would be more transparent as stablecoin issuers would be clearer associated with the lending risk as in today’s fractional banking system which is a mystical creation for many and open for abuse in irresponsible hands.
- Partnership Opportunities: Banks could play key roles in CBDC ecosystems, such as distributing CBDCs, providing customer service, and building CBDC-linked services.
Are They Friends?
Proponents argue that CBDCs and stablecoins can:
- Enhance financial inclusion by making banking and financial services more accessible especially for the unbanked and underbanked (yes, but there is often plenty of lip service).
- Improve the efficiency of payments and settlements (yes, as synthetic byzants structures would be eliminated).
- Provide a digital complement to physical cash as its usage declines
- Reduce the costs associated with maintaining and operating current monetary systems (yes, after the initial investment for deployment and adoption)
Are They Foes?
Critics worry that CBDCs could:
- Disintermediate and compete with banks for deposits and payments, impacting bank business models and lending, undermining the traditional role of commercial banks, especially in deposit gathering and loan making (depends on the viewpoint, but yes it will lead to an entirely new financial system if done consequently or to old wine in new bottles, if to many compromises are made).
- Lead to greater financial surveillance and reduced privacy (not greater than what could already been done today), if not designed with strong privacy and data protection
- Increase financial instability risks, especially during crises, if bank runs into CBDCs occur. Cause financial instability during periods of economic stress, as people might rapidly convert bank deposits into CBDCs (depends on the design and the education of the general public).
Strategic Recommendations for Banks
- Actively Engage and Prepare: Banks should participate in CBDC and stablecoin development, pilots and policy discussions to influence design and ready their systems and processes.
- Embrace Technological Integration: Banks should actively engage in the development and regulatory processes of CBDCs to ensure their technology and business processes are compatible and can leverage new technologies.
- Innovate and Adapt: Banks must develop strategies, business models and value-added services to stay relevant in a more competitive CBDC and stablecoin environment
- Develop New Products And Business Models: Adapt business models to utilize CBDCs for creating value-added services, thereby transforming potential threats into opportunities.
- Double Down on Strengths: Banks should leverage their customer relationships, trust, and expertise to provide CBDC-linked advisory, management and value-added services.
- Focus on Customer Service and Financial Advisory: With the possible commoditization of basic banking services, banks should enhance their roles in personalization of customer service and financial advisory (I hear this already for more than 40 years, but focus has shifted to “making bets”).
Conclusion: Navigating the Dichotomy
As the digital currency landscape evolves, it’s clear that CBDCs and regulated stablecoins bring both opportunities and challenges. For central and commercial banks, the path forward will involve navigating these complex dynamics to harness the benefits while mitigating the risks. Whether friend or foe, CBDCs and stablecoins are set to redefine the future of money and banking. Financial institutions that proactively innovate and adapt will be best positioned to thrive in this new era.
Doing nothing is no longer an option.
Leading the Charge: Chavanette Advisors
As a leading consultancy firm in financial technologies and innovations, Chavanette Advisors is at the forefront of the digital transformation reshaping the financial landscape. With a specialized focus on CBDCs and Regulated Stablecoins, we leverage our expertise to help clients navigate the evolving monetary policies and financial infrastructures of the digital age.
Through comprehensive advisory services and innovative solutions, Chavanette collaborates with financial institutions, government entities, and technology providers worldwide to design and implement effective strategies for the future of finance.
Invitation to Engage and Discover
We encourage you to delve deeper into the impact and possibilities of CBDC within the financial landscape. For those eager to explore more about Central Bank Digital Currencies (CBDCs) and the evolving landscape of central banking, the Chavanette Website, as well as our Alpha Knowledge Platform (αLP) serve as an invaluable resource. Furthermore, there is our CBDC Handbook & Encyclopedia, designed to offer comprehensive insights into this emerging field.
Join the Discussion
Join the conversation on how CBDCs and Regulated Stablecoins can reshape economic practices in the digital economy. Your insights and perspectives are invaluable as we navigate this promising digital journey.
Contact us to learn more about Chavanette Advisors’ approach to setting-up, running and scaling-up a live CBDC pilot for you.
