Financial Firms Face Threat of Central Bank Digital Currencies
Central bank digital currencies have the potential to dramatically change the role of fintechs and financial institutions, which is why some of these companies are competing with each other to get involved early on.
This week Group of ants, the company behind Alipay, was tested for the Chinese digital yuan, the central bank’s digital currency closest to launch among major countries. And Fast this week published an article with Accenture, which has a banking advisory practice, which argues that central bank digital currencies should use existing payment rails such as Swift to support international interoperability.
Swift plans to host a series of trials to assess potential interactions with CBDCs that operate across borders. Swift, who has not returned a request for comment, is arguing against the reinvention of the wheel.
“Many governments have yet to make a decision on CBDCs, but if central banks in Europe or the United States were to go ahead, there could be significant consequences for the banking system,” said Gwenn Bezard , co-founder of Aite Group. , adding that there is a difference between digital currencies designed to be used by consumers to make payments at retailers and a wholesale CBDC for interbank transactions.
âThe roles of banks could be redefined or reduced with a retail CBDC,â Bezard said. “This is one of the reasons the Fed is studying CBDCs. The Fed is concerned about the impact on the banking system.”
Most functional CBDC concepts include at least a combination of retail and wholesale CBDCs. Among the existing CBDCs, the Bahamas Sand dollar is positioned in part as a way for tourists to make payments. âWith a retail CBDC, consumers could theoretically use it to compete with bank deposits,â Bezard said.
Most other CBDCs are in the research stage and do not have an official model. But a growing number of financial institutions and organizations that represent and work for financial firms are seeking to play a facilitative role. One concern is that blockchains will replace the transaction processing steps that generate fee income for banks.
But at the same time, central banks cannot afford a rush from consumers and businesses to pull bank accounts in favor of digital currencies.
Accenture is a driving force behind the Digital Dollar Project, which is working on use cases for CBDCs to identify banks’ contributions to the U.S. central bank’s digital currency structure as it is developed. .
Like Swift, the Digital dollar project plans a series of tests over the next year to examine the impact of a central bank digital currency in different constituencies, including sub-banks, banks, small businesses, large corporations, and international trade . The Digital Dollar Project did not comment for this story, but did share a preview that detailed the pilots.
Among other objectives, the DDP will examine how government-affiliated digital wallets will serve as alternatives or a gateway to traditional banking systems in predominantly urban and rural areas. For small businesses, DDP’s goal is to determine how digital currency can support consumer and supply chain transactions.
The DDP will further test use cases for large corporations and international transactions involving countries with and without CBDCs, and how a digital U.S. dollar would comply with existing laws and regulations.
The planned tests will concern banks and card networks, while also emphasizing that the goals of digital currencies are to reduce the number of steps involved in financial transactions, to shorten time and costs.
The DDP mentions, for example, that many small businesses and fintechs do not have access to Fedwire payments and depend on financial institutions to process payments for them. A digital US dollar could remove this intermediate step.
Distributed ledgers have already proven this concept for international payments, with blockchain companies such as Ripple reduce the need for correspondent banks to handle currency conversions and other steps. This reduction took days outside of the traditional process and was initially viewed as a threat by the banks, but Ripple eventually became a partner with many banks.
The model that DDP seeks for the United States would be “distributed through the existing two-tier banking system and regulated intermediaries”, suggesting that the project would be a public / private mix that would give a substantial role to banks, card networks and other financial institutions. DDP also says it should be a monetary policy neutral transaction object, “similar to the way commercial money based on cash and accounts” works.
In other words, the digital dollar is positioned as a vehicle to economize access to cash at a time when handling cash becomes increasingly expensive, offering financial institutions a way to cut costs by streamlining cash disbursements to businesses and consumers in partnership with government.
Banks could benefit from international transactions and other use cases for CBDCs, Bezard said.
âI don’t think central banks have found ways to make CBDCs interoperable,â he said, adding that international CBDC processes will need to be made more efficient, similar to traditional currency. “It might benefit the banks a bit.”
US banks and card networks are developing CBDC strategies. In addition to its partnership in the Bahamas, MasterCard says he is engaging with governments around the world on CBDC policies and a role for the card brand. Visa is also working with central banks and has filed a patent application for technology that allows governments to digitize their currencies. And BNY Mellon pursues a role in streamlining DBDC’s international transactions.
âDeveloping the central bank’s digital currency platform and currency management is clearly the role of government,â said Tim Sloane, vice president of payments innovation at Mercator Advisory Group. “But to foster wide adoption by both merchants and consumers, it’s best to partner with companies that already have a relationship with a large customer base of consumers and merchants, like Alipay.”