Banking Crisis

BIS Charts Promise, Risks Of Central Bank Digital Money

Tom Burroughes, Group Editor, 4 October 2021

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A few days after taking a cautionary look at ESG investing, the club of some of the world's main central banks has taken a look at central bank digital currencies.

Some of the world’s main central banks and the Basel-based Bank for International Settlements, have waded into another debate on the case for or against digital currencies, saying that policymakers must keep pace with innovation but not crush commercial banks. A few days before, the BIS took aim at another hot trend, warning about a “bubble” in ESG investing.

The rise of bitcoin and other digital assets over recent years raises the risk that central bank issuers of state fiat currency - which in nearly all cases are no longer backed by gold - could lose out to new currency models. More than a decade of massive central bank money printing, heightened by the pandemic, has sparked worries about rising inflation. Policymakers also fret that cryptocurrencies are conduits for criminal activity and tax evasion. 

Separately, the use of central bank digital currencies (CBDC) could undermine the privacy advantages of cryptos, maybe even at odds with privacy protocols such as Europe’s GDPR rules. The Chinese central bank has launched a Digital Currency Electronic Payment (DCEP). Critics may worry how this fits with the Asian country’s social credit oversight of citizens’ behaviour. China, which has cracked down on cryptocurrency mining and trading, was not included in the club of seven central banks working with BIS on the study. The other central banks involved in the BIS study are the US Federal Reserve, Bank of England, European Central Bank, Bank of Canada, Bank of Japan, Sveriges Riksbank and Swiss National Bank.

Another worry for central banks could be that if fiat currencies are bypassed, their ability to set interest rates and monetary policy could be seriously weakened. (It is arguable that this is already the case.)

“As history has demonstrated, the evolution of money and payments delivers new opportunities and business models, alongside new challenges. Our economies are becoming increasingly digital, user needs are rapidly evolving, and innovation is reshaping financial services. Many of our jurisdictions are seeing falling transactional use of cash, and new forms of digital money issued by the non-bank private sector (such as stablecoins) are emerging,” the BIS said. “These developments have accelerated since the onset of the COVID-19 pandemic. Today, central banks are exploring how they can continue to deliver their public policy objectives, ensuring they are able to respond to a future system that appears to be changing rapidly.”

The central banks said that publicly-used "retail" CBDCs must harness both public and private players to mesh with existing payment systems. 

The Bank of England and HM Treasury have launched a taskforce to examine this area and the US Federal Reserve is also exploring the area. 

The BIS report addressed the topic of “stablecoins.” According to one definition, stablecoins are cryptocurrencies that attempt to peg their market value to some external reference. Stablecoins may be pegged to a currency like the US dollar or to a commodity's price such as gold.

Discussing potential risks, the organisation said: “A significant shift from bank deposits into CBDCs (or even into certain new forms of privately issued digital money) could have implications for lending and intermediation by the banking sector. However, our analysis also suggests that these impacts would likely be limited for many plausible levels of CBDC take-up, if the system had the time and flexibility to adjust.”

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