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Economists with global researcher Capital Economics expect the first generation of Central Bank Digital Currencies will be designed to have as little impact on the existing financial system as possible

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Economists with global researcher Capital Economics expect the first generation of Central Bank Digital Currencies will be designed to have as little impact on the existing financial system as possible

Economists with global researcher Capital Economics say the first generation of Central Bank Digital Currencies (CBDCs) will be designed to have as little impact on the existing financial system as possible.

David Oxley, Senior Europe Economist and Mark Williams, Chief Asia Economist with Capital Economics have done a detailed analysis titled: "The CBDCs are coming", in which they crunch all the pros, cons and potential of CBDCs.

They say according to a Bank for International Settlements (BIS) survey published earlier this year, 86% of central banks are investigating CBDCs in one form or another.

There's therefore currently a lot of discussion of CBDCs. The Reserve Bank is preparing to consult publicly on the pros and cons of a CBDC, and there's more on CBDCs from the Bank of England here. The US Federal Reserve is also mulling a CBDC, and you can see more on CBDCs here.

"A lot of attention has focused on the revolutionary nature of CBDCs, not least their potential to supercharge monetary policy and to facilitate innovations like 'programmable money'," Oxley and Williams say.

"But central banks (unsurprisingly) do not have revolution in mind."

'Do no harm'

Instead, they say, major central banks are presenting CBDCs as a response to the long-term decline in cash usage in many countries and encroachment from private sector payment systems.

"The migration of transactions to private payments networks could leave them vulnerable to market abuse, technical outages, or cyber-attack. And it could cause monetary policy to lose traction."

The 'do no harm' approach that central banks have signed up to with BIS implies that the first generation of CBDCs will not have any major implications for monetary or fiscal policy, the economists say.

Oxley and Williams say while the Caribbean has emerged as "an unexpected hot bed of CBDC activity", the big guns in the central banking world are going more slowly.

"We doubt that CBDCs will be widely available in any G10 economy before 2025."

They believe the first CBDCs will:

• Be held in the form of digital wallets but not be programmable.

• Will complement rather than replace cash.

• Not pay interest (positive or negative).

• Have some limit on their use, either in transaction size or the size of digital wallet balances.

The economists say the plans being pursued by central banks are modest.

Not aiming for financial revolution

"Many design choices are still to be nailed down, but the BIS foundational principles, to which a group of major central banks have signed up, show that policymakers are aiming much lower than financial revolution.

"Most notably, the Hippocratic-esque pledge to 'do no harm' signals that policymakers will ensure that the rug is not pulled from beneath banking sectors, even if that puts hard constraints on how widely CBDCs are used." 

They say the introduction of CBDCs "will be careful and gradual so as not to create financial instability".

"But once a CBDC is well established and the issuing central bank feels more confident that it understands and can manage the risks, it would be naive to assume that it wouldn’t start to consider the new policy options that would then be available. CBDCs potentially offer a shortcut to a holy grail of banking reform: separating the plain-vanilla aspect of banking operations from the riskier activities that banks can get embroiled in and the end of 'Too Big to Fail'."

The economists say the logic is that if all deposits intended for run-of-the-mill transactions were allowed to migrate to the safety of CBDCs, governments could let “risky” financial institutions go bust without endangering the core payments function of the banking sector.

"From here, it’s not a giant leap to the complete separation of monetary and credit functions of the banking system foreseen under the Chicago Plan of the 1930s.

"Of course, such decisions would not be taken lightly. And even if the end point of the reforms would be a more stable banking system, the problem would be how to navigate a path to it from the status quo without causing financial collapse."

The biggest impacts

The two economists say the two biggest potential impacts of CBDCs are:

• Supercharging monetary policy: by having the option to charge interest on CBDCs, policymakers could shatter the effective lower-bound for nominal interest rates and allow for steeply negative interest rates, and;

• The risk of "upending" the banking sector: given that CBDCs would offer a risk-free alternative to bank deposits there would probably be a migration of funds from banks to the safety of a CBDC. This would drain funds from commercial banks. Commercial bank balance sheets would contract as they lost both their reserve money asset and customer deposit liability in equal amounts. While banking systems in most developed economies today are awash with excess reserves, some individual banks may be forced to seek new funding – they could raise deposit rates, offer longer term deposits, or tap wholesale markets. Any of these options could raise their cost of funding, and restrict lending etc.

This may not be a big issue if access to CBDCs was limited in some way.

"However, it could be highly disruptive if access to CBDCs was not limited."

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20 Comments

Thus is looking more and more like a done deal.

No cash, the nature of each and every transaction recorded for posterity. Big brother will surely be watching you.

Then who needs retail banking. One national government controlled institution setting rates.

Welcome to the Communist Republic of Aotearoa. You will own nothing and be happy. So says Chairman Xiardern.

All under UN Agenda 2030.

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Yeah, monitoring will come with it. But mortgages take lots of form filling and info collection that central banks won't gear up for. I think real banks will continue for a while to do that.

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..but will the outcome be country by country digital or a 'global' digital?

Since evolutionary times man has been consolidating into larger and fewer 'tribes'. The trend continues. Yuan or US digital might be the final outcome.

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How do you peg a global currency to Venezuela or Zimbabwe where inflation and relative currency valuation are put of control.

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you don't. issued by whomever and whatever they decide to back it with. Guns or Gold the obvious (or nothing ala BTC)

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Both perfect countries for Bitcoin. You forgot Lebanon, they will be the next to adopt it if running to the IMF for money doesn't work.

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Prof Richard Werner said in an interview that the central banks will start small with CBDC offering retail accounts. Then trigger a crisis getting people to swith their currency away from the banks and into the central bank. And then no more retail banks.

I wonder who gets a loan or what businesses get loans under a central bank run world?

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(Low level comment deleted, Ed. Please see our commenting policy and stop trolling - https://www.interest.co.nz/news/65027/here-are-results-our-commenting-p…).

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Noted. Sorry about that.

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I forgot to post this yesterday but it is just as relevant.

Retail banks really only do one thing really well and bolt everything onto this, all products and services they offer at rates that they decide. That one thing is: Judge risk. That's what they do when you get a bank loan, when they decide to offer a new product, when they decide how much funds to retain or pay to shareholders. And this is straight out of the horses mouth, from one of the head people involved in retail mortgage lending at NZs biggest bank. Viewed in this light, the banks are competitive risk judging machines and those that do it the best, get a bigger slice of the pie. It's actually pretty elegant.

Recent evidence shows that the reserve banks of the world are pretty hopeless at getting things right. They kind of know how bad they are, so this is why there will always be a place for retail banks - the risk judgement and fine tuning of it can be farmed off to the orgs that are good at it and whose very existence is predicated on them being good at it. Not only that, imagine a reserve bank trying to offer innovative financial products or any sort of customer service. It would be an absolute nightmare and I think those in charge of the RBs of the world know they would be bad at it.

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(Low level comment deleted, Ed. Please see our commenting policy and stop trolling - https://www.interest.co.nz/news/65027/here-are-results-our-commenting-p…).

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Retail banks really only do one thing really well and bolt everything onto this, all products and services they offer at rates that they decide. That one thing is: Judge risk.

I completely disagree with this notion. How can anyone judge risk effectively when you're ultimately not responsible for the consequences?

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(Low level comment deleted, Ed. Please see our commenting policy and stop trolling - https://www.interest.co.nz/news/65027/here-are-results-our-commenting-p…).

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Are banking executives not responsible for the consequences of their decisions? I think you will find it is pretty cut throat, those that are successful get paid a lot and enjoy the fruits. Those that aren't...well they mostly don't get to the top anyway, but if they screw up, they are answerable to shareholders.

Certainly they bear some responsibility for the economic and monetary consequences as a result of their actions, but they are just filling the space created by the environment the RBNZ and financial legal framework has made.

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....but if they screw up, they are answerable to shareholders

In a perfect world, yes. In reality, no. What's the worse that can happen? Lose their job? How horrific (sarc on). They can simply disappear with the bag of loot they collected when the lending into existence was working in their favor. Worse case scenario, the taxpayer is carrying the can. Not the bank's top brass.

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I understand where you are coming from, but you're being somewhat superficial, and therefore specious. while for an individual loan they may measure risk up front well, but they seriously overlook the bigger picture risk. Their risk measurement is all about the individual being able to pay back the loan, not the larger economic impacts of which part of the economy that that loan is going into. Indeed the private banks have completely ignored the overall economic impact of the mess they themselves created, and the result risk to their business and the economy as a whole. So no not that good after all. And the RBNZ was slow to recognise the risk as well, and this is being generous, because if they were not slow, then they were wilfully negligent!

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"Their risk measurement is all about the individual being able to pay back the loan, not the larger economic impacts of which part of the economy that that loan is going into" - no no, the larger economic impacts should be directed by the government and RBNZ. It's pretty wishful thinking to believe banks in a highly competitive capitalist environment are going to be concerned about eventual consequences. Quite simply - if one bank does not take advantage of a certain set of circumstances, another will. Even if that is short term gain as we currently do not force execs to target long term consequences. There has been talk of this happening though.

People have been saying banks are negligent of the long term effects of their actions for the last 20 years, as far as I am aware. They continue to be hugely profitable year after year. All on a playing field given to them by the RBNZ and the government, who we the people either elect or ask to serve from those we elect. Really you cannot blame them if the whole thing blows up in our faces, it is the electorates unwillingness to elect parties who want to change the speculative parts of the economy that are the problem. You only need to look at the rabid hate piled onto any party who even suggest a capital gains tax to show how most people have an irrational fear of wealth taxation. That's not the banks problem or doing, it is broadly speaking, you, me and the guy next door.

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Pretty much agree with your second paragraph Blobbles. But I would hold that any business that does not take the long term consequences into consideration, will ultimately be doomed to failure by their own hand. And banks are now the cause of some significant economic problems that must inevitably either force Governments to act to control it, or an economic collapse will occur. Both of these will result in significant costs for everyone, including the banks. Our Government will be concerned with getting re-elected and either of those outcomes will cause much angst for them as they try to convince the voting public it wasn't their fault.

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if we are going digital and you dont need infrastructure to operate a bank then they are making themselves redundant and making it easy for any wealthy corporation to move in and share the easy profits they have been taking out of NZ.

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"allow for steeply negative interest rates"

I'll denominate in Bitcoin over CBDCs anyday thanks.

But each to their own.

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