AYA analytic report on macro-financial stability policy developments July 2024

Description:

Our fintech finbuzz analytic report shines light on the current global macro-financial outlook. As of Summer-Fall 2024, this macro analytic report focuses on the macro-financial stability implications of central bank digital currencies (CBDC). Also, this macro analytic report delves into CBDC system design and interoperability, as well as systemic user adoption. In the modern monetary system, each new CBDC helps anchor public trust in money in support of economic welfare, especially in a cash-less society. A sound and efficient CBDC system would need to involve both public and private actors to better ensure interoperability and coexistence with the wider global payment system.

In our current assessment of central bank digital currencies (CBDC), we focus on the macro-financial stability implications of a new CBDC system. Our analysis can shine fresh light on CBDC system design and interoperability, as well as systemic user adoption. In the modern monetary system, each new CBDC can help anchor public trust in money in support of economic welfare, especially in a new cashless society. A sound and efficient CBDC system would need to involve both public and private actors to ensure interoperability and coexistence with the broader payment system. With careful CBDC system design, the central bank garners better control over money supply growth and inflation in the broader economy. This control helps the central bank better align monetary policy and financial system policy decisions with the dual mandate of both price stability and maximum employment (in addition to real output growth per capita in the wider macro context).

In human history, money and payments evolve rapidly to help deliver new business models and opportunities. Today, regional economies have become increasingly digital, and disruptive innovations reshape financial services and user needs. Many markets continue to witness the recent decline in the use of cash. At the same time, new forms of digital money emerge from the non-bank private sector. These major cryptocurrencies include Bitcoin, Ethereum, Dogecoin, Stablecoin, and so forth. In recent years, these fintech developments have dramatically accelerated since the onset of the Covid-19 pandemic crisis worldwide. From the U.S. Federal Reserve System to the European Central Bank, many central banks now attempt to explore how these new forms of digital money can help deliver their public policy objectives. In essence, these objectives include price stability, robust output growth, maximum employment, and macro-financial resilience etc in the modern monetary system.

To the extent that central bank money facilitates the widespread use of new digital payments, CBDC design and issuance remain sovereign decisions. In the ongoing work on G20 cross-border payments, CBDCs can help further enhance the efficacy of fast and safe global payment settlements worldwide. Each central bank may be able to facilitate these payment settlements with CBDCs despite different degrees of interoperability. Also, each central bank has the statutory power to issue its own CBDC with sound and efficient design features to better cooperate with many other central banks in support of broader financial stability both within each country and across many countries worldwide. Finally, CBDCs would likely cause ripple effects on public policy issues well beyond each central bank’s traditional remit.  

Any CBDC system would likely involve both public and private sectors in a delicate balance between macro-financial stability and technological innovations in support of broad user adoption of fast and safe digital payments. Relatively high domestic interoperability would ensure that each CBDC ecosystem coexists with many other national payment systems for better macro-financial stability, resilience, diversity, and inclusion. Operational CBDC ecosystem design features and functions would likely be a significant burden on each central bank. To the extent that each central bank may outsource some of these operational functions, each central bank should establish sufficient safeguards to ensure both the onshore and offshore transfer of capital among the major banks, insurers, and other non-bank financial institutions. Broader user access and the sound and efficient treatment of payment data would play an important role in CBDC system design. Specifically, user privacy concerns would likely trigger new technological challenges for CBDC design, adoption, and domestic interoperability. These new technological challenges include incentives for central financial intermediaries, carrots and sticks for financial service providers, global payment protocols for telecommunication, and technical interoperability and compatibility with traditional financial systems of granular data on digital payments, accounts, and transactions.

At the macro level, both retail users and merchants would likely cause ubiquitous CBDC adoption within each home jurisdiction. After all, central bank money is still the safest form of money available. Beyond security, however, most other valuable features of CBDC would include the lower costs to retail consumers and merchants, offline payments, better privacy protection and data encryption (in stark contrast to commercial options), and secure access for multiple users. With CBDC design and adoption, each central bank should leverage a reasonably flexible core ecosystem to target the total addressable market for both current and future user needs. Also, each central bank should promote healthy competition among core intermediaries, payment processors, and financial service providers in the new CBDC system. As online payments increasingly become part of the modern digital lifestyle, each new CBDC can combine technological innovations with modern payment features into a single minimum viable product (MVP) in a unique way.

Central bank strategies for CBDC system design should help address the diverse economic structures and payment landscapes in both home and host jurisdictions. CBDC adoption may be more widespread and more successful if new central bank money fulfills unmet user needs, achieves broad network effects, and implements state-of-the-art technology for fast and safe payment settlements (especially at the point of sale). Additional measures for broader CBDC adoption include the use of CBDC by public-sector authorities with some minimum level of acceptance. There is no one-size-fits-all solution, and not all central bank strategies would be equally desirable in all home and host jurisdictions.

Careful CBDC system design would help reduce any potential adverse impact on bank disintermediation. A significant shift from bank deposits into CBDCs, or even cryptocurrencies and some new forms of private digital money, would likely lessen the basic needs for bank intermediation and liquidity creation through private loans. Should the new CBDC system take time to adjust in support of the broader financial sector, the central bank should be able to limit any potential adverse impact of new CBDC issuance on private credit expansion. As the macro-financial system seems to dynamically evolve through key episodes of structural changes over many years, CBDC design and issuance can provide new opportunities for financial innovations, especially for banks, insurers, and other non-bank financial intermediaries.

Nevertheless, new financial system risks may arise if CBDC design and adoption inadvertently cause abrupt changes in the broader real economy. These changes would likely involve substantial reductions in private credit, as CBDC adoption may significantly reduce broader consumer reliance on bank deposits, loans, and non-bank credit lines. Widespread CBDC adoption would also increase the latent risks of systemic bank runs. In the modern monetary system, prudent and effective bank regulation combines with deposit insurance and bank failure resolution frameworks to help contain the latent risks of bank runs. In response to the recent bank failures of Silicon Valley Bank, Signature Bank, and First Republic Bank, the U.S. Federal Reserve System carefully applies the 5 major pillars of financial regulation, capital adequacy rules, liquidity controls, leverage limits, macro stress tests, and deposit insurance rules, to prevent these bank failures from snowballing into systemic bank runs. In addition to the Global Financial Crisis of 2008-2009 and corona virus crisis of 2020-2022, these recent bank failures provide vital lessons for bank regulation. In rare times of financial stress, the central bank would need to provide substantial capital and liquidity funds to bolster consumer confidence in the financial system. In modern bank failure resolution, these best practices continue to be relevant for many central banks worldwide.

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