Central banks worldwide are actively exploring the implications of, and options for, issuing Central Bank Digital Currencies (CBDCs). In an increasingly digital economy where demand for central bank notes and coins is rapidly declining, issuing CBDCs is likely to become a necessity to preserve access to public money. Thus, although only a few countries have launched their CBDCs, there has been a rapid progression from conceptual discussions of the benefits and risks of CBDCs to targeted research and pilots.
The International Monetary Fund (IMF) is extensively working on the adoption of CBDCs and in the capacity development of the same for the countries which are planning to adopt them. In a recent interview at Milken Institute -2023 Global conference, IMF managing director Kristalina Georgieva highlighted that retail CBDCs have far more room for error than wholesale CBDCs.
She said, “We think that wholesale CBDCs can be put in place with fairly little space for undesirable surprises, whereas retail CBDCs completely transform the financial system in a way that we don’t quite know what consequences it could bring.”
Here, it is important to note that the Retail CBDC is defined as one of the currencies issued to the general public. It is based on DLT, or distributed ledger technology, and its features include anonymity and traceability. Furthermore, these retail CBDCs are available 24 hours a day, 365 days a year, with the possibility of an interest rate application. Wholesale CBDCs refer to financial institutions that hold reserve deposits with a central bank. it aids in the improvement of payment and securities settlement efficiency. Furthermore, these wholesale CBDCs contribute to the reduction of counterparty credit and liquidity risks.
Georgieva mentioned that the major issues that are associated with retail CBDCs are regulatory and operational risks, further, it can disrupt traditional banking systems. She also highlighted how the implementation can hamper international cooperation during trade and settlements. Other issues also include the security implications, incidents of money laundering, round-tripping and terror financing.
The IMF’s warning about the potential consequences of retail CBDCs highlights the need for caution and careful consideration of the risks and benefits of digital currencies. While CBDCs could offer significant benefits, such as increased financial inclusion and reduced transaction costs, they could also pose significant challenges and uncertainties for the global financial system.
In April this year, the IMF released a handbook that will be a compendium of knowledge and experience on CBDC. It will be the basis for capacity development and help countries make as well-informed decisions as possible when taking the major step to design and issue their own CBDC.
CBDC is likely to have profound implications for monetary policy and financial stability. CBDC could strengthen the usability, resilience, and efficiency of payment systems and increase financial inclusion. However, if poorly designed, CBDC could also lead to financial stability risks, data privacy and legal challenges, financial integrity and cyber risks, and central bank operational risks. In addition, the widespread use of CBDCs could change the configuration of the international monetary system. CBDC could reduce the number of intermediaries in cross-border payments, foster competition and enhance transparency. On the other hand, easy access to foreign CBDCs could lead to risks of currency substitution and capital flow volatility.