Central banks warned over digital currencies

Central banks should think carefully about the implications for financial stability and monetary policy before issuing digital currencies to the general public, according to a report from the Bank for International Settlements (BIS), which suggests bitcoins and other cryptocurrencies are ‘poor imitations of money’

The report from the BIS committee on payments and market infrastructure (CPMI) and its markets committee, has been released ahead of the meeting of the G20 central bank governors and finance ministers next week.

It looks at two types of central bank digital currency: a wholesale currency limited to select financial institutions, and a general purpose currency accessible to the public and analyses their impact on payments, monetary policy implementation and financial stability.

The report warns that a general purpose central bank digital currency (CBDC) could impact bank deposits, a major source of funding for commercial banks, with implications for financial stability, and suggests the underlying technologies might hold more promise for wholesale payments, clearing and settlements.

Benoît Coeuré, chair of the CPMI, said: ‘Central bank digital currencies could help make settling trades of securities and foreign exchange more efficient in the future. But more work and experimentation would be needed to explore these benefits.

‘General purpose central bank digital currencies could revolutionise the way money is provided and the role of central banks in the financial system, but these are uncharted waters, with potential risks. This report is a starting point for further discussion and research and will help countries make choices given their own circumstances.’

The report warns that a CBDC could fuel faster bank runs during periods of financial stability. BIS suggests that in periods of stress a flight towards the central bank may occur on a fast and large scale, challenging commercial banks and the central bank to manage such situations.

The report states: ‘Depending on the context, the shift in deposits could be large in times of stress. A crucial element in such system-wide shifts is the stronger sensitivity of depositors to the actions of others. The more other depositors run from weaker banks, the greater the incentive to run oneself. ‘If CBDC were available, the incentives to run could be sharper and more pervasive than today, as the CBDC would be the favoured destination, especially if deposits were not insured in the first place or deposit insurance was (made more) limited. Whereas weaker banks could experience a run, even stronger banks could face withdrawals in the presence of CBDC.’

In a blog article, Coeuré described ‘bitcoin and its cousins’ as ‘something of a mirage’ and said: ‘Almost nobody prices goods in bitcoin, few use them for payments, and, as a store of value, they are no better than gambling in a casino. Policymakers are rightly worried about consumer and investor abuses, as well as illicit use.’

However, he points out that demand for non-cash is rising, particularly among the younger, more digitally savvy generation.

Coeuré said: ‘If it were to come, a CBDC would have to be as convenient for consumers and businesses to use as the commercial equivalent. It would have to be hacker-proof. If we want to stop illegal use, it should not grant the same anonymity of cash to users. But giving central banks unprecedented amounts of information about individuals is equally controversial. There is no one-size-fits-all solution.’

He is more positive about using blockchain technologies as a way of streamlining many of the cumbersome clearing and settlement processes that are currently needed to complete securities and foreign exchange trades, and to meet the current demand for fully reliable, real-time payments.

‘Despite its many faults, bitcoin has put the spotlight on an old failing of our current system: cross-border retail payments. Such payments not only permit shoppers to easily buy goods online from overseas, but also allow foreign workers to send money home, supporting financial inclusion and development.

‘However, these payment channels are generally much slower, less transparent and way more expensive than domestic ones. Improvements here are the best way of rising to the bitcoin challenge,’ Coeuré said.

Central bank digital currencies report is here.

Report by Pat Sweet

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