Central Banks Tiptoe Into Digital

Once scorned, central bank digital currencies are gaining traction as a new tool for smoother management of the money supply.

Central bank digital currencies, or CBDCs, are “a [slow moving] train leaving a station,” Frantz Teissèdre, head of Interbank Relationships at Societe Generale, once said. “We don’t know where it’s heading, but we want to be on board.”

According to the latest data from the Atlantic Council’s CBDC Tracker, more than 100 countries—representing more than 95% of global GDP—have boarded the CBDC train. That’s up from just 35 countries in May 2020. It’s the central bank equivalent of a modern day goldrush, with central banks lining up to mint digital coins, or at least test the prospect of what that would entail.

Yet, only 10 countries have fully launched actual CBDCs into circulation. Among those countries are China, which is set to expand its digital yuan pilot in 2023; Jamaica, which launched the JAM-DEX in July this year; and Nigeria, which launched its CBDC last October.

In the US, the Federal Reserve Board of Governors is currently exploring what CBDCs could mean for corporates and the public at large. And, in July 2021, the European Central Bank initiated a two-year project to study the potential of a digital euro for retail payments.

“Realistically, widespread adoption of CBDCs is still a number of years away given how few banks are actually issuing it,” says Andy Schmidt, global banking lead at IT and business consulting firm CGI. “Three to five years is the timeline that many central banks are working with currently.”

While it may seem that all central banks have decided to launch their own digital currency, only a relatively small percentage are actively running tests, Paul Beecham, payment innovation lead and crypto expert at Societe Generale, explains. The others are just trying to discourage private competitors from undermining their monetary sovereignty.

The Lessons of Libra

Beecham is referring to the failed Libra project, which was rebranded as Diem and led by Meta Platforms. The company tried to launch a global stablecoin back in 2019, when it was still doing business as Facebook. Libra met with substantial resistance from lawmakers and central banks, largely due to the threat it posed to central bank monetary sovereignty.

Libra may have been kicked into the long grass for now, but it did spur central banks into action, with retail CBDC projects such as Sweden’s e-krona and the digital euro gathering pace. Their goal, as BNP Paribas digital solutions manager Matthieu Deraedt explains, is to ensure that individuals operating in an increasingly digitalized economy still have access to the safest form of money—central bank money—and avoid currency substitution.

As for corporate treasury departments, do they benefit from CBDCs? For treasurers, the main transformation of a retail CBDC, Deraedt argues, would be a change of format. “CBDC being ‘settlement money,’ compared to other retail payments options like debit cards or non-instant domestic payments, the money would arrive faster on the treasurer’s account and probably at a cheaper cost,” he says. 

Once CBDCs are deployed successfully at the domestic level, Deraedt believes the next topic for central banks is CBDC’s role as a vehicle for cross-border transactions. “There we see potential benefits for international treasuries,” he adds.

A full-scale multi-central bank digital currency (mCBDC) network that facilitates round-the-clock, cross-border payments in real time could potentially save global corporates up to $100 billion in transaction costs annually, according to a joint report from J.P. Morgan and management consulting firm Oliver Wyman.

Of the nearly $24 trillion in wholesale payments that is moved across borders every year, global companies incur billions in total transaction costs, the firms stated. That excludes potential hidden costs in the form of trapped liquidity and delayed settlements. CBDCs could potentially solve a lot of these headaches for treasurers.

“The good news for large corporates transferring significant cash within or outside the company is that [a CBDC] would allow them to monitor the funds transfer in real-time and at any moment, reducing the time and money spent on resolving incidents,” says Beecham.

In economies with less well-established banking networks, CBDCs could be used to validate the transaction histories and identities of organizations, thus facilitating trade from companies in those countries, Schmidt says.

Relying on peer-to-peer systems with fewer intermediaries, CBDCs also bring speed. “Funds are transferred instantly through a high-speed, blockchain-powered corridor directly from the payer to the payee,” explains Beecham. That 24/7/365 availability could also be a game changer, as payment systems’ reduced opening times are a big negative for treasurers.

“Lastly, all this simplification of processes may result in cheaper payments and cash management,” he says.

What treasurer wouldn’t welcome that? Fraud in international CBDC payments could also be a thing of the past, says Bob Stark, global head of Market Strategy at Kyriba, given the prospect of very strong controls and fraud prevention inherent in the system.

“The capacity of the system to deliver digitized security and virtually zero risk is an attribute and quality of this new potential value system that corporates, and even individuals, will not overlook,” he says.

But CBDCs are described as “a slow-moving train” for a reason. Realizing their full potential both domestically and cross border, and for multiple currencies, presents a mind-boggling array of challenges and questions—many of which remain unanswered at this stage.

Since the functional and technical designs for different CBDCs are unclear, and there are likely to be differences in design choices and distribution models between countries, Deraedt anticipates it will be difficult for treasurers to apply the same rules to all CBDCs.

“For example, it seems that the US and UK are concluding that blockchain is not the best solution when it comes to a population-scale cash alternative and would prefer an account-based system,” he says. “Whereas other locations, like China or potentially Europe, may use blockchain.”

For treasurers, these choices will impact CBDCs: how they function, their interoperability and the tools to manage them. “End-user experience might also be hampered by an insufficient degree of interoperability,” says Deraedt.

When it comes to the impact CBDCs have on treasury workflows, Beecham says many questions remain unanswered. Will corporates have deposit limits? Will those deposits bear interest or not? Will CBDCs be managed centrally by central banks or distributed in another way? What technology (distributed ledgers or something else) will be used? Will it be interoperable with other payment methods and other digital currencies? Will the CBDC be usable offline?

Most central banks have yet to decide whether distribution will be indirect (banks are involved, the same as today), direct (the central bank holds the accounts and handles KYC), or hybrid (the central bank holds the accounts but commercial banks deal with KYC), Beecham says.

However, central banks are reluctant to bypass commercial banks, as this may cause bank runs that would make banks’ funding position weaker. “Also, if central banks were to open accounts to the whole population and/or decide directly, the deposit rate, their legitimacy and independence could be questioned. So, the main challenge for central banks today is finding the right balance,” Beecham explains.

Anticipating Change

Stark of Kyriba says it will be important for corporate financial professionals to understand the changes that could impact financial services industry partners. An interest-bearing CBDC, for example, could shift lending away from traditional financial institutions.

At this stage, it is difficult to imagine that CBDCs would mean corporates hold deposits directly at the central bank, Deraedt says. However, they could use intermediaries other than commercial banks to access CBDCs. “Why not telcos, for example?” he adds.

Public-Private Balance

One of the key challenges for the development of CBDCs, observes Sean Devaney, director of Strategy for Banking and Financial Markets at CGI, is to balance the need to facilitate lending in the commercial bank sector, against the growth of deposits in CBDCs at the central bank.

“The structure of the CBDCs and the facilities that they offer will drive much of this behavior,” he explains. “However, it is likely that financing will still be sourced from commercial banks, so there will need to be an ongoing relationship between treasurers and their bank.”

Where there is likely to be variation, he says, is in some of the international transfer and cash-sweeping activities, where the likely more efficient, cross-border processing of CBDCs could have a more significant impact on revenue that large commercial banks have come to rely on.

Even if there are no reasons to doubt the commitment of central banks to prepare for CBDC issuance, there is still considerable work ahead if the CBDC gold rush is to result in not just tests or pilots, but more CBDCs in circulation. Nevertheless, Daerdt says corporate treasurers should know that CBDCs will become a reality within two to five years, at least in some geographies and with China at the forefront.

Now is the time to build business cases to assess the long-term impacts and value a digitalization of payments, liquidity, working capital and risk management transformations could deliver, says Stark.

“Our customers, and the market in general, are seeing an acceleration in the adoption of digital technologies across all market segments and industries in response to geopolitical uncertainty, FX volatility and unstable financial markets,” Stark adds. “Potential for a highly secure, safe, and real-time digital currency backed by the Federal Reserve offers very strong business value.”