Viviana Alfonso, Steven Kamin and Fabrizio Zampolli
The Committee on Payments and Market Infrastructure (CMPI) carried out a survey of central banks in Latin America and the Caribbean (LAC) asking about their work on Central Bank Digital Currencies (CBDCs) on behalf of the Bank for International Settlements (BIS) in late 2020 and the first half of 2021. 13 central banks in LAC replied to the first survey and a further eight replied when contacted in 2021.
The goals were to:
Understand their views about CBDCs,
See if their engagement could be explained by the structural characteristics of their economies,
Assess the relevance of the potential benefits, risks and costs of CBDCs to their economies,
Review the design options and design choices already made.
Views of LAC Central Banks towards CBDCs
The LAC is a region already active in CBDCs. Ecuador issued a CBDC in 2014 and Uruguay in 2018, although both have stopped those projects. The Bahamas, the Eastern Caribbean Central Bank and Jamaica have all issued CBDCs.
The survey found that LAC is not dissimilar from the rest of the world’s central banks. While 85% are engaged in research, similar to the global figure, LAC has a greater interest in retail rather than wholesale CBDCs. The primary interest is driven by increasing financial inclusion, the efficiency of domestic payments and the safety of payment systems. For a continent that experiences high level of remittances, increasing the efficiency of cross border payments was not a prominent motivator.
29% of those who answered the survey (6/21) said they were likely to issue a CBDC within 1-3 years, a slightly higher figure than the global average. The medium term plans were similar to the global average. Unusually nearly half of the central banks already have legal authority to issue CBDCs if they wish.
The pandemic changed the priority for 41%, increasing their likeliness to issue a CBDC, slightly higher than the global average. The central banks cited wanting to encourage socially distanced transactions and to be able to channel public funding efficiently as reasons.
The study found that central banks were ahead of their public in terms of their interest in CBDCs. LAC internet searches on CBDCs was markedly lower than other regions while central bank interest was higher.
One finding in the research was that differences between LAC central banks regarding their interests in CBDCs are not being driven primarily by differences in their economic and financial situations.
Drivers of LAC interest in CBDCs
The BIS has created a model to assess the level of interest in CBDCs based on measuring country characteristics such as mobile phone usage, government effectiveness, financial development etc.
For LAC the measure of engagement in CBDCs was less than that of advanced economies, but similar to that of other Emerging Market and Developing Economies.
The characteristics in LAC driving engagement were;
1. Extent of innovation
2. The presence of faster payment systems
3. Government effectiveness
4. The prevalence of financial account ownership
5. The extent of financial development generally
6. The extent of public interest in CBDCs (based on the number of internet searches)
The results were consistent with the regions economic, financial and technical attributes.
Potential benefits of CBDCs
LAC remains a region with high levels of cash usage. Although the pandemic has had some impact on cash usage, it has been relatively small. As a result LAC is unusual in that creating a substitute for cash does not figure as either a driver or a benefit for the region.
The paper lists benefits of CBDCs for the region but starts by highlighting that the region currently has expensive retail digital payment systems and limited access to these systems for many people. To achieve the benefits, digital platforms need to allow private payment providers to offer services based on good data governance and good interoperability between the different payment arrangements.
LAC potential CBDC benefits were;
Increase payment competition and through that added consumer convenience
Reduce costs for users
Support further financial innovations such as programmable contracts
Prevent market dominance by large firms
Support monetary sovereignty against private digital currencies
Increase financial inclusion
Reduce ‘informality’ in the economy (people living outside of the banking system based on cash)
Increased resilience against natural disasters, particularly where repairing digital networks is faster than building new roads etc.
Assist government transfer payments
Reduce the cost of cross-border trade
The paper points out that many of these benefits could be achieved through well-designed retail fast payment systems such as PIX in Brazil or CoDI in Mexico. It argues that since CBDCs allow safe, direct settlement of financial obligations, they eliminate the need for intermediary credit in payments and help reconfigure the payment system in a more parsimonious way.
Mobile phone penetration is 69% in LAC, mobile internet users are 57% (although this still leaves 300 million people not connected) and 49% of the population have bank accounts used for transactions. This last figure is much lower than the average for Emerging Market and Developing Economies which is 70%.
Potential costs and risks of CBDCs
Just as the previous section focuses on theoretical benefits, this section considers costs and risks. Interestingly the paper offers mitigating options for these rather than leaving them as stated costs and risks. The list included;
Cyber attacks and abuse for criminal purposes. It makes the point that if the central bank is responsible for the system, then it would suffer reputational risk if it happens.
Stopping money laundering and the financing of terrorism could require the central bank to increase its oversight powers, and this could be politically sensitive. A two-tier system would help avoid this.
Disintermediation of commercial banks. Strict limits on CBDC holdings, as applies to Bahamas Sand Dollar, would reduce this risk.
International payments could lead to unwanted capital outflows and excessive exchange rate volatility. This can be addressed by putting limits on use, foreign exchange regulations and co-operating with foreign jurisdictions.
Challenges posed by private digital currencies and foreign CBDCs
While the use and adoption of stablecoins and foreign CBDCs could provide increased convenience compared with paying with cash or other domestic alternatives, they would not necessarily reduce costs, improve access to payments, especially if one stablecoin was dominant, they could encourage the substitution of the domestic currency by the stablecoin and reduced monetary policy effectiveness. These last two points would be particularly true if the stablecoin originated abroad or was denominated in a foreign currency.
Ultimately the best protection against the use of foreign CBDCs lies in negating the reasons that people may turn to them, the consequences of central banks failing to pursue sound policies.
Pros and cons
Would the potential benefits be achieved? The paper reviews each of the potential benefits and provides thoughts on why they may be challenging to deliver:
Increase payment competition and through that added consumer convenience. But the region already has quite developed faster payment systems in a number of countries (Brazil Mexico, Chile) and is on track in others to introduce them.
Reduce costs for users. With cash so widely used in the region, CBDCs will have to co-circulate for a considerable time. Central banks will, therefore, have to bear both costs and the CBDC system is likely to be expensive.
Support monetary sovereignty against private digital currencies. Without sound monetary policies from central banks, populations are likely to turn to alternatives.
Increase financial inclusion. While mobile phone penetration is 69% in LAC and mobile internet usage is 57%, relatively high figures, 300 million people do not have access to the mobile internet and while 49% of the population have bank accounts used for transactions, this figure is much lower than the average for Emerging Market and Developing Economies which is 70%. Financial literacy is a major issue in the region.
Reduce ‘informality’ in the economy (people living outside of the banking system based on cash)
Increased resilience against natural disasters, particularly where repairing digital networks is faster than building new roads etc. It has yet to be proven that maintaining the power and digital system infrastructure, particularly in countries as large as many of those in Latin America, will prove better than cash. Given the prevalence of cash in the region currently, cash is likely to be an effective alternative.
Assist government transfer payments. Many countries in the region have found ways of making transfers efficiently during the pandemic.
Reduce the cost of cross-border trade. There are major challenges getting the regulations and technical standards in place to enable cross-border exchanges.
This is an interesting and useful paper. The authors clearly believe that the risks and challenges of CBDCs can be overcome, and the focus is positive about the potential for CBDCs in the region. Clearly the Caribbean, Central America and Latin America contain huge diversity of geography, climate, economies, cultures and politics and so it would be wrong to disagree. The pros and cons will apply differently and to different extents across the region and this paper is a good benchmark against which to consider the opportunities and the way ahead.