The Bank of Israel is looking at creating ‘ordinary’ digital shekels, the transfer of which is recorded in the ledger, and ‘private’ digital shekels.
While spending ordinary shekels would be recorded on the ledger, spending private shekels would not be, providing the same privacy as using cash. An appropriate limit on using private digital shekels is one of the issues yet to be decided for this concept.
The bank has also been exploring how to set quantitative restrictions on payment transactions and how to use ‘smart contracts’ for delivery versus payment transactions. The Bank does not see itself writing applications for specific payment transactions but neither does it see a free for all where anybody can write smart contracts on the blockchain, which is the underlying technology the bank has been using for these trials, since this brings the risks to the entire system. If payment service providers write smart contracts, then how will this be supervised?
The Bank for International Settlements (BIS) Hong Kong Innovation Hub will start Project Selah in the third quarter of 2022. The project sees the Hong Kong Monetary Authority and the Bank of Israel working together, with the BIS, to test a two-tier system in which the central banks will deal directly with consumers without the input of banks.
This is an unusual approach since it means financial intermediaries such as banks would have no exposure from the public holding or transferring CBDCs.
The cyber security risks would lie with the central bank. While it reduces risks to commercial banks, it increases the risk of disintermediation if consumers choose to save their money with the central bank. The ECB is looking at capping the issuance of digital euros to $1.56 trillion to limit this risk.
An OMFIF article neatly summarises why CBDCs are not a priority for central banks, particularly with inflation unleashed and raging around the world.
It quotes recent Monetary Authority of Singapore and UK House of Lord committee comments about the lack of a user case for retail CBDCs, former BIS staff statements about cross border payment efficiencies being possible without CBDCs, new payment innovations such as PIX and regular examples of a lack of resilience in digital payment solutions.
Not yet rather than never ever.
Despite the OMFIF article, the BIS has issued a paper reporting on the results of project Inthanon-LionRock2, Jura, Dunbar and mBridge, all experiments exploring the possibilities and boundaries of cross-border payments using CBDCs.
While the first was a proof of concept and the others prototypes, they all demonstrated the potential for lower costs, faster settlements and increased operational transparency. They explored policy, legal, governance and systemic issues. Perhaps so far, so good.
The report details how new and existing platforms will work together, how scalable solutions are and the resilience and security of the systems as areas needing work.
The Bank of Ghana (BoG) continues its work on CBDCs. Recent announcements have included statements about ensuring the CBDC, the e-cedi, will work offline and its wish that it will work on payment platforms operated by mobile-phone service providers. It sees interoperability with the existing electronic and mobile payment solutions as key. Given that commercial solutions charge fees but CBDCs are free of additional charges, it will be interesting to see how this is achieved.
The BoG is doing this work in the context of a long term digitisation plan which began with the Payment Systems Act 2003.
This established the legal and regulatory basis to allow the adoption of technology in the financial sector. More recently, the Payment Systems and Services Act 2019 was passed to regulate fintechs and to establish a conducive environment for inclusive and competitive delivery of digital financial services.
The US Federal Reserve has issued a paper looking at the possible impact of issuing a retail CBDC on US monetary policy implementation, including but not limited to the CBDC’s potential interaction with the central bank’s balance sheet, the commercial banking sector, and money markets.
The study defines a retail CBDC as a liability of the central bank that is only available to US households and businesses and that a retail CBDC is being introduced at a time when the Federal Reserve is operating with an ample supply of reserve balances and the retail CBDC is unremunerated.
The scenario that was explored assumed demand for a retail CBDC was high, meaning there is widespread adoption of retail CBDC by US individuals and small businesses as a means of payment and as a store of value.
Balance sheet analysis found that the effect on monetary policy implementation from a retail CBDC would depend significantly on the scale and variability of CBDC adoption and how this adoption affects the supply of reserves relative to the reserve demand curve. Demand for a retail CBDC will likely depend on several factors, including whether it is widely accessible; how transferrable or substitutable it will be with other retail payment platforms; whether there are limits on the size of holdings; what degree of privacy it provides; and whether it is remunerated. Given this finding, assuming high demand presumably explored a more stressful scenario of introducing a retail CBDC.
Strong retail CBDC demand could manifest itself as a conversion of physical Federal Reserve notes or deposits at banks, or potentially money funds or US Treasury bills, into retail CBDC. While the exchange of Federal Reserve notes for retail CBDC may not have a direct effect on the supply of aggregate reserves, the exchange of deposits for retail CBDC would lead to a decrease in the supply of aggregate reserves. The decrease in reserves could shift the aggregate reserve supply to the left far enough to intersect with the steep portion of the reserve demand curve. This type of a shift would likely result in upward pressure on the federal funds rate.
The paper concludes from the balance sheet analysis unwanted, upward pressure on the federal funds rate could be counteracted with existing Federal Reserve policy tools. The Federal Reserve could increase the supply of reserves through permanent open market operations such as reserve management purchases (RMPs).
In addition, the Federal Reserve could also make technical adjustments to administered rates to steer rates within the target range of the federal funds rate.
