Dear friends and colleagues,
Good afternoon. Thank you to the organizers for the kind invitation. It is a great pleasure for me to participate in the Bund Summit and contribute to the discussion on digital currency and fintech.
Today I will share with you some of the work we have been doing at the International Monetary Fund on cross-border use of central bank digital currencies, or CBDCs, and its macro-financial implications. My speech is entitled “International Use of Central Bank Digital Currencies”. Let me begin with an important caveat: the views expressed here are my own, and are not necessarily those of the IMF.
Although many of today’s CBDC projects and pilots have a primarily domestic focus, it is matter of policy option and technical designs whether a CBDC is allowed for international use, and various bilateral experiments have demonstrated the feasibility of using CBDCs for cross-border payments.
I will try to address three questions: first, how might CBDCs change the traditional dynamics of international use of currencies? In what ways might CBDCs be used to enhance cross-border payments? Second, what would be the macro-financial consequences for both recipient countries and the issuing country? And third, what might be some of the policy implications?
CBDCs are a digital form of fiat money issued by a central bank. CBDCs embody recent developments and cost reductions in digital technology such as cloud computing and the proliferation of mobile devices, which have dramatically increased the accessibility by individuals and firms to payment instruments previously used only by financial institutions (e.g., real time transfer of balances maintained at central banks). At the same time, distributed ledger technology (DLT) such as blockchains has made it possible to use digital tokens to transfer value over a peer-to-peer system without necessarily going through a central party (for example, commercial banks). As a result, the present international monetary landscape, which is based on connecting banking systems spread around the globe in different locations and time zones, could be reconfigured.
The benefits of using CBDCs for cross-country transactions are conceptually clear. Using CBDC to make a payment or transferring funds across borders could be just as easy as sending an email. This could reduce transaction costs to the benefit of end users, especially for small transactions. Nevertheless, the cost advantage of CBDC relative to traditional systems is difficult to quantify which complicates analysis of net benefit. Additional costs may arise due to investment in cybersecurity and in ensuring compliance with Anti- Money Laundering and Combating the Financing of Terrorism laws and regulations.
Cross-border use of currencies generally falls into two categories, namely the use of currency for international transactions, and domestic use of currency issued by a foreign entity. In the first category, international currencies serve as a medium of exchange, store of value and unit account and are used for international trade, international finance, and foreign exchange reserves. In the second category, a foreign currency displaces a domestic currency for domestic transactions, a situation commonly referred to as currency substitution.
Traditionally, safety, liquidity, trade links, financial connections, and geopolitical factors explain why some currencies are used disproportionally in cross-border transactions. Price stability and confidence in a currency’s value, both stemming from the credibility of the monetary authority, are critical for its use as an international currency since these factors affect the role of the currency as a unit of account and a store of value. The more liquid and developed a country’s financial markets, the more likely that other countries will use its currency for intervention purposes or to denominate financial assets. The larger a country’s share in world output and trade, the more likely that other countries will use its currency due to economies of scale. The status of an international currency is also influenced by the geo-political relationships between the issuing state and the countries that adopt and use the currency.
Network effects or externalities reinforced by synergies across monetary functions also have a strong effect on the international use of a currency. Once a currency is established internationally, the fact that it is used by many entities increases the likelihood that others will adopt it. Synergies between the different functions of an international currency—as unit of account, means of payment, and store of value—can also act as self-reinforcing mechanisms and encourage broader adoption of the currency. For example, the status of the U.S. dollar as the dominant international currency for trade invoicing and payments has boosted the role of the dollar in international finance and vice versa.
The recipient country’s features, such as monetary stability, can have a significant impact on the use of foreign currencies for domestic transactions, or currency substitution. Unsound domestic macroeconomic policies and a lack of trust in policy institutions can encourage domestic users to hold currencies issued by other countries. Hyperinflation can also encourage a switch to foreign currencies as unit of account, store of value and medium of exchange.
In addition to these traditional drivers, there are intrinsic attributes of CBDCs that could drive international use of currencies in ways that are distinct from traditional dynamics, most notably their ability to lower transaction costs and increase accessibility. Programmability of CBDCs, including through the use of smart contracts, could help lower switching costs in foreign exchange markets and transaction costs in securities issuance and trading through tokenization of assets more broadly.
The convenience and easy accessibility of CBDCs make them attractive as vehicle currencies. For example, instead of opening a bank account holding balances of foreign currencies, CBDCs allow residents of foreign countries to have exposures to them without a bank account, something which in many countries is very difficult to obtain due to compliance requirements or other costs. Because they can be transferred over a peer-to-peer system operating around the clock, their use flattens the multi-layered correspondent banking structure, shortens the payment chains, reduces transaction time, and facilitates increased competition among service providers. As a result, cross-border payments could then become cheaper and more inclusive, benefiting in particular small value remittances.
International use of a CBDC would crucially depend on its design features. Convenience and low cost, security and resilience, zero-tolerance for downtime and ability to use when there is no internet connection are essential desirable features of a CBDC. Crucially, while it is important for law enforcement authorities to implement anti-money laundering and combating terrorism financing, providing some degree of anonymity and privacy and protecting personal data would be equally desirable if the CBDC is to be adopted widely.
Legal provisions will heavily influence CBDC use abroad. Importantly, recipient countries may determine the degree to which denomination and settlement of contracts in a foreign currency will be legally authorized. In addition, in designing the CBDC, countries need to decide whether non-residents will be allowed to access the system where CBDC and transfers of CBDC are recorded.
CBDC could be used for cross-border payments in different ways. A domestic CBDC could be used directly for payments from, to and perhaps even within another country. Additionally, CBDCs could be designed to interoperate to facilitate cross-border and cross-currency payments. Systems can be integrated through an interoperable link where the infrastructures combine their functions. For example, dedicated corridor networks can be created for multiple CBDCs to be traded and exchanged on a payment vs payment basis and for payments to be synchronized across different types of ledgers.
Adoption and use of CBDCs is difficult to predict, but using the lens of various hypothetical scenarios, our recent analysis suggests that widescale adoption of digital currencies across borders can impact monetary policy and financial stability.
Though substitution into CBDCs is no different from traditional “dollarization” that occurs in countries that have suffered from high inflation and large exchange rate volatility, the convenience and easier accessibility of digital money enables substitution at a faster pace and larger scale. The macroeconomic impact is likely to be more pronounced if the business cycle of the recipient is not synchronized with that of the issuer since the ability of the country to use monetary policy to absorb shocks will be highly constrained.
Foreign CBDCs can be used to effectively conduct a cross-border transfer while bypassing traditional payment systems, through which exchange restrictions and capital flow management measures are typically enforced. The relative ease of acquiring foreign CBDCs on the internet make them particularly attractive in regimes where the costs and national regulatory burden associated with traditional payment systems are high. To the extent that their adoption facilitates capital flows or increases capital flow volatility, it may sharpen the “policy trilemma”, complicating the conduct of monetary policy and the management of exchange rates.
On the positive side, CBDCs could in principle be designed to facilitate compliance with existing foreign exchange restrictions and capital flow management measures, where restrictive measures are built into the design or programmed through smart contracts. For example, the transfer of value gets rejected if insufficient balance or the metadata for the transaction to succeed do not meet certain requirements.
Cross-border use of a CBDC could also complicate the conduct of monetary policy in the issuing country if external demand for the CBDC results in large capital flows. The impact would be more pronounced if the financial markets are shallow relative to the size of the economy. The issuing central bank will need to consider whether the spill-back effects associated with cross-border use of CBDC are consistent with its domestic policy objectives, and whether it is in their national interest to be the lenders of last resort to those countries that use its CBDC extensively.
In terms of financial stability, greater currency substitution induced by foreign CBDCs could add additional pressures on funding and solvency risks relative to those typically observed in partially “dollarized” economies. Use of foreign CBDC could also lead to higher run risks in stressful times. For certain less developed economies, a run on the banking system is often associated with a run on the currency or the country. If opening and transferring to a digital wallet is faster and more accessible than opening and transferring to an account in a bank abroad, and considering that emergency liquidity assistance from the issuing central bank may not be easily available, incentives for depositors to run could increase.
Overall, our analysis shows that the macro financial implications of adopting and using digital money would depend on the degree of adoption. We find that CBDCs would not qualitatively change the economic forces that lead to the international use of currencies, but they could reinforce the incentives behind currency substitution and currency internationalization. In other words, CBDC on its own is not likely to change fundamentally the current international monetary landscape, if other fundamental factors that determine the status of an international currency, such as credibility of monetary and financial policies, breadth and depth of financial markets, and institutional quality, do not change.
The main policy challenge from the international use of CBDCs is how to preserve monetary and financial stability without forgoing the benefits of more efficient cross-border payments and better access to international capital markets. Meeting the challenges will require close cooperation by country authorities and a strong and persistent commitment by the international policy community.
One approach in striking a good balance between reaping the efficiency gains of international use of a CBDC and minimizing macro-financial risks and spillovers is to encourage interoperability of CBDCs issued by different central banks. Interoperability can enable complementarity and coexistence, and facilitate the development of automated foreign exchange markets. New functionalities and design features of CBDCs may necessitate relevant standards to be developed and for central banks to work collaboratively in their development in order to facilitate interoperability. Importantly, international standards on digital identities may be required for seamless cross-border payments.
Those are my remarks today. Thank you for your attention, and best wishes for a successful conference.
