Executive summary: Lately, the China Finance 40 Forum (CF40) held the Second Bund Summit with the member institutions of its organization committee and had discussions about “Digital Currency, Fintech and Inclusive Finance”.
Experts attending the event pointed out, in order to guarantee central banks’ right to issue currencies and give full play to the resource advantage of commercial banks, the digital renminbi will adopt a “central bank - commercial banks” two-tier operating model. Central bank digital currencies (“CBDCs”) have an apparent edge in cross-border payment. Digital currencies will change the pattern of cross-border payment, reduce transaction costs, boost access convenience, shorten the payment chain and cut transaction time. However, CBDCs may also bring about risks during cross-border payment.
As for the research, development and operation of CBDCs, experts present at the summit suggested that: First, it is important to accurately specify the application scenarios for such currencies, determine the reasons for their research and development, and ensure they are compatible with the existing currency systems. Second, it is essential to adopt corresponding regulatory policies according to different operating systems after the application scenarios are specified. Third, countries should strengthen international cooperation to jointly build a design framework for digital currencies.
I. A two-layered operating system is the best practice for currency operation.
For the digital renminbi to adopt the two-layered operating model, it can guarantee the central bank’s right to issue currency, prevent such right from being passed into other hands, give full play to the resource advantage of commercial banks and the decisive role of the market in resource allocation.
On the one hand, centralized management of digital renminbi issuance can safeguard the position of legal currency, enhance payment efficiency and maintain financial stability. First, this can safeguard the position of legal currency and currency issuance right. Centralized management of digital renminbi helps to fend off the corrosion of cryptoassets and global stablecoins, prevent currency issuance right from being passed into other hands in the era of digital economy, ensure that currency issuance always serves the general purpose of the country’s development and reform, and guarantee currency value stability, security and legal tender status of digital renminbi, among its other features. Second, this can enhance the efficiency of the payment system, and improve monetary policy transmission. Centralized management of digital renminbi can fulfill payment and settlement at the same time, boost the capital turnover efficiency of merchants, help address liquidity problems of small and medium-sized enterprises, and enhance currency circulation speed and monetary policy implementation efficiency. Meanwhile, it also helps to remove retail payment barriers and market segmentation, avoid market distortion, protect the rights and interests of financial consumers, and promote inclusive finance. Third, this can maintain financial stability. A controllable anonymity mechanism is adopted for the digital renminbi. Under the condition that individual privacy is protected, the People’s Bank of China (PBOC) can analyze transaction data and directions of fund flows with mastered technologies such as big data and AI, prevent and crack down on criminal acts such as money laundering, terrorism financing and tax evasion, and effectively maintain financial stability.
On the other hand, commercial banks providing the service of digital renminbi conversion is the requirement of laws and regulations, as well as a successful experience in international practices. It can also bring into full play the role of market in allocating resources. On the one hand, the Regulations on the Administration of Renminbi grant financial institutions engaged in renminbi deposits and withdrawals the right to manage the circulation of the currency in cooperation with the PBOC, therefore commercial banks have the legal foundation to provide conversion and circulation services for digital renminbi. Whereas non-bank payment institutions shall not engage in such businesses as currency conversion, cash deposit and withdrawal, or do so in disguised forms. It should be noted that third-party payment institutions and other commercial banks can still undertake the currency circulation service. On the other hand, the two-tier model in which the digital yuan is issued by the central bank to commercial banks is an international best practice. First, large commercial banks have mature infrastructure, sound systems and adequate talent pools, so their provision of the conversion service can fully harness market forces and fulfill the survival of the fittest. Second, commercial banks of this category have extensive experience in retail business, risk control system and other aspects, and can effectively prevent operational risks, and boost the public’s confidence in holding and using digital renminbi. Third, by allowing commercial banks to convert digital renminbi, itcan give full play to their intermediary role, and provide a more direct and efficient channel for the transmission of digital currency.
II. Benefits and Risks of Promoting CBDCs in Cross-border Payments
Currently, the research and pilots on digital currencies conducted by central banks are mainly focused on domestic application scenarios, but CBDCs can also be applied to cross-border payments. CBDCs may be superior to traditional currencies in cross-border payments.
First, digital currencies may alter the landscape of cross-border payments based on the relationships of correspondent and clearing banks distributed all over the world. CBDCs can fully embody the latest developments of digital technology and the cost advantages it brings, such as the popularization of cloud computing and mobile devices. These new technologies allow individuals and enterprises to access payment tools and services which previously could only be used by financial institutions. For example, real-time fund transfers of the clearing balance of central banks. Meanwhile, blockchain and other distributed ledger technologies (DLT) have fulfilled value transfers of digital currencies in point-to-point systems, making it unnecessary to transfer funds via commercial banks.
Second, CBDCs can lower transaction costs and boost access convenience. CBDCs are programmable, including being programmed through intelligent contracts, which helps to lower the costs of foreign exchange transactions, as well as the costs of securities issuance and transactions through larger scales of the securitization of assets.
Third, CBDCs can fulfill fund transfers in point-to-point systems running round the clock, which can shorten the payment chain and reduce transaction time. Therefore, the use of such digital currencies can prompt the traditional multi-layered correspondent bank structures to become even more flattened, shorten the payment chain, reduce transaction time, increase transparency, and promote competition among currency service providers. As a result, cross-border payment becomes more convenient, inclusive, and beneficial to small-amount remitters.
Nevertheless, CBDCs can also bring about risks arising from cross-border payments. First, the pressure of currency substitution is rising. When a country allows another country’s CBDC to be used within its territory, currency substitution could be faster in speed and larger in scale due to access convenience of digital currencies. Second, cross-border use of CBDCs may affect the implementation of monetary policy. If the economic cycle of a user country and an issuing country is not in sync, the former’s ability to use monetary policy to deal with the shocks so generated will be limited, which will produce notable macroeconomic impact. Third, in terms of financial stability, currency substitution caused by direct use of a foreign country’s digital currency may aggravate the risk of currency mismatch. During a crisis, using the digital currencies of other countries may even increase the risk of runs on domestic banks, because fund transfers via digital wallets can be more convenient than transfers to overseas bank accounts, resulting in growing risk of bank runs caused by depositors.
III. Policy Advice
First, accurately specify the application scenarios of CBDCs, determine the reasons for the research and development regrading CBDCs, and ensure CBDCs are compatible with existing currency systems when put into use. Whether a CBDC adopts distributed ledgers or other forms, it must be able to co-exist with existing currency systems. It shall not affect financial stability or security, and must ensure the resilience of payment and banking industries, to which central banks shall also make active contributions.
Second, relevant institutions shall adopt corresponding regulatory policies according to different operating systems after the application scenarios are specified. The digital renminbi will mainly adopt a “central bank - commercial banks” two-tier operating model. In this context, firstly, it is imperative to comply with four principles while adhering to centralized management by the central bank: One is coordinated management of the scale of the issuance of digital renminbi to prevent over-issues. Two is the formulation of uniform business standards, technical specifications, security and application standards to fulfill connectivity among designated operating institutions, and avoid payment barriers. Three is coordinated management of information about digital renminbi. This includes coordinated management of the digital renminbi wallet, unifying understanding of the digital renminbi , effectively lowering anti-counterfeiting costs, jointly developing a wallet ecological platform by the central bank and designated operating institutions through joint building and sharing, and fulfilling respective visual identities and feature functions. Four is coordinated building of infrastructure for issuing digital renminbi to fulfill connectivity among operating institutions and avoid payment barriers.
Secondly, for the selection of commercial banks as designated operating institutions for digital renminbi, those with solid capital and technological strengths shall be chosen to provide digital renminbi conversion service. (i) This can make full use of existing resources and technical reserves. Commercial banks designated as operating institutions shall have mature infrastructure, sound service systems and adequate talent pools, so their provision of the conversion service can fully mobilize market forces and fulfill the survival of the fittest. (ii) This can reduce potential risks. Commercial banks designated as operating institutions have extensive experience in retail business governance system, risk control measures and other aspects, and can effectively prevent operational risks, and boost the public’s confidence in holding and using digital renminbi. (iii) This can avoid financial disintermediation. Digital renminbi adopts a currency issuance system under a binary model with no interest to be paid, and can avoid competition with the deposits of commercial banks. (iv) This is conducive to monetary policy transmission. Commercial banks’ provision of digital renminbi conversion can increase the speed and efficiency of funds flowing back to commercial banks, propel them to play the role as financial intermediaries, and provide a more direct and efficient channel for monetary policy transmission.
Third, experts of international organizations suggest that countries should strengthen international cooperation to jointly build a design framework for digital currencies. There are still frictions in cross-border payments now, whereas currencies involve sovereignty. CBDCs may turn out to be a way to solve existing frictions in the future.
