Retail CBDCs: why commercial banks will be key players

By Jeremy Boot, head of Digital Assets at Temenos

Central Bank Digital Currencies (CBDCs) – a digital form of central bank money – are firmly on the rader of Central Banks globally. According to the Atlantic Council over 100 countries are actively exploring a CBDC. Many are further along on their journey with some already launched. But why do we need them? And what role will commercial banks play?

Types of CBDC

First, let’s clarify the different types of CBDC. Retail CBDCs are domestic networks aiming to facilitate financial inclusion and digital payments within a given country. Its where we there are live CBDCs today such as in Nigeria, Jamaica, and the East Caribbean

Wholesale CBDCs are intended for the settlement of interbank transfers and related wholesale transactions. Conversely, tend to be low volume/higher value compared to retail. Several research projects are ongoing.

mCBDC (multiple CBDC) is all about cross-border, linking up CBDC networks across jurisdictions for international settlements, using either interoperable platforms or single platforms with multiple subnets. These promise huge potential to shake-up the inefficiencies of the existing correspondent banking model, albeit challenges remain on areas such as governance and standards.

In this article we’ll be looking at retail CBDCs. So, why do we even need them?

Why do we need retail CBDCs?

The answer varies depending on where in the world you are. Financial inclusion is often quoted as a key driver, and this is particularly relevant for countries with larger unbanked populations and those who don’t already have digital payment networks.

In such countries retail CBDC may help facilitate payments for those populations and boost digital economies. No doubt it’s also of interest to preserve monetary sovereignty by protecting against the rise of alternatives that could fill the void – foreign currency stablecoins or CBDCs, or crypto for example.

Central banks might like the idea of CBDCs progressively replacing cash with a view to cost savings from minting, distribution, and storage of physical money. Other arguments include the programmable nature of CBDC as a direct monetary policy tool, and a building block for mCBDC as these evolve.

Of course, some countries already have effective digital payment solutions. For example, here in Switzerland we have Twint. In my local coffee shop I open my phone, scan a QR code, swipe, and buy my coffee. Quick, easy, and effective. Other countries have similar systems. So, in such places, do we really need another system such as a retail CBDC?

It perhaps comes down to the future role of public money. As cash usage declines should the state preserve access to central bank money through a digital equivalent? Does the average person understand (or care about) the difference between having a claim on deposits at an institution versus a bearer instrument with direct claim on the central bank? Is it too dangerous to leave money in only the hands of the private sector?

These are questions the policy makers are thrashing out. In Europe, the attitude from the ECB certainly seems to be gearing towards launching CBDC. Fabio Panetta from the ECB executive board recently said “Issuing CBDCs is likely to become a necessity”.

Of course beyond simply launching a CBDC, success will be about convincing the population to actually use it. And to achieve this privacy concerns must be addressed and there needs to be real added-value compared to alternatives.

In summary there remain questions about retail CBDCs in digitised economies; but in many parts of the world momentum is building. So, as retail CBDCs are launched, how will they work ?

How will retail CBDCs work?

The evolving standard is the 2-tier model, where the central bank mints and issues CBDC to approved intermediaries such as commercial banks, who maintain the relationship with the user and act as distributors. Mechanisms for issuance might involve directly exchanging CBDC for reserves held at the central bank. This would allow adding CBDC as a new monetary option without impacting the base money supply.

The intermediary is then able to hold CBDC ready to distribute to the wider population. They would also perform the role of customer onboarding and wallet opening, and provide exchange facilities to allow conversion between CBDC and regular money. Once the customer has CBDC in their wallet, they can send to another person or use it for payments. And then the reverse process: the user can convert CBDC back into money, the intermediary can redeem back at the central bank, who can then re-issue or remove it from circulation according to policy.

It’s possible we will see multiple types of intermediary participate in CBDC networks and provide wallet facilities. Nevertheless commercial banks are expected to be key players.

Why commercial banks will be key players

Commercial banks are the natural candidates for distributing CBDC to the population of a given country.

First, commercial banks have the means to participate. They have the liquidity in the form of reserves meaning if a CBDC get’s launched, they can be quickly to participate and hold CBDC ready for distribution.

Banks have the existing broad customer base that extends in many countries to most of the population. They can support in this way public accessibility to CBDC. Furthermore, they have the experience in account opening, KYC processes, and managing the customer, areas the central bank would not typically want to get involved in.

Banks hold customer deposits and so are ideally placed to provide the on/off ramps and slick conversion facilities between those deposit accounts and CBDC wallets. Linking bank accounts to wallets with direct conversion also solves the tricky problem of receiving payments that exceed wallet balance limits.

And then banks have the high regulatory and operational standards that would be a pre-requisite to participating in CBDC systems. For example, for connecting to the infrastructure that could involve hosting and operating a node on a DLT network.

So, banks are well placed to participate, but for them to offer such services would require investment, it doesn’t come for free. It raises the interesting question of what’s in it for the banks? How might they justify the cost, and what kind of services might they offer? These are questions we’ll explore in part 2 of this article.