As central banks all over the world are exploring the potential benefits of central bank digital currencies (CBDCs), the International Monetary Fund (IFM) published October 11 2024, a report evaluating the financial stability implications of the issuance of CBDCs. According to the report, more than 90 per cent of central banks currently engage in some form of CBDC work, and around two-thirds of central banks consider that they were likely to or might possibly issue a retail CBDC in either the short or medium term.
CBDCs have emerged as a compelling frontier in the evolution of money and finance, while promising to reshape financial systems, enhancing payment efficiencies and extending financial inclusion to underserved populations. But like any transformative technology, CBDCs bring both opportunities and complex challenges, and many questions must be answered for a secure and stable financial future before CBDCs are deployed.
The IMF's in-depth analysis examines CBDCs' potential to redefine the financial landscape. The findings highlight how CBDCs could lead to a more resilient and efficient monetary system, while also stressing the critical need for thoughtful policies to mitigate associated risks ahead of time. Let us explore the IMF's insights into CBDCs' potential, the hurdles ahead, and the critical choices central banks must make to utilise digital currencies effectively.
While some papers give examples of how a central bank's balance sheet might change with CBDC issuance, IMF provides a more comprehensive look at how both central and commercial bank balance sheets can adjust to CBDC issuance.
At the heart of the CBDC movement lies the hypothesis that digital currency is accessible, reliable, and sovereign. Unlike cryptocurrencies or private stablecoins, which operate independently of central authorities, CBDCs are designed and issued by central banks. This alignment with state monetary authorities enables CBDCs to serve as a safer alternative to private digital currencies, reinforcing trust in national monetary systems, with the key following advantages:
The IMF recognises the positive sides of CBDCs, but also highlights and cautions that their implementation comes with inherent risks that must be carefully managed to avoid unintended consequences. If CBDCs are not thoughtfully designed, they could disrupt the traditional financial ecosystem, challenging the roles of commercial banks, de-valuing the natural currency and potentially leading to financial instability.
Ultimately, the success of CBDCs hinges on key decisions made by policymakers and central banks. CBDCs are not any simple innovation. It is a complex technology that can substantially re-design the financial systems as we know them. Thus, central banks must balance innovation with caution, ensuring that the promise of CBDCs does not come at the expense of financial stability.
IMF emphasises the following critical choices for central bank:
In addition to the above, there is one key question and there are no clear answers yet. But I believe that this question needs to be answered first:
Who will control the CBDC infrastructure?
This is an elemental question with significant implications for both sovereignty and privacy: who will control the technology underpinning CBDCs, and how will this control shape the future of money? While the IMF's recommendations provide a clear framework for financial stability, the questions around infrastructure ownership, data access, and governance remain unanswered. The ownership and structure of the underlying CBDC technology will ultimately determine how transparent, secure, and accessible these digital currencies will be.
As central banks across the world explore CBDCs, the IMF's analysis provides a supportive sounding board for managing the opportunities and risks ahead. The message from the IMF is clear:
The future of money is digital, but the path to CBDCs should be deliberate, transparent, and secure. CBDCs represent an opportunity to enhance financial inclusion, modernise payments, and reinforce monetary sovereignty. However, unlocking these benefits requires careful planning, proactive regulation, and a steadfast commitment to financial stability and data protection.
Countries that proceed with CBDC initiatives need to prioritise sound policies, responsive regulation, and user-focused design to realise CBDCs' potential without disrupting the financial system, while recognising the power and major risk of using (controlling) the financial data of the people.