‘Monetary sovereignty’ issue raised in CBDC roll-out

Limitations on digital currency deposit and withdrawal amounts plus the effect on a nation’s ‘monetary sovereignty’ were key points all raised on the eve of major banks confirming a pilot program sign-on.

Both the Commonwealth Bank of Australia (CBA) and Australia and New Zealand Limited (ANZ) on Thursday (2 March) confirmed their participation in the RBA and Digital Finance Cooperative Research Centre (DFCRC)’s CBDC pilot.

Speaking at an invite-only IIF Australia Forum event on Wednesday (1 March), Reserve Bank of Australia assistant governor (financial system), Brad Jones, outlined a plethora of issues facing the proposed global roll-out of central bank digital currencies and the pros and cons of it.

While the speed at which CBDC pilots are being trialled varies per nation depending on different factors, there was an increase in momentum and rising philosophical questions to the debate.

“My sense is there’s both a common element to what’s generating this momentum … and then there’s a whole host of country-specific factors,” Mr Jones explained.

“The common element is that there is clearly profound structural change in the way that commercial activity is conducted; that digitalisation of the economy.

“That is raising really profound questions about the role of money in the digital era.

“We obviously are all observing a structural decline in transaction-related demand for cash and so there are big questions, almost philosophical questions, being raised about the role of money, public and private money, and their interaction in that sort of the context.”

Citing China’s CBDC interest being ‘financial stability issues’ and the “well recognised” decline of cash in the eurozone, Mr Jones paid particular attention to the US.

“I have absolutely detected a shift in the last 18 months or so [in] growing support, particularly in Congress, behind the idea that the primacy of the US dollar and its role in the international financial system could be at risk if all the others [countries] race ahead and the US sits behind now. There’s some big hurdles to cover there.”

“And then in low-income countries, [there’s] a whole different range of motivation, mainly related to looking to a CBDC to increase financial inclusion.”

Currency substitution and ‘conceding’ sovereignty

Notably, one of the cases that has been made for why countries should move to introduce a general purpose CBDC in particular is “that you ‘concede’ monetary sovereignty,” Mr Jones said.

As an example, he pondered that if banknotes were no longer freely circulating in a country and it didn't have a domestic CBDC – and that nation’s trading partners did – CBDC “would find its way into your country,” he explained.

“What you're basically talking about there is a form of currency substitution,” he cautioned.

“Currency substitution, if it were to take effect, would pose very material problems for the transmission of monetary policy and the safeguarding financial stability,” he warned.

However, he said from his reading there is a “a deep history” of literature on what determines if a country will face currency substitution.

“On my reading at least, they have very little if anything to do with issues of technical form with a currency,” he said.

“What they had to do with is quality of your institutions, your economic policymaking institutions, your financial institution, quality of financial institutions, the rule of law, and whether domestic residents and foreign investors have reason to question the integrity of your currency.

“Those conditions [that] typically have determined whether you are vulnerable to that or not, they're just not apparent in Australia,” Mr Jones reassured.

Transmission through the banking system

In clarifying the retail versus wholesale divide of digital currency and the impact on lending and spending, Mr Jones addressed debate about CBDC ‘limits’ becoming logical – albeit problematic.

“The first concern is that if in normal times households and businesses decide that they want to park their liquidity in sinking CBDC central bank deposits - effectively rather than commercial bank deposits - the result of that would potentially be central banks would find themselves inundated with deposits they don't need and can't productively invest,” he said.

Conversely, as Australian commercial banks do need deposits as a source of funding (60 per cent of bank funding comes from deposits - a 20 percentage point increase prior to the GFC), if that funding were no longer available they would either have to “source that funding from more expensive, or more volatile sources”, or “quite radically change how they distribute credit”, Mr Jones explained.

“The funding and lending models would potentially be severely impacted and that would have implications for monetary policy transmission because countries like Australia's monetary policy transmits through the banking system.”

If CBDC has limits then ‘what’s the point?’

The other issue is how people en masse could use CBDC during stressed times.

As digital current is more easily accessible, if customers were ever worried about the traditional banking system, or a bank, a mass ‘limitless’ transaction might occur.

While the central banks discuss measures to “dampen those risks”, Mr Jones confirmed that solutions all led to enforcing transaction limits. 

Citing the Bank of England’s recent £‎10,000 ‘cap’, one solution would be limiting how much an individual could transfer, including penalties on withdrawals from banks.

“What they all have in common is that they're all designed to limit or restrict the use of a CBDC, which in turn … raises an interesting question: well [if] the solution of the problem is actually to restrict the use of the thing in the first place, why do you need it? Where's all this going?”

[Related: Australians unconvinced by digital currency]