ICTworks

The evolution of money and payment systems delivers is creating new opportunities and business models alongside new challenges. As economies are becoming more digital, user needs are changing; and being met by a widening variety of innovative financial service providers. With increasing disruption, central banks are rethinking traditional approaches to payment infrastructure and are exploring how they can continue to deliver their public policy objectives in the context of a changing environment with Central Bank Digital Currencies (CBDC).

Central Bank Digital Currency in an Economy

To better understand the role CBDC can play in an economy, one first needs to understand the difference between private and public forms of money.

Public money is usually issued by a central bank, is accessible to everyone within that economy and is considered the safest form of money – cash is the best example of public money. Private money is created by; and accessed via private financial institutions. The private sector plays an important role in creating money within an economy; in the simplest terms, the deposits of one individual is lent to the next and in that way money is created.

But to access the system, make payments, receive or borrow money one must be financially included, or have a financial product with a private financial service provider. Almost all digital forms of money are private – they are created using the channels of private financial institutions. For the millions of unbanked and underserved consumers, digital money and digital transactions are not a part of their daily lives.

In many economies cash is decreasing, even in developing markets the use of cash by higher income segments is decreasing. This means that 1) as cash decreases access to a public good decreases; 2) the cost of the cash remaining in the economy is borne by low-income households; and 3) these Lower-income segments are excluded from a growing part of economic activity.

Furthermore, private institutions will naturally choose to focus on servicing their high-income and higher revenue generating customers, again neglecting certain segments or groups. This can lead to a market failure and the exclusion of individuals from the digital economy.

What is a Central Bank Digital Currency?

Central Bank Digital Currency (CBDC) is a digital fiat currency issued by the central bank rather than a commercial bank. It represents a new form of central bank money where a bearer of a country’s CBDC would have a direct claim against the issuing Central Bank in the same way that a bearer of cash has a claim against the central bank. A CBDC should be as widely available to the general public as cash.

While it is often implicit or assumed that CBDC would be issued on a distributed ledger technology (DLT) platform, it is not a requirement and CBDC can be issued on existing digital channels and in a centralised manner.

Central Bank CBDC Strategy

A Central bank looking to launch a CBDC has many design choices to make. There is no one-size-fits-all approach or standard issue CBDC and different choices have different economic and regulatory impacts. Each central bank must be clear about its primary objectives for implementing a CBDC; it must have a well thought through strategy that informs the design choices. The central bank must also have an understanding of the impacts and trade-offs of each decision.

As an example, a Central Bank may choose to pay interest on CBDC holdings, however this may then require holders of CBDC to register with the national tax authority; which would negatively impact the privacy of the CBDC holder. Privacy is a key and often desirable characteristic of cash. One could argue that being a registered CBDC holder may decrease the potential for illicit transactions, but it may also decrease the adoption of CBDC and any Central Bank would need to weigh these trade-offs before making a decision.

Why Banks Consider a CBDC?

While financial access on the continent lags, some of the most innovative and disruptive financial products have been developed in African countries and CBDC is the next frontier of innovation that can see African nations leapfrog developments in financial systems and inclusion.

There are already at least 10 African Central Banks that have announced that they are considering and researching CBDC, including Nigeria, Ghana, Zimbabwe, Tanzania, South Africa, Rwanda, Namibia, Morocco, Mauritius, and Kenya. Both Nigeria and Ghana have implemented or piloted CBDC in their economies.

Some of the compelling reasons for a developing nation to consider, include:

• Achieving financial inclusion: Despite several decades of interventions, the average rate of financial inclusion in Africa is just above 41%, partly due to the high cost of financial services, which forces many financial institutions to focus on serving the wealthiest consumers. CBDC can introduce competition, stimulate innovation, and drive down costs to broaden access.
• Managing the disappearance of public money: Cash is a public form of money, but usage is declining in favour of digital money provided by banks. As demand decreases the cost of supplying cash falls on lower income consumers, who use more cash. CBDC provides a public, digital alternative to cash and private digital money.
• Supporting payment system resilience: Digital payments that operate on private rails are owned by private (and often foreign) providers which creates a single source of failure for digital payments. A CBDC can improve resilience by providing a new payments infrastructure while new technologies such as distributed ledgers are inherently more resilient than incumbent infrastructure.
• Ensuring monetary sovereignty: Competition from private crypto-assets, and foreign CBDCs may deter usage of locally denominated currency and weaken a central bank’s abilities to conduct their operations. A CBDC can compete with these alternatives and facilitate participation in the global CBDC ecosystem.
• Guarding financial stability: Outflows to alternative digital currency may shrink liabilities available to commercial banks for lending, leading to a shift in credit provision to the operators of these private digital currency ecosystems. Growing adoption of private crypto-assets may introduce additional financial stability risks. A CBCD can mitigate against the risks by providing an equally attractive and interoperable payment instrument.
• Ensuring access to the digital economy: The digital economy is an exponentially growing component of the economy as digital technologies are embedded in the everyday activities of consumers, businesses and governments. A CBDC can provide modern infrastructure to effectively participate and compete in a changing digital world.

 Nigeria’s e-Naira

Nigeria was the first African country to launch a CBDC, the e-Naira, in 2021, and by November 2021 the Central Bank of Nigeria (CBN) reported just under 500,000 consumer wallets and 78,000 merchant wallets. A total of 37,810 transactions translating to NGN 208.91 million in transactions was recorded in one month after its launch.

Commercial banks are responsible for onboarding customers; and the current onboarding requirements require an email that includes a Bank Verification Number (a unique ID). This has made it difficult for  citizens without access to email or without an existing bank account to access eNaira and has possibly slowed adoption. This is an example of Central Banks needing to have a clear strategy and understanding the trade-offs of design decisions.

If CBDCs gain wide adoption, the regulator would have access to unprecedented amounts of transactional data that could be used to facilitate the distribution of financial and other services at the national level. In addition, regulators have confirmed that in future, the CBDC will have an offline functionally which will improve it use-case in areas with poor internet penetration and could therefore lead to increased financial inclusion.

There are critics of CBDC who believe, among other things, that the cost of implementing a CBDC is not worth the potential benefits. However, the momentum for CBDC continues to build and Central Banks must ensure that there is a clear and economically sound strategy that underpins their business case.

By Bavani Naidoo, Financial Services Strategy Partner, Genesis Analytics