Banking system at risk amid CBDC bolstering

Bank systems risk impairment as coronavirus spurs plans to experiment with central bank digital currencies (CBDCs), says Gregory Klumov, CEO of STASIS, the company backing the euro-pegged digital asset EURS.

“The main risk of the actual CBDC product if introduced massively is how the banking system would be impaired: how many banks would lose access to deposits and funding as a result?”

The past month has seen several central banks announce plans to experiment with CBDCs. On March 30 the Bank of France officially launched an experiment program for a digital euro, testing the integration of a CBDC for interbank settlements, followed by a similar declaration by South Korea’s central bank of April 7.

Earlier this month, the Bank of International Settlements (BIS) urged central banks to consider developing CBDCs in response to concerns of the spread of coronavirus through cash and pin pad payments.

“Of course it’s totally symbolic,” says Klumov. “The major issue with [paper] currency is counterfeiting of the notes, nobody really knows the correct number because it’s hard to estimate how many notes are being counterfeit … The second problem is the settlement time and convenience. And third is the cash component in terms of viruses and some other health related issues it can cause.”

The pandemic also raises issues of delivering resources immediately to individuals in times of crisis. It was rumoured that the US Federal Reserve had included a CBDC experiment in its bailout bill, targeted at delivering cash directly to US citizens, a protocol which was ultimately not included in the bill.

“There is a negative track record of trying to address liquidity needs of an average person through the banking system and it was really clear the last time governments provided support to financial industry. Most of the money ended up in stock repurchases and bonuses for the top management, but nobody is willing to extend credit to the average person. So CBDCs could be a solution to directly target society and dispatch resources in the hands of people so they can go and spend them in times of a lockdown,” says Klumov.

Yet there is uncertainty around how CBDCs would function and whether the impact on the existing banking system would be too drastic to amend. According to Klumov, the risk of CBDCs may be greater than the reward; if consumers have direct access to the central banks for transactions, the banking system could face decreasing capital and a fundamental change to their roles in transactions.

“How would a banking system cope with the outflow of deposits? Because it’s clear that a lot of customers hold money with banks just to transact with them,” says Klumov.

“If they finally get an opportunity to transact elsewhere, how much of the money and deposits will be left with the banks, and how can that impair the funding cost of the banking system? How high will the cost of capital could be for the banks to continue to lend to the economy?”

Another model for CBDCs could be an institution-only approach, wherein institutions use CBDCs to settle payments amongst themselves without accessing the consumer. Klumov believes the former method is most likely to occur in Europe, where central banks appear more open to experimentation and the European Commission wants to see greater adoption of the euro globally, which is currently underused in payments in relation to the US dollar.

“To me it looks like the US is stubbornly trying to defend their hundred year old monopoly and they don’t want to experiment. They want to stubbornly say ‘these are the securities, these are the commodities, these are money service businesses’ … It’s really hard to fit this modern distributed ledger technology (DLT) products and technology into that old framework,” says Klumov.

He believes CBDC usage among customers would also legitimise the business model of stablecoins, or cryptocurrencies pegged to a stable asset or basket of assets, which currently operate in a regulatory “grey zone” with processes of self-regulation and auditing.

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