IMF: Central Bank Digital Currency (CBDC) from the Central Bank's Perspective - Impact and Challenges on Monetary Market Operations

The International Monetary Fund (IMF) has released a publication titled "Implications of Central Bank Digital Currency for Monetary Operations", which examines the potential impact and challenges of central bank digital currency (CBDC) issuance on short-term interest rates, liquidity, and monetary market operations from the central bank's perspective.

What is CBDC?

Central Bank Digital Currency (CBDC) refers to the digital version of a country's national currency created by the central bank of a nation. The basic concept is to issue and control the circulation of a digital form of the national legal tender.

In the White House 2023 Presidential Economic Report, it is mentioned that money can exist in physical form such as cash and digital form like electronic bank accounts. CBDC is akin to central bank liabilities similar to cash but existing on a digital platform, enabling real-time exchange and settlement. CBDC systems can be established in various ways, such as wholesale CBDC, restricted to financial institutions like banks, and retail CBDC for individual use. The creation of CBDC does not necessarily rely on Distributed Ledger Technology (DLT); it may depend on a trusted central institution, the central bank of a nation, to operate the CBDC system.

The benefits of CBDC include laying the foundation for further technological innovations in payment systems, facilitating faster cross-border transactions, and promoting financial inclusion and fairness by enabling a broader range of consumers to access financial services through CBDC.

CBDC Replacing Cash, Commercial Bank Deposits, and Reserves

The IMF's report examines CBDC from the perspective of central banks, studying the potential impacts of issuing CBDC on short-term interest rates, liquidity, and monetary market operations. According to the IMF's analysis, CBDC could potentially replace cash, commercial bank deposits, and reserves, with different scenarios having varying impacts on short-term interest rates. Therefore, central banks may need to adjust their monetary operations accordingly, including their liquidity forecasting methods, providing additional reserves to address upward pressures on short-term interest rates, and ensuring interoperability between CBDC and reserves.

Replacing Cash with CBDC

Cash is primarily used for large volumes of small retail payments, and many central banks envision CBDC primarily for this use case. In environments where cash is the primary means of payment and financial inclusion is low, the replacement of cash with CBDC is more likely. In jurisdictions where the use of cash is already at low levels, central banks may opt for a CBDC design with features similar to cash, such as being widely and publicly accessible, zero interest, and with smaller transaction limits.

As cash does not involve interest rate issues, its impact on short-term interest rates is limited but may pose challenges for liquidity forecasting.

Case Study: Cambodia's Bakong System

The Bakong system is a digital payment system developed by the National Bank of Cambodia (NBC) aimed at improving the efficiency and security of payment systems and promoting inclusive finance. While not a CBDC, its digital nature and impact on liquidity provide insights. Key features include:

• Multi-functional payment platform: Bakong combines e-wallet, mobile payments, and internet banking functions, allowing users to transfer funds by scanning QR codes or using phone numbers.
• Inter-institutional payments: The system supports inter-institutional payment transactions, enhancing payment system efficiency and promoting cashless payments in Cambodian riels (KHR).
• Financial inclusion: The Bakong system aims to enhance financial inclusion, especially in areas with limited financial service coverage.
• Digital economy: The Bakong system supports Cambodia's transition to a digital economy and contributes to economic development.

IMF research found that the Bakong system's transaction volatility is higher than cash, posing challenges for liquidity forecasting.

Replacing Bank Deposits with CBDC

Bank deposits are typically used for both small and large payments and are often used as a store of value. In this scenario, CBDC is assumed to be used by individuals and businesses with bank accounts. When depositors replace deposits with CBDC, banks would need to exchange CBDC with reserves or collateral. Additionally, banks may need to adjust their demand for cash, CBDC, and reserves accordingly. Depositors may find holding CBDC attractive for various reasons and may replace some deposits with CBDC when making investment decisions. For example, in an increasingly digital economy, CBDC may make it more convenient for depositors to make payments. Additionally, during banking crises, depositors may prefer the risk-free CBDC over bank deposits without considering the return on CBDC.

Replacing bank deposits with CBDC could impact short-term interest rates, as the supply and demand for reserves would be affected, especially in situations of scarce reserves.

Replacing Reserves with CBDC

Some central banks are exploring technical upgrades to their real-time settlement systems, while others are considering coexisting CBDC systems with current systems. In this scenario, it is assumed that CBDC would not entirely replace reserve systems but upgrade and expand them. Furthermore, providing access to financial institutions with reserve accounts, charging varying degrees of interest on reserves based on current reserve rates, and increasing the transaction limit for CBDC transactions are also considered. The use case for CBDC would arise when financial institutions need CBDC to settle their financial obligations efficiently and cannot do so through traditional real-time gross settlement systems.

Some potential use cases for CBDC include facilitating atomic delivery and payment settlement for tokenized securities, serving as settlement assets for tokenized deposits, enhancing cross-border wholesale payments, or providing flexibility as a backup for real-time gross settlement systems operating 24/7. Additionally, when banks act as intermediaries for household and corporate CBDC, scenarios supporting the above bank deposit use cases may arise.

However, if reserve substitution can only occur during central bank business hours, banks would need to accumulate CBDC balances in advance to meet the CBDC demands of individuals and businesses outside of working hours.

Case Study: Bank of England's Omnibus Account

The Bank of England (BoE) introduced a new omnibus account model, the Omnibus Account, in 2021, allowing more innovative payment system operators access to this real-time gross settlement system. The Omnibus Account is held by payment system operators, facilitating wholesale settlements on behalf of their participants and ensuring that account funds correspond one-to-one with participant balances.

The Omnibus Account's daily balance accrues interest at the bank's overnight rate, and operators must pass on the full rate to participants in their systems. This model ensures that monetary policy transmission remains unaffected, as funds in the Omnibus Account are equivalent to those in standard settlement system accounts.

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IMF Recommendations on Central Bank Issuance of CBDC

The IMF previously issued a report titled "Inclusive Strategies to Promote the Adoption of Central Bank Digital Currencies (CBDCs)" to promote the use of CBDCs by central banks worldwide. The report emphasizes the use of the REDI strategy, composed of "Regulation, Education, Design, and Incentives," to stimulate and increase the adoption of CBDCs, indicating a positive view on CBDCs.

However, the report also highlights that central banks need to adjust their monetary operations when introducing CBDCs, such as adjusting liquidity forecasting methods and potentially providing additional reserves through open market operations or asset purchases to address fluctuations in CBDC demand. Additionally, setting holding limits or adjusting access criteria may be necessary to reduce the impact on bank intermediaries, indicating that there are many considerations and challenges to address before issuing CBDCs.