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Central bank digital currency: what are we talking about ?

6/10/2021

While central banks are considering whether (or not) to launch their own digital currencies so as to counter private crypto-assets, the design of these central bank digital currencies will be of the utmost importance with regard to their consequences on the financing of the economy and the monetary policy transmission.

TRANSCRIPT // Central bank digital currency: what are we talking about ? : June 2021

FOCUS

FRANÇOIS DOUX

The People’s Bank of China, Sweden’s Sveriges Riksbank, the Fed in the USA, the European Central Bank in the eurozone and even the Banque de France are all looking closely at central bank digital currencies, or CBDCs. To examine this topic, we are joined by Laurent Quignon, Head of Banking Economics at BNP Paribas.

FRANÇOIS DOUX

Hello Laurent.

LAURENT QUIGNON

Hello François.

FRANÇOIS DOUX

We read a lot in the press about these central bank digital currencies and also about cryptocurrencies. We hear about bitcoin, libra, ethereum...  What is the difference between what we call “central bank digital currencies” and these cryptocurrencies?

LAURENT QUIGNON

Allow me to begin, François, if I may, with a quick terminological detour. I prefer to talk about “cryptoassets” rather than “cryptocurrencies”, as these are not currencies in the legal sense. These cryptoassets are issued and circulated via a distributed ledger based on blockchain technology and are not, therefore, issued by an identifiable institution. They do not, therefore, represent a claim on  someone, unlike official currencies, which represent a claim on the central bank, whether we are talking about the coins and notes in our portfolios,  or a claim on a commercial bank, such as our bank deposits. Another difference between cryptoassets and official currencies is that the various forms of currency can be converted into notes and coins, which are legal tender, which is obviously not the case for cryptoassets.

FRANÇOIS DOUX

Particularly as these cryptoassets, bitcoin and the like, are very volatile, as we have seen in the news. But, despite these fundamental differences, Laurent Quignon, is there a risk of competition between these cryptoassets and traditional central bank currencies?

LAURENT QUIGNON

Central banks do indeed see CBDCs as a possible, official alternative to private cryptoassets. But in reality, and depending on the approach taken, a CBDC is not simply an official version of a private cryptoasset. It is something different. And this offer is likely to have relatively substantial effects, again depending on the approach taken, on the operation of the banking system, the financing of the economy and the transmission of monetary policy.

FRANÇOIS DOUX

So at the point, if I dare say it, that central banks are moving into the digital sphere, what exactly will this change for monetary policy, Laurent Quignon? Could scriptural money and fiduciary money also be transposed into digital form?

LAURENT QUIGNON

Well, in the current state of affairs, the only form of central bank currency accessible to the general public is notes and coins, which represent less than 10% of total money supply. The remaining 90% is created by commercial banks in the form of bank deposits. So in the future, if a new form of central bank money was available in digital form, on top of notes and coins, this would tend to increase the use and holdings of central bank money by the general public, which would probably affect the structure of money supply.

FRANÇOIS DOUX

What would be the effect, in the end, if Joe or Josephine Public turned to the central bank? Would the financing of the economy be changed?

LAURENT QUIGNON

Again, the devil is in the detail. If we consider a fairly simple instrument that would in effect be a sort of banknote 3.0, the use and holding of this would remain limited as is now the case for notes and coins, for fiduciary money. Ultimately, this would provide an alternative but with limited consequences. However, if the approach was to open up access to the central bank balance sheet to everyone, with the opening of accounts with the central bank, this would have a substantial effect on the equilibrium and sharing of tasks between commercial banks and the central bank.

FRANÇOIS DOUX

In concrete terms, for second tier banks, for commercial banks, could this result in lower levels of deposits?

LAURENT QUIGNON

Yes, indeed. Bank deposits are created within the framework of lending transactions. This is the process of money creation. If in future a significant share of these bank deposits – which also represent a very important resource for banks in the financing of the economy – was converted into a CBDC, this would mean a corresponding reduction in bank resources and reserves at the central bank for commercial banks. In the same way that a flight of bank deposits and commercial bank reserves to fiduciary money results in a fall in the credit multiplier and the ability of banks to lend to the economy, we would see a fall, in a similar process, in the credit multiplier and the ability of banks to lend with this central bank digital currency.

FRANÇOIS DOUX

Laurent Quignon, would commercial banks not be able to offset the fall in deposits by raising resources on the markets?

LAURENT QUIGNON

In reality such a solution would prove largely illusory, as long-term resources raised by financial and monetary institutions are a negative counterpart of money supply. In other words, the issuance by banks of long-term securities requires a debit in the account of the subscriber, and thus an additional reduction in bank deposits. So, we can say that these two resources, negotiable securities and bank deposits, are substitutes for each other rather than complementary. In the final analysis, although a CBDC offers a possible response, with greater security for the saver, to private cryptoassets, the details need to be very carefully considered if we are to protect the financing of the economy and the effectiveness of monetary policy.

FRANÇOIS DOUX

Protecting the financing of the economy and the effectiveness of monetary policy feels like a good place to end. Thank you, Laurent Quignon for this update on central bank digital currencies. Coming up, the Chart of the Month with William de Vijlder.

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