Central Bank Digital Currencies (CBDCs) are digital versions of fiat currencies that are backed and issued by central banks. Here are five ways CBDCs could impact the global financial system.
Digitization of payments
CBDC maybe make payments faster and more efficient as they would eliminate the need for intermediaries. As a result, costs could be reduced financial inclusion and an improved global payment system.
CBDCs could also enable faster and more efficient cross-border payments, as they would not be subject to the constraints of the traditional financial system. The ease and lower cost of transacting business across borders could have a major impact on world trade. Additionally, since they would be backed by a central bank and subject to strict security controls, CBDCs could help reduce risks associated with payment systems, such as fraud and cyber-attacks.
Reduced use of cash
The the use of cash may decline with the introduction of CBDC as more and more people switch to digital payments. This could make it easier for central banks to monitor the movement of cash and thwart fraud and other criminal activity.
As more consumers switch to digital payments, there may be a need for ATMs to dispense cash. This can result in fewer ATMs being used and less money spent on servicing them. In addition, CBDCs could enable peer-to-peer payments between people and companies, removing the requirement for personal cash transactions. Without the need for actual cash, it would make it easier for people to give and receive money.
Increased financial stability
By giving central banks more direct control over the money supply and interest rates, CBDCs can enhance financial stability. Although CBDCs could offer an alternative to conventional bank deposits, they could also help reduce the risks associated with bank runs.
People may withdraw their money from banks during hard financial times, which could lead to the bank failing. People would have another option to withdraw their money using CBDC, reducing the possibility of bank runs.
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Because they are backed by central banks and subject to strict security regulations, CBDCs could increase the resilience of payment networks. This would reduce the likelihood of cyber attacks and help prevent payment system failures.
New instruments of monetary policy
CBDCs could allow central banks to use new monetary policy tools, as outlined below:
Interest rate management
Central banks could use the CBDC to implement negative interest rates, meaning that commercial banks must pay interest to the central bank for holding their reserves, rather than receiving interest on their reserves. Commercial banks can then charge these costs to their clients, including depositors.
However, people can avoid paying negative interest rates by keeping physical cash outside the banking system. With traditional cash, it is difficult to impose negative interest rates because people can simply hold physical cash to avoid paying negative interest. However, with a CBDC, central banks could theoretically charge negative interest rates on deposits, encouraging people to spend instead of save.
Digital wallets with spending limits
CBDCs could allow central banks to implement digital wallets with spending limits. These wallets could be used to provide targeted support to specific sectors of the economy in times of stress such as a pandemic. For example, the central bank could provide recession-hit households with digital wallets with spending limits, stimulating spending and boosting the economy.
Real time data
A CBDC could provide real-time data on spending patterns to central banks, allowing them to make more informed monetary policy decisions. This could help central banks respond more quickly to changes in the economy and reduce the risk of recession.
Automatic policy implementation
CBDCs could allow central banks to conduct monetary policy autonomously. For example, a central bank can set a desired inflation rate and then automatically adjust the money supply to meet that target. This would reduce the need for manual monetary policy measures.
Impact on the international monetary system
Although countries with stronger CBDCs may have a greater impact on international financial markets, the adoption of central bank digital currencies could potentially lead to changes in the international monetary system. Moreover, CBDCs could contribute to reducing the hegemony of the US dollar in global trade and finance.
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Sand dollar, the digital counterpart of the Bahamian dollar that is issued by the central bank and guaranteed by the government, is one example of a CBDC implementation. Given the lack of access to conventional banking services in the Bahamas, the sand dollar is intended to promote financial inclusion in the country. In addition, it aims to increase the efficiency of payments while reducing the cost of providing financial services.
Since the sand dollar is a relatively new currency, it is not yet certain how it will affect the global monetary system. However, it may face competition from other digital currencies such as Bitcoin (BTC) and ether (ETH).