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Central Banks Look To Two-Tier Retail CBDC Model Amid Disruption Fears

Last updated: | 3 min read
Source: AdobeStock/pedrosala

The world’s central banks increasingly recognize that central bank digital currencies (CBDCs) have the potential to disrupt global finance, encouraging a rising number of banks to adopt a two-tier retail CBDC model that uses the existing market infrastructure, according to a recent report by international risk assessment firm Moody’s.  

“Based on existing and proposed pilot schemes, CBDC development is being done in conjunction with existing financial market infrastructure, the two-tier model,” the report said, adding:   

“Under this approach banks and other financial intermediaries would maintain their client-facing roles and would play a part in disseminating CBDCs.” 

In spite of this cautious approach, CBDCs are viewed as a potentially highly disruptive instrument for global finance. 

Disintermediation and fee loss risks will increase for the world’s banks as they adapt to CBDCs, but the level of disruption will depend on various key design and policy choices, Moody’s said.

“Central banks have to focus on the precise form of their retail CBDC and on whether it operates on centralized architecture. They would also have to consider holding limits, whether CBDCs bear interest, and the cost of use compared to existing payment rails,” according to the report. 

Should CBDCs become highly integrated with and accessible to market participants, in particular, major tech companies, through application software interface (API) technology — they could also trigger broader disruption to the existing financial institutions across the world, as indicated by the analysis.

Programmability and the digital currencies’ potential use for cross-border payments are also likely to increase CBDCs’ global adoption. 

“Although not meant to compete directly with bank deposits, CBDCs would provide an attractive risk-free alternative, raising bank funding costs, particularly as CBDCs held directly by individuals would not be available for fractional reserve lending and if holding limits are high,” the report states.

Moody’s also recognizes that CBDCs could pave the way for a broad use of risk-free instant payments, and they may also expand the share of payments processed through a likely cheaper central bank-operated payment infrastructure. As a result, the current fee income to banks and other financial institutions from payment processing would drop, further reducing the profitability of legacy finance players.

Also, a recent paper by Patrick McConnell, Visiting Fellow at Macquarie University Applied Finance Centre (MAFC) in Sydney, demonstrates a cautious approach to CBDCs, similar to that shown by numerous banks. 

“There have been many claims … that adding programmability to a CBDC could bring a plethora of economic benefits including automated payments, such as paying toll road usage; automated checking of money laundering; automated collection of taxes; and distribution of consumer support in emergencies,” McConnell writes.

This said, many of the claimed benefits either already exist or could be rolled out within existing systems. 

“Most notably, these benefits could be achieved by utilizing the Instant Payments Systems (IPS), such as the FedNow system which currently is being implemented by the US Federal Reserve,” the author claims.

Meanwhile, in another indication of a growing momentum for CBDCs, the Bank for International Settlements (BIS) recently unveiled plans to step up its CBDC pilot program in a cross-border initiative designed to test inter-central bank settlements using multiple CBDCs. 

The initiative is the brainchild of the BIS’s Innovation Hub which will cooperate with the four central banks in the Asia-Oceania region: the Reserve Bank of Australia (RBA), Bank Negara Malaysia, the Monetary Authority of Singapore, and the South African Reserve Bank.


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