WE have the Mosi-Oa-Tunya gold coins, a Reserve Bank of Zimbabwe-controlled currency and a new baby is on the way, the RBZ’s Central Bank Digital Currency (CBDC).
RBZ governor John Mangudya says the central bank’s intention to introduce Zimbabwe’s own central bank digital currency, CBDC, is at an advanced stage. But what really is a CBDC and is it a solution to Zimbabwe’s monetary quagmire?
Under the current fiat money standard, a central bank issues its liabilities to the public in two main forms: physical notes and coins and bank reserves. The latter comprise digital central bank money (or settlement accounts), available to banks and selected financial institutions and are used to settle ultimate liabilities in an economy; this implies final settlement in the system. It could be argued this is a wholesale CBDC. Notes and coins are the metallic money and paper currency, or simply “cash” used by the public at large for daily transactions. Cash payments also imply final settlement.
Bank customer deposits are not physical, but they are not money either in the legal sense, as a deposit is a promise to pay in specie whenever the customer demands it (redemption in kind). Thus, payments in commercial bank money (that is, customer-initiated wire transfers) are not final settlement, but merely a liability transfer between banks pending clearing, either by compensation of credits and debts between banks, or by the transference of reserves, that is, central bank-issued money.
Proposals for creating digital currencies by central banks have taken the form either of “electronic tokens” or “accounts”. Tokens are designed to mimic paper money. They are similar to pre-paid debit cards, but in digital format.
Account-based CBDCs would be universal central bank accounts. They are designed to give retail customers access to bank accounts directly with the central bank — in this case the RBZ. Like electronic tokens, these accounts are liabilities of the central bank. They would be reserve balances held at the RBZ, except that they would be available to everyone, and not only to designated financial institutions.
Whether as a token or a bank account, a CBDC would be a form of money created by the RBZ. This form of money will be as “sovereign” as you can get. It follows that proposals to create CBDCs should be considered in practice what they are in theory: an attempt to crowd out privately created money – and, therefore, an invitation for a greater degree of government-directed credit, money creation, and financial repression. This is indeed a way of steering the economy towards narrow banking.
A CBDC just constitutes a new form of central bank liability, or digital cash. In this new arrangement, a depositor may wish to redeem either in physical specie (notes, paper-money) or digital specie (CBDC, electronic cash) through a digital wallet. Once the digital currency is in wide circulation, users may transact via their digital wallet, making and receiving payments without having to use a financial institution. All payments are settled within the Central Bank Digital Currency system that is within the RBZ’s system.. Therefore, a hypothetical CBDC would be held by the user via its digital wallet and transferred electronically within the very same system.
From the user standpoint, the only counterparty would be the RBZ itself, which would be in charge of issuing digital currency units and operating the network. The digital currency should work like physical cash, being a bearer asset with no financial intermediary, allowing for instant and final settlement between parties.
From the commercial bank standpoint, bank deposit withdrawals result in loss of bank reserves, either by handing over physical cash to customers or by crediting the customers’ CBDC wallet.
In a CBDC withdrawal, a commercial bank’s balance sheet would see a decrease in its bank reserves account (credit bank’s assets) and a decrease in customer deposits (debit bank’s liabilities), whereas the RBZ’s balance sheet would record a decrease in bank reserves (debit central bank’s liabilities) and an increase in CBDC in circulation (credit central bank’s liabilities). In other words, this would amount to banking disintermediation.
Note that from the central bank perspective, no new money has been created; monetary media has merely been shifted from bank reserves to CBDC. However, for the commercial bank, this does entail a loss of reserves, which has consequences for liquidity management. Moreover, it also entails the destruction of bank money, since a demand deposit was just written off (such bank liabilities fall under the monetary aggregate M1).
It is essential to comprehend the balance sheet repercussions of CBDCs because these have profound implications for financial intermediation and stability, while affecting the creation and circulation of outside money (cash, either physical or digital) and inside money (bank money, bank deposits).
So the RBZ’s move to introduce a CBDC could very well displace the use of physical cash, making up most of money in circulation over time. However, in contrast to physical cash, users have fewer incentives to return this outside money to the banking system. Since a CBDC, in any of its conceivable forms, enables electronic payments over any distance and in any amount, in most if not all of the proposals, users would have a much lower propensity to deposit a CBDC at a bank to convert it into a demand deposit. Relatively higher than cash payment convenience would cease to be a feature of commercial bank accounts.
This may mean permanent lower reserves for commercial banks to manage liquidity. Thus, to encourage customers to deposit funds, financial institutions may have to offer higher rates of interest on deposits, which reduces banks’ profitability. The combination of higher funding costs with lower bank reserves may diminish credit expansion and indeed result in narrow banking.
About the writer: Tinashe Kaduwo is a researcher and economist. Contact: [email protected] WhatsApp +263773376128