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Why Central Bank Digital currencies have a role to play in commercial banking, and how?


7th Jul 2021 Managing your Money

Commercial banks form the bedrock of modern financial structures.

. In many countries, a small portion of payment settlements takes place through deposit accounts in the non-bank private sector at commercial banks. Within the financial system, state legal tender, currency or cash, is available to NBPS through commercial banks which has the order to accept cash swaps.

With the share of cash used for payment settlements showing a gradual decline in many countries, and more so since the ongoing pandemic began, there is a fear that state-money-cash may lose its significance in the settlement of liabilities that arise from trade and exchange.

A new set of financial institutions that enable convenient and fast transfers between deposit accounts have arisen. Monopolization of information using fintech by these institutions is enabling them to gain control over financial decision-making. The only challenge to them perhaps comes from cryptocurrencies that allow settlements without intermediaries according to British Bitcoin Profit.

The introduction of central bank digital currencies (CBDCs) could, however, not only challenge payment intermediaries but also cryptocurrencies, particularly if CBDCs utilize some form of cryptography. In this process, the commercial banking system may be impacted and its nature and role in the evolving financial architecture transformed.

Significance of Central Bank Digital Currencies on Commercial Banks

The implication of central bank digital currencies on commercial banking depend on the objective of a government and its central bank. If they decide to see commercial banking as an institution that allows more decentralized financial decision making the CBDCs could work with them to challenge eCommerce, large tech, cryptocurrency and fintech companies from dominating the financial industry.

In such a framework, CBDCs may be issued through commercial banks just like cash. While the central bank can allow the NBPS to have accounts with it, which in the present system is not possible, the maximum amount held in such accounts will be capped.

This would not only ensure that state money cash or currency remains a small portion of the total money supply but also makes it more viable for adopting crypto-technology-based CBDCs as most financial transactions will continue to take place using commercial bank deposits, ensuring traceability.

Another reason why adopting this model is that central banks recognize the importance of the knowledge commercial banks possesses on the creditworthiness of borrowers, acquired from long-term relationships developed between both parties. Moreover, commercial banks are discerning and responsive to the specific needs of individuals and businesses for credit, which is often the starting point of the production process.

Drawbacks of CBDCs on Commercial Banks

there exists a contrasting view over CBDCs, which asserts the foreseeable emergence of a more centralized financial system. This will happen because non-crypto CBDCs give central banks access to information about consumer spending, which in any case is already becoming increasingly available to private-sector financial institutions using fintech and unsettling traditional insurance and banking services. Furthermore, greater centralization of banking functions will provide governments with the ability to not only control the direction and flow of credit and investments in the economy but also facilitate closer surveillance over its people.

For CBDCs to become a primary means of payment settlements over commercial bank deposit accounts, the NBPS must be given the option to open accounts at the central bank without limit. As we know, in the present system, government spending passes through the central bank and commercial banking system until it finally reaches the account of the NBPS.

In the process, commercial banks are credited with reserve money in their accounts held at the central bank. If, however, the NBPS has accounts at the central bank, this primary source of reserve money for interbank settlements is eliminated. More importantly, any excess reserves that are usually swapped for government bonds by commercial banks and later used as collateral for repo transactions will also become scarce.

Without adequate reserves and bonds to access reserves from the central bank, expansion of credit to the economy by the commercial banking sector is constrained, striking at the very root of endogenous money creation and the essence of modern banking itself.


A centralized CBDC model will, however, shorten the transmission mechanism as central banks would be in a position to influence the interest payable by commercial banks and consequently on loans made by them through changes in the interest paid on their risk-free deposits.

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