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How CBDCs Could Impact the Banking Sector

November 23, 2023


How Will CBDCs Affect Banks

With central banks worldwide exploring CBDCs, the banking sector needs to prepare for digital currencies becoming mainstream. Here’s more.

Central banks worldwide are working on developing a next-gen payment method that will offer many of the features we value about cash, such as universal acceptance, ubiquity, and anonymity. In addition, increasingly digitized financial services and the reduced use of cash have brought financial inclusion challenges to the forefront. As a result, about 90% of central banks are exploring Central Bank Digital Currencies (CBDCs). While the US and South Africa are still in an exploratory phase, China is already looking at pilot runs, and the EU has launched a development project. CBDCs are already operational in some geographies, such as the Bahamas and Nigeria.

The Roadmap for CBDCs

Source: McKinsey & Co

Why CBDCs?

CBDCs differ from other types of digital currencies since they are backed by central bank deposits or a government pledge. This endows CBDCs with stable value, trust, and audit transparency. This “cash 2.0” can be deployed using various technology models, depending on the central bank’s use cases and objectives. Plus, these currencies don’t need to be based on decentralized technologies alone and can be administered by central bank agents or via distributed ledger technology.

The key reasons why central banks are focusing on CBDCs include:

  • Declining use of cash: From accounting for 18% of POS transactions globally in 2021, cash is expected to decline to a mere 10% share worldwide by 2025. This trend poses a risk of marginalizing the only source of public or central bank funds in several economies.
  • Rising interest in private digital assets: This trend signals rising competition for central banks as the sore provider of monetary value in an economy. Investors are increasingly including digital assets in their portfolios, with some analysts stating this rising use of digital assets could potentially challenge fiat currencies as units of measurement for value and transactions.
  • Shrinking role of central banks as payment innovators: Central banks can regain their contribution in this regard by taking charge of the design and development of digital assets, as well as clarifying their use cases.
  • Growth of global payment systems: To safeguard systemic stability in an increasingly global payments ecosystem, many central banks seek greater local governance over international payment systems. This is where CBDCs could help as “the anchor of local digital payment systems.”

CBDCs have the potential to expand legacy cash use cases, such as reducing cross-border transaction costs and driving financial inclusion.

Will CBDCs Disrupt the Banking Sector?

Although most central bank CBDC initiatives are still in their nascent stages, the banking industry would do well to keep its eyes on the developing situation and shape its business models accordingly for the future. The emergence of CBDCs offers both opportunities and risks for various stakeholders and staying prepared is the only way to remain relevant and survive the disruption.

Disintermediation of Banks

Banks and other third parties could lose their role as intermediaries with CBDCs allowing individuals and businesses to transact directly with each other. Consumers might be able to store these digital currencies with the central bank rather than depending on commercial banks. This will impact the ability of banks to earn from their traditional role in the payment system.

If banks are removed from the payment equation, it could lead to increased competition among FinTechs and Big Tech to provide innovative payment services.

Lower Bank Deposits

If consumers begin holding funds in the form of CBDCs directly with central banks traditional bank deposits in fiat currencies would decline. This would hurt the capital available with banks for lending, which in turn could lead to contraction of credit and slowing economic growth.

Opportunities for Banks

Central bank digital currencies don’t just spell gloom and doom for the banking sector. They also bring multiple opportunities.

Innovative Services

In search of new avenues of revenue generation, banks could explore payment services that are cheaper, faster, and more secure than traditional methods of transaction. Plus, new products could be launched based on CBDCs, such as investment vehicles and digital wallets.

Financial Inclusion

CBDCs hold the promise of enhancing financial inclusion, allowing banks to reach underserved populations with more affordable and accessible payment options. In fact, banks could work in collaboration with FinTech and central banks to create CBDC-based products that cater to the needs of these populations, opening up new markets.

Cheaper Cross-Border Payments

CBDCs also have the potential to lower the cost of international payments. At present, cross-border transactions tend to be slow and plagued with multiple fees that often add up to more than 5% of the transaction amount. Central bank digital currencies could not only increase transaction speed but could also lower the various fees associated with cross-border payments.

In fact, CBDCs could redefine the way forex functions. This would require the digital infrastructure to be revamped to support digital asset-based transactions. FinTech innovation will play a key role in improving throughput and streamlining operations.


Banks Will Play a Key Role in the Success of CBDCs

The success of CBDCs will need to be driven by public-private partnerships. This will facilitate central banks to capitalize on established client relationships and infrastructure to launch the digital assets and implement their use cases. The public-private collaboration will also help align CBDCs with consumer needs, with the banking sector supplying data analytics on consumption habits, especially in the retail scenario.

By including private stakeholders in the process, central banks will be able to build a better sense of ownership of the new currency while managing any fear of displacement. This will directly impact successful adoption.

However, to be a part of this change, the banking sector will need to invest in digital infrastructure to support CBDCs, strengthen their security measures, and gain clarity in regulations. For a smooth transition to the new normal of central bank digital currencies, banks will need a technology partner that specializes in the finance sector. Opus Technologies is a leading digital payments solutions provider with over 27+ years of experience. Our CBDC-enablement services ensure smooth and quick migration of legacy systems with minimal operational disruptions. Schedule a call with our experts to learn how we can help you prepare for CBDCs.

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