Designing CBDCs to foster the inclusion of the unbanked

Central banks around the world are considering issuing their own digital currencies. Although financial inclusion is often cited as a key motivation, this result is not automatic. How precisely can central bank digital currencies (CBDCs) be designed and implemented to ensure that the unbanked have access to essential financial services?

According to the World Bank, 1.7 billion adults worldwide are unbanked. Lacking access to formal financial sector services, they are forced to resort to alternatives, often at significant cost or risk. Such financial exclusion entrenches poverty, limits opportunities and prevents people from protecting themselves against hardship. It stifles hope for a better future.

Financial inclusion begins, but does not end, with the ability to make and receive payments. People need a fast, safe and cheap way to transfer money. To date, central banks have largely met this need by providing the most inclusive form of money we currently have: cash. But the exclusive use of cash leaves the unbanked outside the formal financial system and without the data and transaction tracking needed to easily access financial services. It can therefore be much more difficult for small businesses to build up savings and access credit.

But the payments landscape is changing, due to the widespread adoption of digital and mobile technologies. Cash transactions are declining amid the shift to digital payments – a trend accelerated by the Covid-19 pandemic, when online transactions increased. Given these broad developments, it is imperative that we work to bridge the growing digital divide. Central banks and policymakers now have the opportunity to explore reforms, including issuing digital central bank money for all.

CBDCs could provide an opportunity to overcome some of the barriers faced by the unbanked. Traditional services have potentially prohibitive costs and requirements such as transaction fees, minimum account balances, or formal proof of identity. Other barriers include low levels of trust in digital payments and lack of smartphones among some groups.

While CBDCs aren’t the only way to overcome these barriers, they could be part of the inclusion toolkit. Central banks are already coordinating further improvements in retail payments by adopting rapid payment systems, and CBDCs represent a natural extension of this continuum. Quick payment systems and CBDCs can incentivize competing providers to offer new services, reduce costs, and ultimately expand access. Another advantage of CBDCs is that, by their very nature, they will incorporate the unique benefits of central bank money – security, finality, liquidity and integrity.

CBDCs could circumvent many of the commercial vested interests that have arisen around payment systems and contributed to inefficiencies and costs for users. They could also reduce costs by removing the credit and liquidity risks inherent in other forms of digital currency. A CBDC has the potential to upgrade and connect payment systems, both domestically and internationally. This could incentivize countries with limited financial infrastructure to move directly to a CBDC agreement, creating an opportunity to connect to an inclusive, safe and efficient payment system.

There are also benefits for social policies. For example, governments could use CBDCs to channel financial support to low-income households, which would strengthen longer-term inclusion and act as another gateway to other financial services.

To realize these benefits, any deployment of CBDCs must be accompanied by policy reforms and safeguards to address potential difficulties and risks, such as low levels of financial and digital literacy, and operational challenges, including cybersecurity. Policy reforms should also prevent disintermediation: the danger of money being held in large quantities in CBDC wallets, rather than as deposits in commercial banks, making it unavailable for loans (such as mortgages) and for other productive purposes.

Central banks should also consider designing CBDCs to level the playing field by giving people control over their transaction data and the ability to share it with a wider set of financial service providers. Growing data privacy concerns could be addressed by building personal data protections into the structure of a CBDC.

Central banks exploring CBDCs will have many design choices to make to balance privacy and transparency, and to ensure both financial inclusion and financial integrity. They will need to consider whether to grant direct access to consumers or use a purely intermediary model that offers CBDC digital wallets through banks or non-bank financial service providers. More dialogue, research, and testing will be needed to show how CBDCs can become drivers of financial inclusion.

Central bankers and other public sector representatives have a duty to ensure that the financial system is inclusive, open, competitive and responsive to the needs and interests of all groups. If designed correctly, CBDCs hold great promise in helping to support a digital financial system that works for everyone.

Queen Máxima of the Netherlands is the UN Secretary-General’s Special Advocate for Inclusive Finance for Development; and Agustín Carstens, former governor of the Bank of Mexico, is the director general of the Bank for International Settlements.

Copyright: Project union

Michael J. Birnbaum