Millions of people in the US are outside of the formal financial system and transact primarily in cash. Many more are underserved by the current financial system, which needs an upgrade. It is time to expand from traditional notions of financial inclusion to the broader goal of universal financial health – to make the system more affordable, efficient and inclusive. Innovations in technology and digital currencies, including distributed ledgers, cryptography and smart contracts, could be part of the solution.

Financial health is the ability to spend, save, borrow and plan in a manner that enables resilience and the pursuit of opportunities. It can be measured by eight indicators, shown in Figure 1.

Figure 1: Eight indicators of financial health

Source: Financial Health Network

While only 5% of US households are unbanked, more than two-thirds of Americans are not financially healthy. A digital currency – be it a private or central bank digital currency – has the potential to improve this. As CBDCs and private digital currencies evolve and emerge, it is worthwhile to analyse their potential for boosting financial health.

First, the structure of spending, saving, borrowing and planning are preceded by one’s ability to earn income and receive funds. The way people receive money and earnings can have a significant impact on the other elements of financial health. Improvements in this regard could adaptively help optimise people’s capacity to build a stable financial life. For example, timely and early access to wages for precarious income earners could enable them to pay bills on time, lowering the cost of uncertainty and delays that cascade to other parts of their finances. A digital dollar and/or private digital currencies that are instantaneously available could provide an efficient way to receive the inflows of tax refunds, government-to-person payments, business-to-consumer payments and peer-to-peer payments.

Second, spending and cash flow management depends on the timely availability of funds. A mismatch of balances and payments can result in overdrafts, insufficient funds and late fees. The inefficiency of the payments system is evident in the high fees US consumers pay to use alternative financial services, such as cheque cashers ($2bn annually) and small-dollar loans ($7bn annually). Consumers are willing to pay for these services because they offer transparent fee structures and instant access to cash. If a digital currency was designed to let people receive money and pay expenses instantly, without opacity and uncertainty on costs and timing, it could reduce reliance on alternative providers, lowering the incidence and cost of payment delays and associated fees.

Third, having sufficient liquid savings is key to building financial resilience and weathering shocks. However, one-quarter of Americans have no emergency savings, while 69% are living paycheque to paycheque. Digital currencies could make G2P payments more efficient and facilitate savings. For 30% of Americans, a tax refund is their single largest cash inflow in a year, with nearly half of Americans saving at least a portion of it. G2P payments delivered as a programmable CBDC could be designated for certain purposes (such as discounted groceries) or to nudge people towards tax-advantaged savings schemes. The benefits of programmability would also apply to private digital currencies; digital assets are already a popular form of saving.

Interoperability between CBDCs, private digital currencies, e-money, cash and commercial bank money will be critical. Most Americans save their money with private banking institutions. Enabling people to easily move their money into savings will be crucial for digital currency networks.

Fourth, having manageable debt and a good credit score is important for a sustainable and healthy financial future. On-time payments are the single biggest factor affecting a credit score. Late payments can result in fees, reduce credit score, limit options and increase the cost of borrowing in the future. Digital dollar and private digital currency networks could reduce late payments due to the instantaneous nature of payments.

Lastly, advanced financial planning is usually indicated by the use of budgeting tools. If properly controlled and permissioned by the user, consolidated financial data – along with greater ease of fund movement enabled by digital currency – can facilitate greater visibility and unlock new options in financial planning. Mental accounting could be made more tangible and actionable with greater transparency and less friction to plan for risks and needs. Budgeting and financial management apps may be able to offer even more flexible and customised services, such as insurance and investment, in a world where financial services run on interoperable digital currency networks.

Digital currency networks could reduce, or even eliminate, operational and financial inefficiencies in payments, clearing and settlement. Programmability offers exciting possibilities: it could perform automatic know-your-customer checks and sanctions screening, ensure compliance, reduce fraud and enable tokens or currencies to perform specific functions, such as paying a mortgage on a certain date.

Interoperability with existing systems is essential for achieving ubiquity and utility. To improve financial health, new assets need to be designed to work with existing systems, plugging holes where they persist. The specifics around the operation of a digital currency network are far from settled. Financial health benefits are not guaranteed. But policy-makers, technologists and corporate leaders can make digital currency choices that move us closer to the goal of universal financial health.

Ivy Lau is Lead Manager, Global Public Policy and Research, PayPal. This is an excerpt from an essay originally published on the Financial Health Network website.