Are CBDCs a ticking timebomb for commercial banks?

Banks need digital currency integration plans

Most central banks have advanced plans to launch central bank digital currencies to run in parallel with traditional money. There have been many pilot schemes, with some now being made live. Several central banks are accelerating the introduction of CBDCs to stem the growth of private digital currencies which are emerging as a viable alternative to fiat money.

The direction of travel is clear: CBDCs are inevitable and have moved from theory to practice. Banks should act now or risk strategic irrelevance or even obsolescence. Fractional reserve banking could even disappear in jurisdictions where the operating model chosen would have people keeping their CBDC on deposit at the central bank.

In these instances where the central bank would assume the role of lender and service provider to consumers and businesses, the traditional banking model is under threat. As the function of end-client management for lending and financial services products is not one that many central banks want to control, they are working with commercial banks to make sure that this revolution is a smooth one and does not completely disrupt the existing financial system.

Virtual money is the next phase of the digital revolution and is potentially the biggest change in the monetary system since the invention of paper money. Digital currencies promise to fulfil all the functions of money for consumers and businesses while at the same time enhancing the central banks’ ability to fine tune, monitor and optimise monetary policy within an economy. But central banks will enlist the support of commercial banks – as intermediaries – to drive adoption through the network effect.

Without the universal support of commercial banks, CBDCs may not be integrated, adoption will be hindered and everyone will lose out. Banks are at various stages of preparedness and those that have not started must start soon. But there’s a lot to consider.

CBDCs will disrupt many areas of banking while streamlining, refining and simplifying others. Bank operating models must be adapted and a successful CBDC implementation must be aligned with a bank’s technology strategy, business goals and strategic ambition.

Money is the lifeblood of any bank so the arrival of a new type of money touches every part of its operation. CBDCs are not simply an additional currency but an entirely new way of operating. While this is a challenge it is also an opportunity to streamline business processes, boost digitalisation and promote innovation.

Although there are many proven CBDC solutions, they cannot operate alone and must be fully integrated within a bank’s end-to-end value stream. For many banks, integration will be a significant technical and operational challenge, particularly for smaller outfits or those with legacy technology.

Ideally, CBDCs should be considered as part of a digitalisation strategy, which simplifies integration and testing. But in every case there is a need for a thorough technical and business assessment of the challenges and opportunities. It is also crucial to note that CBDCs will become legal tender so participation will eventually become obligatory.

There are many good reasons to get involved with CBDCs early, particularly around availability of resourcing and expertise. Banks that leave it to the last minute will undoubtedly face higher costs and miss out on the opportunity to influence the future direction of CBDCs.

By starting early, banks can also benefit from a fully integrated end-to-end solution. Those who delay or ignore CBDCs may face disintermediation by central banks who can opt for a direct distribution model or a smaller network of intermediary banks. The good news is that banks can think big and start small. But the crucial thing is to start soon.

David Creer is Global DLT, Crypto and E-money Lead at GFT and Alexander Feenie is Managing Partner at Chavanette Advisors.

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