Bank lobby group the New Zealand Banking Association (NZBA) is reiterating its concern about the Reserve Bank (RBNZ) potentially introducing a central bank digital currency (CBDC), going as far as saying analysis is needed on what impact a CBDC could potentially have on accelerating any bank runs.
NZBA raises this concern, and others, in a submission to the RBNZ on its digital cash in NZ consultation paper. Released in April, the RBNZ consultation paper seeks public feedback on a CBDC to be used by the general public, which they wouldn’t need a commercial bank account for, and it says could lead to banks and other deposit takers losing profits and liquidity. The RBNZ also says this digital money would be private but not anonymous like cash.
According to NZBA, the consultation paper doesn't address financial stability risk in any meaningful way.
"If RBNZ is to progress these proposals any further it must engage the industry on key issues such as funding and liquidity, ratings, exposure to offshore funding market disruptions, exposure to risk of rapid withdrawals and consequential risk management and mitigation parameters for CBDC," says NZBA.
"In particular, further analysis needs to be carried out on what impact CBDC could have on accelerating bank runs, for example if consumers respond quickly to rumours of a bank’s financial stress by transferring private money into CBDC. These risks will need to be carefully balanced against the scale and nature of benefits that CBDC will deliver."
A bank run occurs when customers withdraw deposits en masse over fears about the bank's solvency, increasingly the probability of default. This happened with Britain's Northern Rock in 2007.
NZBA says it also "strongly opposes" the idea of the RBNZ paying interest on any CBDC.
"This could divert liquidity that the market needs for investment capital or could drive up real interest rates when the macroeconomic settings do not require this. It is possible that, if interest is paid by RBNZ on CBDC, consumers move from investment products offered by financial institutions, leading to less liquidity in the current market. To compete with
this shift, financial institutions may need to offer more interest to attract investments, in turn pushing up interest rates where there is no apparent macroeconomic reason to do so."
"Additionally, we believe that the case for a CBDC is to provide a new payment instrument that facilitates payments. Paying interest on CBDC could arguably bring the RBNZ into the realm of providing a savings product, thus confusing the value proposition that CBDC should deliver. CBDC must be configured correctly to avoid system wide unintended consequences."
What is a CBDC?
NZ banks' scepticism over the central bank's potential introduction of a CBDC isn't new. In 2022 NZBA argued it was important to investigate what public policy problem a CBDC would address.
A CBDC is the digital form of a country’s fiat currency. That means an RBNZ issued CBDC, like the physical NZ dollar, would be a liability of the RBNZ, backed essentially by trust in the Government and its institutions. By law the RBNZ is the sole supplier of NZ banknotes and coins, with this being a key raison d'être for the central bank.
A retail CBDC would allow households and businesses to directly make electronic payments using money issued by the RBNZ. It could be swapped 1:1 with physical cash, and other forms of NZ dollars, like money in a bank account. It'd be "available to everyone and distributed by the private sector – but you would not need a bank account to use it," the RBNZ says.
Accounts would be held with intermediaries and service providers, not the RBNZ itself. If people wanted to use a lot of digital cash, then banks and other deposit takers will lose deposits, the RBNZ says, potentially causing them to lose profits and liquidity.
The RBNZ says a CBDC could help NZ money stay relevant and useful, ensuring monetary sovereignty, in a world of crypto-assets, distributed ledgers, smart contracts, digital currencies issued by global technology companies, and potentially other countries' CBDCs. It could also support competition and innovation, and assist with financial inclusion, the central bank says.
'Follow the Aussies'
NZBA argues rather than going down the path of a retail CBDC, the RBNZ ought to be looking at the potential for a wholesale CBDC, which the Reserve Bank of Australia is doing, for use in wholesale payment and settlement systems.
"We believe that there are more compelling use cases for an appropriately designed wholesale CBDC to improve efficiency in and deepen wholesale cross border trade. A wholesale CBDC could play a transformative role in this space, which represents commercial opportunities and value propositions which would justify the investment required."
"In our view, New Zealand should follow the example of Australia in developing a proof of concept in the wholesale market, which will likely avoid the regulatory complexities associated with retail," NZBA says.
Investment would be needed
The bank lobby group, meanwhile, says if the RBNZ introduces a retail CBDC banks will have to make "a significant level" of upfront and ongoing investment to ensure the CBDC can be accessed by the public and integrated into market facing acceptance devices and processes including point-of-sale terminals, to e-commerce gateways and online billing systems.
"The scale of consumer demand needs to be of a sufficient level to ensure a return on investment which is sustainable over time. Without this, there is a risk of underinvestment and a lack of innovation," says NZBA.
"That investment may not be sustainable through bank profits, as under these proposals, the RBNZ could be removing access to bank margins and system funding."
'NZ bank could issue an NZ dollar stablecoin'
NZBA notes private entities have already issued stablecoins in NZ backed 1:1 with the NZ dollar, as have some Australian banks with their stablecoins backed by the Aussie dollar. Stablecoins are cryptoassets, or cryptocurrencies, whose value is pegged, or tied, to a fiat currency, commodity, or financial instrument.
"It is possible that a major NZ bank could issue an NZ dollar stablecoin with some of the same blockchain based functionality the RBNZ is proposing for a CBDC if there was a clear market demand," NZBA says.
"In this regard, it is worth referring to the Australian experience. The Reserve Bank of Australia undertook a trial of a CBDC last year, with the outcome that it was unclear the introduction of a CBDC would deliver compelling benefits."
In terms of any risk to the NZ dollar from cryptocurrencies, NZBA argues even if cryptocurrencies such as Bitcoin overcome issues with public trust, volatility and poor functionality, it's not clear they would present a challenge to monetary sovereignty, or that CBDC would address this risk.
NZBA argues in terms of the emergence of alternative currencies, there are two possible scenarios. One is a NZ dollar-denominated stablecoin would work in the same way as commercial bank liabilities, and regardless of the rate of adoption, the RBNZ would retain its ability to set NZ dollar interest rates.
Secondly it says non-NZ dollar denominated assets, such as Bitcoin or a US dollar-denominated stablecoin, face significant challenges to widespread adoption, as users could be exposed to exchange rate risk as long as some of their interactions such as wages and salaries, purchases, savings or borrowings are still NZ dollar denominated.
"The greater challenge would likely be if there was a widespread abandonment of the NZ dollar. However, in the few instances overseas where such a shift has occurred, the cause has generally been that the local currency has been seriously mismanaged, resulting in hyperinflation."
"In this situation, a CBDC is unlikely to address the fundamental problem of a loss of trust in the central bank itself. We refer to Ecuador’s dinero electronico which has failed, and Nigeria’s e-Naira which is struggling, both for this reason," NZBA says.
"The proposal to introduce CBDC is a significant one, and we do not feel that the justification for this introduction has been clearly articulated. For example, the use cases outlined in the [RBNZ] consultation paper are much broader, in our
view, than the harms which it is intended to solve (for example, financial inclusion and threats to monetary sovereignty). Many of the use cases may well be delivered by other regulatory reforms and industry initiatives already underway, such as Next Gen Payments and confirmation of payee."
*There's more on monetary sovereignty and the RBNZ's thinking about a CBDC in this Of Interest podcast episode with RBNZ Director of Money and Cash Ian Woolford. And there's detail on what other central banks are doing in this paper from the Bank for International Settlements.
*This article was first published in our email for paying subscribers early on Wednesday morning. See here for more details and how to subscribe.
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