World Economy

BIS Warns Central Banks on Digital Currency Issuance

Japan is the first country to legitimately regulate cryptocurrency, as it passed legislation last year requiring digital currency exchanges be registered and subject themselves to inspection
The Basel-based Bank for International SettlementsThe Basel-based Bank for International Settlements

While the central banks of some countries are hoping to be a part of the virtual currency revolution, the Bank for International Settlements is concerned about the repercussions of going digital.

A cashless society is definitely the way of the future, a future that some governments and banks are trying to be a part of. Central bank digital currencies may be an abomination of decentralized cryptocurrencies, but it is happening, news outlets reported.

“A central bank digital currency could allow for ‘digital runs’ towards the central bank with unprecedented speed and scale,” the Basel-based BIS said in a report put together by its committees for payments and markets.

Benoit Coeure, chair of the BIS Committee on Payments and Market Infrastructures says: "Central bank digital currencies could help make settling trades of securities and foreign exchange more efficient in the future. But more work and experimentation would be needed to explore these benefits, Finextra reported.

"General purpose central bank digital currencies could revolutionize the way money is provided and the role of central banks in the financial system, but these are uncharted waters, with potential risks. This report is a starting point for further discussion and research and will help countries make choices given their own circumstances."

Could Hurt Financial Stability

Central banks the world over are seriously studying whether digital currencies backed by global central banks can be used as a legal tender alongside fiat notes and coins.

Sweden’s Riksbank is hoping to offer its e-Krona and the Bank of England has a cryptocurrency unit to help it along its virtual currency journey.

Research from the Bank of Canada suggests a central bank digital currency has the potential to become a cheaper and easier to use alternative to cash and cards. However, the study notes that a shift from bank deposits to CBDC could also have an impact on bank funding and credit provision, which could hurt financial stability.

The Bank of England's Mark Carney says the BIS perspective is an important contribution to the G20 discussion on digital currencies, given central banks' mandate to safeguard financial stability for the public.

The head of Germany’s Bundesbank, Jens Weidmann has also been vocal on the implications of CBDCs. On a positive note, he had previously said: “Allowing the public to hold claims on the central bank might make their liquid assets safer, because a central bank cannot become insolvent.”

However, he added that in times of economic uncertainty, citizens would most likely convert their fiat into the country’s official digital currency, which is great for the public but not for the banks. This easy conversion could make bank runs occur more frequently, which could then negatively impact the bank’s solvency.

Negative Impacts

However, the BIS cautioned that making electronic central bank money widely available could create a significant threat to the financial system. The reason: if the public had direct access to the currency, they would flock to the central bank in times of panic, creating a “digital run” from private banks to the state.

A report written by Klaus Lober, who is a senior advisor at the European Central Bank and Aerdt Houben, who is the director of the financial stability division at De Nederlandsche Bank, details the negative impact it could have on the economy.

According to this report, these virtual currencies could become direct competition for traditional fiat, which could lead to an increase in interest rates. The report states:

"The introduction of a central bank digital currency would raise fundamental issues that go far beyond payment systems and monetary policy transmission and implementation. A general purpose CBDC could give rise to higher instability of commercial bank deposit funding.

"Even if designed primarily with payment purposes in mind, in periods of stress a flight towards the central bank may occur on a fast and large scale, challenging commercial banks and the central bank to manage such situations. Introducing a central bank digital currency could result in a wider presence of central banks in financial systems."

The report went on to say that as a result, there could be a “greater role for central banks in allocating economic resources, which could entail overall economic losses should such entities be less efficient than the private sector in allocating resources.”

The report added that it might not only be the economic sector that could face repercussions: It could move central banks into uncharted territory and could also lead to greater political interference.

This is not the first time that the BIS has spread FUD about critiqued cryptocurrencies. Its General Manager, Agustin Carstens, previously stated that they are a “threat to financial stability” and that Bitcoin, in particular, is “a combination of a bubble, a Ponzi scheme and an environmental disaster.”

Jacqueline Loh, who is the chair of the BIS markets committee, added: Any step towards a possible launch of a CBDC should be subject to careful and thorough consideration.

Crypto to Headline G20 Discussions

Finance ministers and central bankers from 20 of the world’s largest economies will meet in Buenos Aires next week, and cryptocurrency will most certainly be a hot topic.

Unsurprisingly, France and Germany are set to put forth joint proposals calling for strict regulation of the cryptocurrency market. The proposals are said to focus on preventing money laundering and the financing of terrorism, in addition to consumer protection. Rules will also be proposed, which prevent banks from holding cryptocurrency.

The move by the two major European countries is expected, given that finance ministers from both have already expressed extreme concern over the use of cryptocurrencies worldwide.

Japan is the first country to legitimately regulate cryptocurrency, as it passed legislation last year requiring digital currency exchanges be registered and subject themselves to inspection.

Japan, France, and Germany may find themselves in the minority, however, as the majority of G20 nations have expressed minimal interest in imposing regulations on cryptocurrencies. Rather, many countries would rather not risk stifling innovation by imposing harsh restrictions on the budding market.

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