Central Bank Digital Currencies, often called CBDCs, are a new form of digital cash intended to replace physical cash. The word ‘disruption’ is not typically associated with central banks; but as central banks edge closer to introducing their own digital currencies, significant disruption could play out in the financial system, Chetan Ahya, Chief Economist and Global Head of Economics for Morgan Stanley, briefs.

What level of disruption will CBDCs bring to the financial system?

“Efforts to introduce CBDCs are gaining momentum, with as many as 86% of world central banks exploring launching digital currencies. China has launched pilot trials in a number of cities, the European Central Bank will make a decision on the digital euro this summer, and the Boston Fed is set to release its initial research in the fall.”

“Commercial banks will face the risk of disintermediation. Once CBDC accounts are launched, consumers will be able to transfer their bank deposits there, subject to limits imposed by the central banks. And the technological infrastructure of CBDCs will also make it easier for new non-bank entities to enter the payment space. As this transition accelerates, the competitive pressures on commercial banks will increase.”

“Another impact could be on the transactions data. We see a tug of war playing out between the consumers who want to stay anonymous, and fintech companies that will innovate and incentivize consumers to get onto their platforms in order to acquire transactions data. If fintechs succeed, network effects could proliferate, allowing fintechs to take market share from commercial banks.”

“CBDCs will have the potential to disrupt the international payment system. If a country’s CBDC gains acceptance for international transactions, the country could gain significant advantages in financing costs and control over financial transactions, similar to the US dollar’s privileged role today. Some central banks like the ECB and the People’s Bank of China see the move towards digital currency as an opportunity to raise the international status of their currencies, and increase their use in cross-border payments.”

“While CBDC initiatives are not intended to disrupt the banking system, they will have unintended consequences, which are disruptive. The pace of disruption will hinge on how quickly network effects take hold in the CBDC system, and the more widely digital currencies are accepted, the more opportunity for innovation, and the greater the scope for disruption to the financial system.”

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