Central Banks have been drafting policies and taking measures to keep the countries economy afloat as a part of their public policy objectives. Central bank money or fiat currency offers a common unit of account, store of value, and medium of exchange for the sale of goods and services and settlement of financial transactions.

Despite that requirements and technology are emerging. There is a need for the traditional systems to upgrade their policies so as to equally partner the progression on sound footing. 

Fiscal transfers and cross-border payments form an important aspect with CBDC needs to address. We learn more in the following sections.

CBDC

The common principles that form the basis of issuance of CBDC by any nation are as follows:

  • No central bank should compromise monetary or financial stability by issuing a CBDC; 
  • A CBDC should  coexist with and complement existing forms of money; and
  • A CBDC should promote innovation and efficiency.

A CBDC is an instrument of digital payment, denominated in the national unit of account, backed by a reserve of gold or any other foreign currency, that is a direct liability of the central bank

Fiscal Transfers

CBDC facilitates fiscal transfers. Covid-19 presents before a classic case scenario in which the government utilizes efficient facilities to quickly transfer funds to the public or businesses in critical need. A CBDC system with identified users could be used for these payments. The above-mentioned system could be a CBDC system linked with a national digital identity scheme.

One can easily argue, that with the electronic payment facilities, why to call the CBDC at all. From the user’s perspective, cash could theoretically serve the same purpose, however, the transfer from electronic to physical and back to electronic money incurs an expense and is inconvenient. From the payment provider’s perspective, the existing wholesale central bank payment systems suffice for this role, although, not all payment service providers will be eligible or want to participate.

CBDC is hailed to play a role in making materializing fiscal transfers and efficiently so (especially in areas with very low bank density). On its own, though, CBDC would neither be necessary or sufficient. A linked digital identity system would be necessary to realize the true improvement. With such a system established, the incremental benefit of CBDC over transfer to, for instance, commercial accounts, etc could be small, in accordance with the designs. Moreover, if fiscal transfers were made with CBDC there runs a risk of blurring the division between monetary and fiscal policy independence. 

Read: Top 10 Countries Experimenting with Central Bank Digital Currency

Cross Border Payments and CBDC

CBDC may be used for cross-border payments in various ways. A domestic CBDC could be used for payments from, to, and perhaps even within a different currency area. This would facilitate efficiency, however, might entail risks for the foreign jurisdiction. Adding to that, CBDC systems may be designed to interoperate. 

Interoperability enables cross-border and inter-currency payments. Interoperability is a feature, broadly understood, and potentially envelops a multitude of ways in which payment systems or arrangements can interact with one another. 

At a grass-roots technical level, this may involve reducing the barriers to the participation of both systems, for example, through common messaging standards and overlap in operating times. Further, coordination between the systems can extend to common business arrangements, for example, stipulating a settlement agent between the systems for certain payments.

Yet another way of resolving cross-border payments involves the integration of the systems through an interoperable link where the infrastructures intertwine their functions (eg arrangements where there are multiple CBDCs).

Interoperability among domestic CBDCs is, however, not just a question of technical design and function on common standards and interfaces. Varying legal and regulatory frameworks present a significant obstacle to cross-border payments. Harmonizing these frameworks could be a challenge. 

Finally…

The monetary policy and financial stability have grave implications upon themselves with regards to cross-border CBDC arrangements. Hence, they require thorough analysis. Creating a CBDC that is convenient for cross-border payments could promote adoption.

Facilitating easy access for tourists and foreign travelers would boost merchant acceptance. On the other hand, significant foreign holdings of a CBDC could result in stronger unintended international spillovers.

More research on the potential spillover risks and challenges of a cross-border CBDC is needed to better understand how to safely materialize efficiencies. 

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