As the world increasingly shifts towards digital payments and currencies, central banks across the globe are exploring how such emerging technologies can be used to address pain points in the financial system, while at the same time providing the implicit trust and protection of a central bank.
One way that central banks are looking to digitise their financial infrastructure is through the introduction of central bank digital currencies (CBDCs) -- a central bank-issued digital currency that represents a liability of the central bank.
CBDCs can be either retail (the digital equivalent of cash for use by households and businesses), or wholesale (accessed only by financial institutions, similar to existing central bank settlement accounts).
As of October 2021, the Bank for International Settlements (BIS) reports that there are two retail CBDCs that have gone live while CBDC pilots are underway in 26 jurisdictions. In total, 65 central banks, including the Bank of Thailand, have communicated publicly about their work on CBDCs as they prepare for the future financial landscape.
Underpinned by blockchain technologies, CBDCs are paving the way forward for central banks for a host of reasons. A common policy goal in Asia Pacific is the need for a digital complement to fiat central bank money, in order to support more resilient and diverse payment systems.
REACHING THE UNBANKED
However, as central banks have realised the benefits CBDCs offer, policy goals have further evolved to address some of the region's greatest socio-economic challenges. This includes driving greater financial inclusion among the unbanked -- which according to the World Bank stands at around 18% of the adult population in Thailand.
In line with this, Ripple recently partnered with the Royal Monetary Authority of Bhutan to pilot a CBDC with the aim of increasing financial inclusion from the current 64% to 85% by 2023. Ripple also recently announced a partnership with the Republic of Palau, focused on developing strategies for cross-border payments and a US dollar-backed digital currency in order to help provide the citizens of Palau with greater financial access.
CBDCs are also reimagining how we define and exchange value to create more resilient and diverse domestic payment systems. A CBDC could be programmed to support specific policy goals -- such as delivering targeted financial stimulus support, or for providing assistance in times of a crisis. CBDCs used for this purpose could be time-bound, made region-specific, and linked to specific policy outcomes.
However, something that is often overlooked yet is crucially important is how CBDCs could transform cross-border payments in an increasingly interconnected global labour market -- especially among nations where remittances play an important role in economic development.
In Thailand, like many developing nations across Asia Pacific, remittances are an economic lifeline. Overseas Thai workers remitted US$5.93 billion into Thailand in 2020, stimulating economic growth and contributing to household savings. This represents a 39% increase from the $4.26 billion remitted into Thailand in 2018.
Research has shown that remittances are effective in minimising large fluctuations in household income by 5% on average, allowing for more stability even in uncertain times. Remittance recipient households also have a relatively higher propensity to save than households that do not receive remittances.
Even so, international remittances to Thailand are costly, full of friction and slow. Data from the World Bank indicate that the average transaction cost of sending remittances to Thailand was around 7.7% in 2020. This is mainly due to the fact that some remittance corridors are typically too small to warrant adequate attention from major financial institutions, making it difficult for them to reach the economies of scale needed to reduce costs.
The inherent friction that exists in today's current global payments infrastructure, causing cross-border remittances to be costly and slow, gives rise to an important use case for retail CBDCs.
Let's also not forget that as the region continues to globalise, more consumers and businesses will inevitably need to transact with suppliers and vendors across borders. CBDCs also have the potential to help create links and cooperation between regional economies and trading blocs, such as Asean.
Importantly, CBDCs could even support micropayments (amounts under $5), even across borders. Currently, the transaction costs associated with micropayments are too high to support their execution.
BRIDGING THE GAP
It is clear that the introduction of CBDCs will be one of the defining transformations in the history of money. However, if we are to realise the full potential of CBDCs, central banks will need to bridge the gap by ensuring seamless cross-border functionality. The ultimate goal must be to enhance global trade and financial inclusion -- and not maintain the existing siloed, inefficient and inequitable status quo.
This makes interoperability between CBDCs highly critical, by allowing CBDCs to connect with other domestic services as well as each other. Interoperability will enhance the utility of CBDCs, lower transaction costs and reduce barriers for new market entrants -- while allowing each central bank to retain its sovereignty.
Without seamless cross-border interoperability, most CBDC projects will not achieve their full potential. It is therefore imperative that central banks address the interoperability challenge by tapping into the innovation that the private sector has to offer -- in order to accelerate initiatives and thereby reaping the rewards of a more vibrant and inclusive economy.
Rahul Advani is policy director for Asia Pacific at Ripple, a global payment systems infrastructure company.