In Myself latest article I discussed how retail CBDCs are gaining momentum globally and how they are expected to perform, with commercial banks as major players. But offering CBDC services even with limited wallets can result in an outflow of deposits and a reduced balance sheet is obviously not good news. So why would banks want to do this?
What’s in it for the banks?
On the one hand, there will be pressure to participate, coming from customer expectations, the competitive market, and possibly the state in the form of regulation. If retail CBDCs are launched, they are likely to be an intrinsic part of a country’s financial system and banks will be forced to follow.
So what could banks get out of this? How could they monetize it?
Making customers pay for CBDC payments would be a huge disincentive to acceptance. No one wants to pay payment fees today! But in many countries, we pay for access to cash in the form of ATM fees. So it could be that banks charge small fees for CBDC conversion services. Or they may only charge companies that receive CBDC and would need escrow and exchange services. Such charges could be offset by reduced merchant transaction fees compared to credit card networks, assuming central banks make the CBDC network cheap or free to use.
Then, as CBDCs progressively replace cash banks, you may be able to save money on infrastructure and the logistics required to support physical cash.
In addition, we are likely to see new services evolve that could be monetized. With fast settlement times, CBDCs could open up new efficiencies in the way liquidity is managed. If privacy rules allow it, transactional data could reveal new trends and enable the positioning of new products. Future use cases around automated payments (think smart cars with automatic pay-to-charge or park) would require wallets and infrastructure to gain access to the CBDC network that could be charged.
There is also the issue of future readiness, being ready for other potential use cases, such as if CBDC ever expanded into commercial bank lending, or simply keeping a door open for uses yet to be thought of.
Assuming banks participate in CBDC networks, how would this fit into your banking model?
First, let’s take a quick look at how CBDCs are built. This is a vast topic in itself (see this excellent
Role of Oliver Wyman and AWS for a detailed look), but a few key points are worth noting.
The foundation of it all is of course the CBDC network. It is where the central bank mints, issues, and controls the CBDC, and where the data storage, transaction processing, and governance model reside. The trend is towards distributed ledger technology (DLT), although there are also centralized CBDC systems like in China. For DLT systems, brokers connect to the network through the node infrastructure.
Then there are different types of wallet. Noncustodial wallets contain all the information (such as private keys for cryptographic systems) required for a user to sign their own transactions. The downside of this type of wallet is that, like a physical wallet, if you lose your phone, without proper backup, you could lose your assets. They are best suited to small quantities.
Custody wallets, on the other hand, delegate the responsibility of signing transactions to an intermediary who manages connectivity to the DLT ledger. This type of wallet can still support bearer instruments when the assets are held within a segregated structure (as opposed to omnibus), ie with customer-specific ledger accounts. If for some reason the bank failed, those assets could be traced and recovered.
Bank CBDC Services
As a first step, central banks may well mandate the creation of generic wallet apps for their populations. However, the challenge in a standalone app is getting users to download it, sign up, and link a payment method for initial access to CBDC, all potential causes of friction.
Therefore, we could see banks labeling such apps to facilitate integration with the existing financial system and, as adoption grows, incorporating custody wallets directly into existing mobile banking apps.
Banks can provide origination capabilities to support the opening of customer ledger accounts and wallets. With some CBDCs, we see requirements for multiple wallet tiers with different balance limits offering varying degrees of privacy and imposing different levels of KYC. Banks are in an ideal position to support and manage this complexity.
Then the key advantage for banks: they can provide clever conversion facilities to allow users to link their deposit accounts and easily ‘top up’ or ‘withdraw’ their wallets whenever they want. In this way, they can provide an integrated experience, aggregated holdings across deposits, savings, loans, cards, and CBDCs, all in one place. They have customer support services ready to go to help in case of customer difficulty, for example, if transactions fail due to exceeding limits.
On the back end, the bank can orchestrate the issuance and redemption of CBDCs with the central bank in its vault account and manage its liquidity. They have the experience to handle the processing of client conversions: fund reservation, balance verification, the CBDC transaction in the banks ledger to the client’s account, and the finalization of deposit balances. They can provide escrow services for businesses that accept CBDCs. They may offer payment processing and AML checks, where these are not offered at the CBDC network level.
modern banking platform
In short, there are several potential CBDC touchpoints where banks can act. However, for banks to fully unlock the potential, a modern, composable banking platform is required. A platform that can scale for the banking business. That allows for the direct addition of new products and the strong flexibility to allow for the processing required for CBDC. And that brings an open architecture to ease integrations to DLT nodes.
This is a critical first step for banks to fully access the potential opportunities that digital currencies will bring.
The digital payments space is ripe for innovation and CBDCs are gaining momentum globally as an option to fill that need. Commercial banks are expected to be key participants in these networks as they emerge, providing access to CBDCs and supporting adoption by the general population. Banks can see this new technology as an opportunity to invest and develop new products and services as the world moves into the age of digital currencies.