Explore the CBDC race, its impact on monetary policy, financial stability

Central Bank Digital Currencies (CBDCs) and the Reshaping of Global Payments

The global financial system is on the cusp of a revolution, driven by the emergence of Central Bank Digital Currencies (CBDCs). Far from being a mere technological upgrade, a **CBDC**—a **digital currency** issued and backed by a country's central bank—represents a fundamental shift in the nature of money and the plumbing of finance. Central banks across the world are engaged in a fierce global race to issue a digital version of their national currency, a movement that is poised to redefine commerce, overhaul **monetary policy**, and drastically impact both commercial banking and the realm of **international transfers**.

The Global Race to Digital Sovereignty

The impetus behind the **CBDC** movement is multifaceted. The decline of physical cash usage, the rise of private cryptocurrencies and stablecoins, and the persistent inefficiencies in existing payment systems have all fueled the debate. Central banks recognize the need to provide a safe, risk-free **digital currency** that maintains the monetary anchor in an increasingly digitalized economy.

As of early 2025, the pace of **CBDC** exploration is accelerating dramatically. A significant statistic reported by the Bank for International Settlements (BIS) and the Atlantic Council indicates that over 130 countries, representing 98% of global GDP, are exploring a **CBDC**. While this is largely exploration, the actual rollout is gaining momentum. For instance, as of March 2024, there are four live retail CBDCs (in countries like The Bahamas, Nigeria, and Jamaica) and dozens of jurisdictions running either retail or wholesale pilots.

This is not a uniform movement. The motivations vary:

• China with its e-CNY is a clear frontrunner, driven by goals including domestic **payment innovation**, countering the dominance of major private payment platforms, and potentially asserting global financial influence.
• Advanced Economies like the European Union (with the Digital Euro project) and the United Kingdom are prioritizing preserving the role of public money, ensuring competition, and mitigating risks posed by private digital money forms. The European Central Bank, for example, is in the preparation phase for a potential Digital Euro, with an eye toward a rollout starting in late 2025 at the earliest.
• Emerging Economies (e.g., Nigeria’s eNaira) often see the most compelling use case as boosting **financial inclusion** for unbanked populations by offering a widely accessible, low-cost digital payment method.

The competition is intense because a successful **CBDC** issuance by a major economy could confer a powerful first-mover advantage, potentially enhancing the international role of its currency and establishing global technical standards. This is the new financial battleground, a critical component of national economic sovereignty in the digital age.

Overhauling Cross-Border Payments

Perhaps the most transformative impact of **CBDCs** lies in the area of **cross-border payments**. The current system, largely reliant on correspondent banking networks (like SWIFT), is notoriously slow, costly, and opaque. This legacy infrastructure results in significant friction:

• High Costs: Transaction fees can be substantial, particularly for smaller remittances.
• Slow Speed: Settlement often takes days due to time zone differences, compliance checks, and counterparty risk.
• Complexity: The process involves multiple intermediaries, increasing complexity and risk.

**CBDCs**, especially when designed for interoperability, offer a compelling solution. The use of a wholesale **CBDC** (w**CBDC**) for interbank transactions, for example, could enable near-instant, atomic settlement (where the transfer of two assets is contingent on both occurring simultaneously, eliminating settlement risk) and drastically reduce costs.

Central banks are exploring several models to achieve this **payment innovation** for international transfers:

1. Single CBDC System: A single central bank extends access to its **digital currency** to foreign financial institutions or even non-residents. While simple, this raises concerns about the monetary autonomy of smaller nations and could accelerate "digital dollarization" if a large reserve currency's **CBDC** is widely adopted abroad.
2. Interlinked CBDC Systems (Bilateral/Multilateral): National **CBDC** systems are connected through common technical standards and governance, allowing for seamless foreign exchange and transfer. Projects like the BIS’s Project Dunbar and mBridge are actively exploring this multilateral approach, which involves multiple central banks cooperating to create a common platform.
3. Compatible CBDC Systems: National systems remain independent but adopt shared messaging formats and legal/regulatory standards (like harmonized KYC/AML checks) to improve flow efficiency.

The World Bank and BIS have highlighted that the implementation of interlinked or multilateral **CBDC** systems could be a “game-changer,” offering a quantum leap in efficiency over the current fragmented system, thus dramatically reducing the time and cost of **cross-border payments**.

Impact on Commercial Banking

The introduction of a widely accessible retail **CBDC** presents both opportunities and existential risks for commercial banks, fundamentally altering their role as the primary conduit for consumer deposits and digital payments.

Risks and Challenges

• Disintermediation and Funding Risk: The greatest potential threat is a phenomenon known as "disintermediation." If the public can hold a direct, risk-free liability of the central bank (the **CBDC**), they may shift large sums of money away from commercial bank deposits, especially during periods of **financial stability** concern or crisis. Banks rely on these deposits for lending and operational funding. A significant deposit drain would force banks to seek more expensive and potentially less stable sources of funding, increasing their cost of capital and potentially restricting credit availability. To mitigate this, many central banks are exploring design features such as caps on individual **CBDC** holdings and a tiered interest rate system (where the **digital currency** is non-interest-bearing or less remunerated than bank deposits).
• Erosion of Payment Revenue: As a government-backed, low-cost payment rail, a **CBDC** could undercut the lucrative interchange and transaction fee revenues currently enjoyed by banks and card network providers.

Opportunities and New Roles

Commercial banks are not being made redundant; rather, their role is evolving. Most proposed **CBDC** models (often called a "two-tiered model") envision commercial banks acting as the primary intermediaries or distributors of the **digital currency**:

• Customer-Facing Services: Banks can build innovative services on top of the **CBDC** platform, such as programmable digital wallets, enhanced security features, and integration with existing financial management tools.
• Financial Inclusion and Onboarding: Banks can leverage the **CBDC** infrastructure to offer accounts and services to currently unbanked or underbanked populations at a lower cost, expanding their customer base.
• Wholesale Efficiency: The adoption of w**CBDCs** offers substantial efficiency gains for interbank settlements, foreign exchange, and securities transactions. For instance, w**CBDCs** enable immediate "Delivery versus Payment" (DvP) settlement for tokenized assets, vastly improving the speed and safety of the securities market.

For commercial banks to embrace this, a fair compensation model for their distribution and innovation efforts will be crucial to ensure they remain incentivized partners in the new ecosystem.

Monetary Policy Implications

The introduction of a **CBDC** has profound, albeit complex, implications for **monetary policy** transmission, a core function of the central bank.

• Interest Rate Transmission: In a traditional system, a central bank affects interest rates by manipulating the rate on commercial bank reserves. A retail **CBDC** that is interest-bearing would create a new policy tool. The central bank could directly influence the interest rate floor for the entire economy by adjusting the remuneration rate on the **digital currency**. This could potentially make **monetary policy** more direct and faster-acting, bypassing some intermediation effects. However, setting the interest rate too high could exacerbate the disintermediation risk by making the **CBDC** too attractive compared to bank deposits.
• Liquidity Management: The launch of a **CBDC** requires the central bank to carefully manage its operational framework. If a **CBDC** primarily substitutes for cash, the impact on the banking system's overall liquidity may be manageable. If it substitutes for large volumes of commercial bank deposits, the central bank will need enhanced tools to forecast and manage liquidity in the banking system to prevent unintended consequences.
• Data and Surveillance: A **CBDC** could potentially provide the central bank with vast, real-time, high-granularity data on aggregate payment flows. While this aggregated data could inform **monetary policy** decisions with unprecedented speed and accuracy, central banks must navigate public concerns about privacy and surveillance, which is a major driver of resistance in Western economies like the United States. Design features like pseudonymity and a two-tiered system are being proposed to balance privacy with compliance needs.

The Role of Financial Stability

Maintaining **financial stability** is a paramount consideration in the **CBDC** design. The core risk is the potential for rapid and large-scale bank runs, accelerated by the "digital nature" of the **CBDC**. In a crisis, depositors could instantly convert bank money into risk-free **digital currency** with a few clicks on a mobile app, potentially triggering a self-fulfilling prophecy of instability.

To contain this risk, design features are critical:

• Holding Limits (Caps): Imposing a limit on the amount of **CBDC** an individual can hold is a common proposal. This limits the scale of substitution during a bank run scenario and ensures the **CBDC** remains primarily a payment tool, not a large-scale store of value.
• Non-Interest Bearing or Tiered Remuneration: As mentioned, a lower or zero interest rate compared to bank deposits serves as a natural deterrent against using the **CBDC** as a primary savings vehicle in normal times.
• Legal and Regulatory Frameworks: Robust, clear legal and regulatory certainty around the **CBDC**’s status, data privacy, and the roles of intermediaries is essential to build public trust and ensure predictable operation, thereby enhancing overall **financial stability**