Impact of CBDCs on Businesses and the Financial Sector

Central Banks across the world are rushing to board the CBDC bandwagon. The world of money is headed for disruption, and so is the business world. Although CBDCs will have long term benefits, disturbances in the short run can be problematic.

Experts suggest that companies need to buckle up for the challenges they face. These disruptions are multifold.

Major Fallouts of CBDCs

First, through their transactions in CBDCs, firms will hand over a significant amount of information to central banks. This information will eventually flow to the governments. Governments will have the data to make much more intelligent and sharper decisions. Sovereigns can use this information disproportionately to achieve indiscriminate goals and leverage businesses.

Second, governments will exercise greater control over parts of the economy that weren’t controllable. Lending institutions might be asked to lend to SMEs at concessional rates. This is a practice in various countries now as well. But more data will make it easier for the regulator to track loans. This will result in two significant outcomes. One, there will be crowding out of loans, and it will become difficult for well-established firms to access credit. And two, it will lead to higher rates of lending for these companies. There are apprehensions about the future of lending itself as well. The current fractional lending model is at risk of oblivion.

Third, companies will face a higher threat of cyber attacks. Firms will be looking at more frequent attacks on their software systems. In a recent report, the BIS says that the CBDCs will be at a heightened risk of attacks from the dark web. Central banks need to take care of the security implications. The companies and other users who interact with the system will have to take special care of their technology as well. This warrants new investment into building abilities to prevent financial crimes and safeguard their CBDC reserves.

Fourth, fall out will be volatile exchange rates. The use of CBDCs across borders might exacerbate the risk of currency substitution. A foreign digital currency will displace the domestic currency. This will put financial stability and monetary sovereignty at risk. This risk will cause fluctuations in the foreign exchange market. And MNCs will need to prepare for this volatility.

Future of the Financial Services Industry

Central bank digital currency (CBDC) creates the opportunity to build a new financial system that is more secure, less risky and more efficient than the current system.

The current financial system has three main goals:

1) Financing productive enterprises, households and governments while providing returns to investors;

2) Insuring against risk;

3) Making payments.

The financial system has 3 broad components:

  • Institutions: Banks and other financial intermediaries like Stock Exchanges etc
  • Rules: The International rules that govern the system. These are formulated by multiple institutions, like the BIS.
  • Software: The code used to carry out transactions. SWIFT and CHIPS work on software.

The current advances in blockchain-based technologies will surely disrupt the financial services industry first. Firms can expect to see significant changes in their functioning over the next few years.

https://youtu.be/fpb-qJv6dBs

Policymakers worldwide have expressed interest in reducing linkages in the financial system. They want to make it straightforward and reduce the risks that currently exist. This will become a reality with CBDCs making their way into the system. They are expected to lead to no need for intermediaries like banks, etc. Thus forcing financial institutions to rethink and redesign their roles in the new system. The Economist gives an excellent picture of what could happen in the near future.

Firms in the financial services industry have developed their niches to attract business and increase their base in the industry. Consolidation post the 2008 crisis has also led to a handful of corporations concentrating power. This has resulted in anti-competitive practices. The current industry has high switching costs, making it difficult for an ordinary individual to exert power. This reduced competitiveness of the industry is another target that CBDCs will address. CBDCs will reduce these switching costs, thus leading to a more competitive industry.

The industry also has to face uncertainty about the architecture of the payments system that will be put in place in different countries. There could be two primary forms.

Or a combination of these two could also be mandated. National governments will influence this decision, and there could be a disparity in the architecture worldwide, thus increasing the complexities for a firm.

With the changing face of the industry and as blockchain becomes the basis of the new financial system, governments and central banks will be looking to increase their control over the sector using regulations. We have seen a pattern wherein sovereigns lag behind technology and introduce legislation which is an afterthought. As the financial services industry embraces blockchain, they face a risk of ever-changing and outdated regulations that will negatively impact their business prospects.

Originally published at https://www.investorrepublic.com on December 10, 2021.

--

--

Alumni of the Integrated Programme in Management at the IIM, Indore. Interested in Public Policy, Politics and International Affairs.

Get the Medium app

A button that says 'Download on the App Store', and if clicked it will lead you to the iOS App store
A button that says 'Get it on, Google Play', and if clicked it will lead you to the Google Play store
Aditya Gulia

Alumni of the Integrated Programme in Management at the IIM, Indore. Interested in Public Policy, Politics and International Affairs.