Inclusive CBDCs: Inflated Expectations or A New Productivity?

In the tech world, the Gartner Hype Cycle is often used to explain the evolution in acceptance of new innovations. A breakthrough technology triggers a ‘peak of inflated expectations,’ where soaring rhetoric outstrips value. The dashing of these expectations leads to a ‘trough of disillusionment’, where interest wanes as early implementations fail to deliver on their initial promise. 

Some technologies never climb out of that trough, while others reach a ‘plateau of productivity,’ in which mainstream adoption begins to take hold, success becomes more clearly defined, and tangible benefits are recognized – landing somewhere between the best and the worst predictions.  

When CGAP authored our first Central Bank Digital Currencies (CBDCs) blog in 2021, we gave a skeptical take on a new technology where frothy rhetoric seemed to outstrip the innovation’s promise to advance financial inclusion. Today, as early retail CBDC launches have faced limited adoption (e.g., Nigeria, the Bahamas) and some countries have deprioritized CBDCs (e.g., Kenya, the Philippines), the tone of the debate seems to be shifting toward skepticism. 

It is possible that CBDCs are entering their own ‘trough of disillusionment’ – at least in relation to financial inclusion.  We still think the promise of CBDCs as a panacea to financial exclusion seems overblown. Nevertheless, many central banks are moving ahead with planned pilots, or even live implementations – some still hoping to improve financial inclusion in the process. 

Given this activity is underway, this blog series will explore where CBDCs might be able to provide incremental gains for inclusion, even if they don’t create the revolutionary change once promised earlier in the hype cycle.  

A ‘public option’ for retail financial services 

Public banks have played an important role in advancing financial inclusion in some of the largest global economies, including China and India. While typically less nimble than their privately owned peers, public institutions often have the mandate to serve marginalized communities and go where unit economics may otherwise prevent sustainable business models. 

Retail CBDCs open the door to the idea of central banks providing retail services directly to customers – going where the private sector might not, subsidizing services, or exploring products (like offline payments in remote areas) viewed as unattractive to the private sector.  

Still, there are plenty of detractors to this argument and plenty of reasons to tread carefully. Subsidized, public models can risk crowding out private sector growth, and putting central banks in the position of competing with the financial service providers they supervise should give us pause.  Many central banks are also simply not well positioned to take on the job of managing a mass market business. 

Yet, in the right context, with the right central bank and the right product design, a public option could work to complement an existing market to provide incremental gains. We will discuss this in-depth in the third blog of this series.

Improved competition in retail financial services, while ensuring adequate supervision

Historically, allowing for the issuance of non-bank wallets has meant creating a system of ‘e-money’ backed by funds held in float accounts in banks. This model has successfully allowed products like M-PESA to scale to the mass market, but it isn’t without risk or complication.

Allowing nonbanks to issue e-money requires them to manage a system of float accounts with a matching representation of e-money held in sufficiently safe investments, which must be closely supervised by financial authorities. As a result, countries allowing for nonbank e-money issuance had to carefully craft licensing, regulatory, and supervision requirements. In other countries, reticent regulators have avoided permitting wallet services to non-banks altogether, instead only allowing for bank-led wallet services (e.g., South Africa, Egypt). 

With CBDCs, a single ledger – transparent to regulators in real-time – has the potential to eliminate the need for a separate system of trust accounts and e-money issuance.  Customer funds are held in CBDC sitting with the central bank. This would have two effects. First, eliminating the possibility of intra-day or even inter-day mismatches between the value seen in customer wallets and what’s protected within a bank, which can reduce customer risk in the event of the failure of an existing wallet provider. Second, holding the funds of wallet customers in a CBDC can open the door to rethinking the licensing/supervision of wallet providers more generally, potentially allowing for a wider variety of institutions to offer wallets.

Neither of these effects implies a sea-change for retail financial services. The risk of non-bank failure or failure of the banks holding float accounts is often mitigated through fund safeguarding and diversification requirements, and the exposure from trust fund mismatches is often small. Similarly, the types of fintechs dissuaded by operating e-money systems are also not likely to invest in building large-scale agent and merchant networks, even with a CBDC. Yet to overlook these potential incremental gains may be doing governments considering CBDCs a disservice.   

Allowing a rethinking of retail cross-border payments, with potential impacts on prices

It is still far from certain whether CBDCs have the potential to disrupt cross-border payments, or even have significant impacts on the price of transfers. Compliance costs (e.g., AML screening) and overhead (e.g., local branch or agent networks) make up a large part of the fees that a low-income person pays for a remittance, and those factors are unlikely to change with CBDCs. 

Many of the CBDC designs being proposed also still require FX dealers or market makers to manage currency exchange. This means that even when it comes to FX/liquidity expenses, cost drivers would not go away, but simply shift to different actors. However, as CBDCs change these markets – impacting competition and transparency in FX provision – there could be the potential for some incremental gain to end-user prices where market economics can be improved.  

Similarly, models of linked CBDCs such as Icebreaker could open money transfer services to a larger group of local financial service providers (not dissimilar to the discussion happening around linked instant payment systems) – further applying pressure on fees through increased competition. 

None of the benefits listed here are likely to change the trajectory of inclusive finance in a country, region, or around the world. But just as we must look beyond the hype, it’s equally important we look past the disillusion to consider the value CBDCs can realistically provide.