IMF Backs Central Bank Digital Currencies

Whether central banks should create their own-state backed cryptocurrencies received a somewhat surprisingly bold endorsement from the International Monetary Fund’s managing director Christine Lagarde this week.

The former French finance minister's somewhat favorable stance in favor of such state-backed digital money stood at slight variance from the position of the Basel-based Bank of International Settlements (BIS), which has cautioned the global lenders of last resorts from entertaining such ideas.

The BIS has questioned, among other things, the benefits such digital money would offer over current banking payment mechanisms and, most importantly, their implications on financial stability, and has wondered what would happen, in case of, bank runs, for instance.

The rise of private digital currencies such as Bitcoin, as well as numerous technology startups peddling all sorts of payment systems, has triggered a debate as to whether the central banks should also jump into the blockchain bandwagon, and consider issuing their own cryptocurrencies.

Think about them as something akin to government-backed Bitcoins or Ether (of Ethereum), or XRP, a native token of Ripple, a cryptocurrency firm, which has become a formidable competitor to Swift, the provider of global bank remittance architecture, known for being slow, expensive and prone to errors.

In a speech titled, “Winds of Change: The Case for a Digital Currency,” delivered at the Singapore Fintech Festival (Nov. 11-16), Lagarde, the French Olympic-grade swimmer turned lawyer, threw down a gauntlet at global central bankers to seriously look into the possibilities of issuing their own digital currencies.

“I believe we should consider the possibility to issue digital currency,” Lagarde said. “There may be a role for the state to supply money to the digital economy.”

One of the biggest risks the BIS noted was that banks runs have been triggered by such e-currencies. Lagarde countered the point by saying that “the jury is still out on whether digital currencies would really upset financial stability.”

Of course, digital currency would be more suitable in some places than others. It would make a lot of sense in some Scandinavian countries where the use of cash has declined substantially to the point where some places don’t even accept cash.

There are, however, major implications of such a digital currency, the primary among them being the issue of privacy.

Blockchain, or distributed ledger, effectively gives governments the power to track each and every transaction, which is why every thinking Chinese citizen is worried about the zeal with which the Chinese government seems to be pursuing this ambition. The People’s Bank of China, or the PBOC, the Chinese central bank, has set up a dedicated unit entrusted with the task of creating such a currency with an army of researchers deep in the trenches working on the underlying technology to support a state-backed e-money, known as e-yuan.

The PBOC already ranks amongst the top in the world in terms of the number of blockchain patents, ranking at par with Chinese firms such as Alibaba and US banks such as Bank of America and Merrill Lynch (BAML). (The majority of them are related to central bank digital currencies.)

Such a currency would allow the government trace your every payment – from your grocery bills to your bar tabs to gym memberships. Cash is anonymous, but digital money is not.

But Lagarde is pushing such a currency for the right reasons. And she believes such a currency could help promote financial inclusion, the holy grail of any development agenda, without compromising on security and privacy, however utopian that might sound.

In reality, however, such an anonymous digital money has the potential to be a bonanza for criminals, as she herself noted, and privacy would eventually have to be sacrificed in this trade-off.

With nearly 1.7 billion of the world’s population having no access to formal banking services, financial inclusion should naturally be an important issue for multilateral lenders like the IMF, which claims to speak for both the rich and the poor nations.

Lagarde said that the “digital currency offers great promise, through its ability to reach people and businesses in remote and marginalized regions,” adding that: “We know that banks are not exactly rushing to serve poor and rural populations.”

Central banks must stay relevant, she said, when “cryptocurrencies such as Bitcoin, Ethereum and Ripple are vying for a spot in the cashless world, constantly reinventing themselves in the hope of offering more stable value, and quicker, cheaper settlement.”

Indian Prime Minister Narendra Modi’s keynote address at the same fintech conference supported the view that financial inclusion is the first step towards social inclusion, which explains why bodies like the IMF and the World Bank are important stakeholders in the discussion about digital currencies.

In contrast to the position of the BIS, the Washington, DC-based supranational lender believes this is a risk the central banks must take, in order to take a leap to encourage innovation, or even risk being disrupted by private digital currencies.

As Lagarde said in her somewhat inspiring speech: “The obvious ones (risks) are risks to financial integrity and financial stability. But I would also like to highlight risks of stifling innovation—the last thing you want.”

Obviously, the questions about whether privacy is too much a price to be paid would need to be answered, particularly for those living China, who now have in the IMF a major guru backing their landmark e-yuan project.