Central Bank Governor Says FedNow Will Negate Need For CBDC

September 7, 2022
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US debates about a digital dollar are heating up as the country is inching closer to the adoption of FedNow, raising the question of why a country with a well-functioning payment infrastructure would invest in the development of a central bank digital currency (CBDC).

US debates about a digital dollar are heating up as the country is inching closer to the adoption of FedNow, raising the question of why a country with a well-functioning payment infrastructure would invest in the development of a central bank digital currency (CBDC).

At the VenCent Fintech Conference in August, Michelle Bowman, governor of the Federal Reserve, praised the forthcoming FedNow, the long-awaited launch of the Fed’s retail payment system.

Bowman says FedNow will transform the way payments are made and make the whole process more convenient, in real-time, available on any day and with immediate settlement.

Perhaps significantly, she also argued that her “expectation is that FedNow addresses the issues that some have raised about the need for a CBDC”.

This view is not unique to the Fed governor, though. According to Bowman, the central bank has received more than 2,000 comments on its consultation about a US CBDC, most of which have not yet been published. Some of those that have been made available mirror the views expressed by the governor.

The American Bankers Association (ABA), the National Association of Federally-Insured Credit Unions (NAFCU) and the National Community Reinvestment Coalition (NCRC) are just some of the organisations arguing that a new CBDC would provide functionality “that is equivalent” to existing or in-development private and public real-time systems, including The Clearing House’s RTP service and the upcoming FedNow platform.

In addition, banks argue that “[b]anks have invested significant resources in expanding faster, safer, and more inclusive options, including [peer-to-peer] P2P, real-time payments systems and upgraded Automated Clearing House (ACH) products.”

A part of the new solutions can address key use cases of a CBDC, which the ABA stresses does not “deliver benefits above those available from other existing options”.

There are legislators on both sides of the aisle who believe that a CBDC could actually be highly disruptive, while established market players, including both banks and also stablecoin issuers, are simply trying to protect their existing business model.

As Congressman Jim Himes (D-CT) told Politico late last month: “There is a ‘don’t take my cheese’ opposition coming largely from the banks who view the CBDC as a potential disrupter of their very profitable payment systems.”

A payment rail and an alternative to cash

When considering the comparison of FedNow and digital cash, it first must be pointed out that a significant difference exists between the nature of the two.

FedNow will be a new 24x7x365 real-time gross settlement (RTGS) system that is expected to offer consumers a more efficient and convenient way of making payments and serve as a springboard for smaller institutions to develop innovative payment services.

Such infrastructures are already in place in much of the world, including UK and Europe, and the launch of FedNow next year, alongside The Clearing House's RTP, will ensure instant payments are fully reachable across all bank accounts in the US.

A CBDC, on the other hand, would be a type of central bank money, such as notes or coins, issued in a digital form.

Accordingly, the two are not like-for-like comparable, according to Joshua Pynn, strategic insights consultant at payments consultancy CMSPI.

FedNow serves as an alternative payment method for getting more innovative payment options in the hands of consumers. CBDCs can act as an alternative for cash but allows financially unrepresented people to have greater access to digital payment services, Pynn explained.

As such, Pynn told VIXIO that “CBDCs could be separate from bank holdings and provide additional disruption to not only consumer payments, but financial institutions as well. These solutions could present some unique opportunities for merchants and serve different functions.”

Whether a digital dollar could create real use cases for businesses and individuals within the country or it is simply a solution in search of a problem, there may be other factors in play that America, as the world’s largest economy and issuer of the world’s reserve currency, may take into account.

Movements on the global scene

While the Fed is taking a cautious stance with regard to the study of a US CBDC, other players on the global scene are taking giant leaps to develop their own digital currencies.

China is trialling its e-CNY in its largest cities, India is targeting the year-end to issue its digital rupee, and Russia is planning to make a digital ruble available across all banks by 2024.

Some lawmakers voiced concerns back in early 2021 about China taking a pioneer position in this space and potentially threatening the dollar’s dominance. However, the US may face further challenges if these countries decide to connect their CBDC systems and transact directly with one another without the need to use SWIFT or the dollar-based global financial system.

More recently, Lael Brainard, vice chair of the Fed Board, reiterated these concerns, stressing that the US dollar may lose its dominance in international trade should the country lag behind.

"I don't think we should be taking the global status of the dollar for granted and in a world where other major jurisdictions move to the issuance of their own digital currencies it is important to think about whether the United States would continue to have the same type of dominance without also issuing one," Brainard told Congress.

"We recognize there are risks of not acting, just as there are risks of acting," Brainard said, adding that even if they started to set up a CBDC it would probably take five years until it would be ready for a full rollout.

However, with the US being the largest economy in the world, as well as the US dollar being core to the function of many cross-border industries, the US will likely be needed from the beginning in the development of CBDCs, Pynn noted.

“There likely needs to be a coordinated effort across jurisdictions, and it’s essential to bring industry and international stakeholders to the table. Without a harmonised, interoperable global CBDC, international bank transfers and cash withdrawals may create huge frictions for the customer’s experience,” he added.

‘Nature abhors a vacuum’

In addition to the significant momentum we are seeing in Asia to issue a digital fiat, there are ongoing studies in the EU, France, Canada and Australia that are looking at various aspects of a CBDC.

“Clearly there must be something there if these countries with real-time payments capabilities are exploring CBDC," noted Gene Grant, CEO of LevelField. He also pointed out that the market is not going to wait for the Fed to prioritise digital currency.

“Nature abhors a vacuum, and in this case, the market has determined there is a need for a constant source of value within the digital asset ecosystem. Consequently, we are witnessing the rise of stablecoins to fill that void," Grant explained.

"One question to be asked is whether the market will be better serviced by private sector stablecoin solutions like USDC or the bank consortium USDF, or a CBDC?”

“What is clear is that the market will not wait," Grant stressed.

Although the value of the stablecoins is pegged to another asset, typically a fiat currency, and is less likely to be affected by the crypto market volatility, recent developments show that all that glitters is not gold.

Apart from the disastrous collapse of the LUNA stablecoin in May, the Wall Street Journal estimated last week that a 0.3 percent drop in the total value of Tether’s assets could result in “technical insolvency”. Tether is the largest stablecoin in the world with a market cap of $67.5bn.

"What I do hope is that the private stablecoins are highly regulated, perhaps in accordance with the recommendations of the President’s Working Group on Financial Markets, so that they do not precipitate a financial crisis,” Grant said.

“If something bad does happen, then won’t the big question be whether that potential mess could have been avoided if the Fed had acted to take a leadership position?" he noted.

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