Central Bank Digital Currencies (CBDCs) - Why Major Banks Should be Worried about
New Zealand’s major banks have enjoyed a near continuous stream of healthy profits, the benefits of which have extended beyond their shareholders to as far afield as the Reserve Bank of New Zealand (RBNZ). As their regulator, RBNZ has benefited from the financial stability attributable from the health of our major banks. As has been said more than once, a healthy bank is a profitable bank, and one would struggle to argue against NZ’s major banks being anything other than ‘highly’ profitable.
Central Bank Digital Currencies Key Messages
- Central Bank Digital Currencies (CBDC’s) are legal tender notes and coins in a digital form.
- CBDC’s remove the requirement for banks to act as intermediaries in the banking system and remove barriers to entry.
- CBDC’s can improve transparency, reduce fraud and limit tax leakage from the cash economy
- RBNZ has the role of determining the scope, design and timing of a CBDC and ensuring that the financial system remains stable.
- Non-bank financial institutions who are well positioned to innovate will be encouraged by central banks consideration of CBDC’s
High profitability though is not unique to New Zealand, most developed economies have banking systems that are dominated by a handful of major players. Where New Zealand may differ though, is the level of control exerted over our domestic banks by even larger offshore banks and that despite their deep pockets only minimal innovation has eventuated beyond internet and mobile banking in New Zealand. Introducing a CBDC could act as a catalyst for rapid technology development. By transitioning away from physical cash, RBNZ could remove a significant barrier to entry in the banking system and open a gateway to accelerating innovation. Whilst major banks may feel a level of discomfort with such developments, their customers will unlikely complain about the benefits of having a broader choice of financial service providers.
A recent report by the Bank for International Settlements (‘BIS’) found 80% of central banks in developed economies are already investigating CBDC’s. The BIS also noted that whilst they encourage co-operation, there is no “one size fits all” approach to development, meaning each central bank would need to determine the nature and scope of their own CBDC.
In New Zealand, such decisions would be up to RBNZ who could either implement a CBDC themselves or use a public private partnership approach. In RBNZ’s favour is New Zealand’s relatively vanilla financial markets and our already well-established electronic payments and settlements network. Since a high degree of coordination and cooperation with other central banks is essential to maintain cross-border payments, the heavy lifting for RBNZ would likely come in the form of integrating its CBDC into the broader international monetary system. If RBNZ were to turn its back on implementing a CBDC, they could find themselves missing out on the opportunities realised by other central banks who have already shown their intent to replace physical cash.
It is worth considering some loose parallels between the crossroads faced by the telecommunications industry in the 1990s and our banking system today. During the 1990’s, the incumbent telecom provider had invested heavily in copper fixed-line technology, establishing a significant barrier to entry. To protect their investment, they engaged in a bitter and protracted legal dispute to avoid competition. The period was defined by protectionist and litigious behaviours which proved a major distraction from pursuing innovation and developing future technologies. Eventually, short sightedness caught up with them; implementing new technology became slow and cumbersome and customers competing in offshore markets became frustrated at their comparative disadvantage. The telecommunications industry inevitably underwent a period of huge shakeup and technological change.
Similarly, todays bricks and mortar banking industry, rests upon outdated technology developed initially to manage physical cash. In some instances, banks systems are so heavily customised they may not be sufficiently scalable, or in fact those customisations reversible, to transition to a CBDC at all. Compounding this problem is the realisation that interest rates are already low and no longer bounded by zero (negative interest rates) which is requiring some banks to already consider full system rebuilds. Without revising their existing operating models, addressing large technology deficits and/or lowering profitability expectations, the major banks like their telecommunication counterparts of the 1990’s may struggle to deliver on their customers shifting expectations.
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