As overseer, the central bank imposes requirements on the participants so that they support the functioning of the payment system as a whole.
Many central banks also have a role in the supervision and regulation of commercial banks, which are the core participants of the payment system. Prudential regulation and supervision reinforce the system. Further, in performing this role, central bank money is "neutral", ie provided on an equal basis to all commercial parties with a commitment to competitive fairness. Central bank digital currencies should be viewed in the context of these functions of the central bank in the monetary system.
Wholesale CBDCs are for use by regulated financial institutions. They build on the current two-tier structure, which places the central bank at the foundation of the payment system while assigning customer-facing activities to PSPs. The central bank grants accounts to commercial banks and other PSPs, and domestic payments are settled on the central bank's balance sheet.
Wholesale CBDCs are intended for the settlement of interbank transfers and related wholesale transactions, for example to settle payments between financial institutions. They could encompass digital assets or cross-border payments. Wholesale CBDCs and central bank reserves operate in a very similar way. Settlement is made by debiting the account of the bank that has net obligations to the rest of the system and crediting the account of the bank that has a net claim on the system. An additional benefit of settlement in wholesale CBDCs is to allow for new forms of the conditionality of payments, requiring that a payment only settles on condition of delivery of another payment or delivery of an asset.
Retail CBDCs modify the conventional two-tier monetary system in that they make central bank digital money available to the general public, just as cash is available to the general public as a direct claim on the central bank.
One attribute of retail CBDCs is that they do not entail any credit risk for payment system participants, as they are a direct claim on the central bank Graph III. A retail CBDC is akin to a digital form of cash, the provision of which is a core responsibility of central banks. Other forms of digital retail money represent a claim on an intermediary.
Such intermediaries could experience illiquidity due to temporary lack of funds or even insolvency, which could also lead to payment outages. While such risks are already substantially reduced through collateralisation and other safeguards in most cases, retail CBDCs would put an end to any residual risk. One option makes for a cash-like design, allowing for so-called token-based access and anonymity in payments.
This option would give individual users access to the CBDC based on a password-like digital signature using private-public key cryptography, without requiring personal identification. The other approach is built on verifying users' identity "account-based access" and would be rooted in a digital identity scheme. These issues are intimately tied to broader policy debates on data governance and privacy, which we return to in a later section.
From the public interest perspective, the crucial issue for the payment system is how the introduction of retail CBDCs will affect data governance, the competitive landscape of the PSPs and the industrial organisation of the broader payments industry. In this connection, the experience of jurisdictions with a long history of operating retail FPS provides some useful lessons. Central banks can enhance the functioning of the monetary system by facilitating the entry of new players to foster private sector innovation in payment services.
These goals could be achieved by creating open payment platforms that promote competition and innovation, ensuring that the network effects are channelled towards a virtuous circle of greater competition and better services. Wholesale CBDCs are intended for the settlement of interbank transfers and related wholesale transactions.
They serve the same purpose as reserves held at the central bank but with additional functionality. One example is the conditionality of payments, whereby a payment only settles if certain conditions are met. This could encompass a broad variety of conditional payment instructions, going far beyond today's delivery-versus-payment mechanism in real-time gross settlement RTGS systems.
In effect, wholesale CBDCs could make central bank money programmable, to support automation and mitigate risks. Further, wholesale CBDCs would be implemented on new technology stacks.
This clean-slate approach would let wholesale CBDC systems be designed with international standards in mind to support interoperability. This project demonstrates the feasibility of settling digital assets in central bank money. Both PoCs were found to be functionally feasible, and transfers were shown to be legally robust and final. Each PoC presents different practical and operational benefits and challenges. Rules and standards that promote good data governance are among the key elements in establishing and maintaining open markets and a competitive level playing field.
These can yield concrete economic benefits. The BIS Annual Economic Report drew a contrast between "walled gardens", where users are served in a closed proprietary network, and a public town square in which buyers and sellers can meet without artificial barriers.
In return for access to all buyers, the sellers must stick to the standards set by the public authorities with a view to promoting the virtuous circle of greater participation and better services.
The analogy with the payment system is that the market stallholders in the public town square are like PSPs, each offering basic payment functionality with their particular bundle of services, such as banking, e-commerce, messaging and social media.
Just as the market stallholders must stick to the standards laid down by the town authorities, these PSPs must adhere to various technical standards and data access requirements. These include technical standards such as application programming interfaces APIs that impose a common format for data exchange from service providers see Box III.
Together with data governance frameworks that assign ownership of data to users, these standards ensure interoperability of the services between PSPs so that they can work seamlessly for the user. AIS allow users to "port" data on their transactions from one provider to another. For instance, a user who has accounts with two different banks can open the app of one bank to check the balances in the other. PIS allow a user to operate the app of one PSP to make an outgoing payment from the account of another.
An application programming interface API, see glossary acts as a digital communication interface between service providers and their users. In its simplest form, a modern payment API first takes a request from an authorised user eg a user who wants to send a friend money through a mobile banking app. It then sends the request to a server to obtain information eg the friend's bank account details or the sender's account balance. Finally, it reports the retrieved information back to the user the money has been sent.
APIs ensure the secure exchange of data and instructions between parties in digital interactions. Through encryption, they allow only the parties directly involved in a transaction to access the information transmitted. They accomplish this by ensuring proper authentication verifying the credentials of the parties involved, eg from a digital ID, as discussed further in a later section and authorisation which specifies the resources a user is authorised to access or modify.
Crucially, APIs can be set up to transmit only data relevant to a specific transaction. For example, a bank may provide an API that allows other banks to request the full name of the holder of a specific account, based on the account number provided. But this API will not allow the querying bank to retrieve the account holder's home address or transaction history. Insofar as APIs provide strong security features, they can add an additional layer of security to interactions.
A key benefit of APIs is that they enable interoperability between different providers and simplify transactions. For example, many large financial institutions or big techs possess valuable consumer data, eg on payment transactions.
By allowing other market participants to access and analyse data in order to develop and improve their products, APIs ensure a level playing field. This promotes competition and delivers benefits to consumers. An example is "open banking", which allows third-party financial service providers to access transaction and other financial data from traditional financial institutions through APIs.
For example, a fintech could use banks' transaction data to assess credit risk and offer a loan at lower, more transparent rates than those offered by traditional financial institutions.
Payment APIs may offer software that allows organisations to create interoperable digital payment services to connect customers, merchants, banks and other financial providers. For example, to send money to another user via an API, all that is required from the sender's perspective is the unique phone number of the recipient. Behind the scenes, the payment process follows three general steps Graph III.
In the first step, the phone number provided is used to identify and authenticate the unique recipient, as well as their bank connection, account details etc. The second step is agreement, in which the recipient's bank or financial services provider needs to agree to the transaction on the customer's behalf. Once there is agreement, in a third step funds are transferred and made available to the recipient immediately.
In all steps, cryptography ensures that the transaction is non-repudiable and that information is shared securely. APIs thus securely connect otherwise separate bank and non-bank payment service providers, benefiting consumers through cheaper services. Much as the local authorities preside over their town's marketplace, a central bank can provide the payment system with access to its settlement accounts.
In the case of a retail FPS, the balance sheet of the central bank is, metaphorically speaking, a public space where the sellers of the payment services all interact.
The central bank is best placed to play this role, as it issues the economy's unit of account and ensures ultimate finality see glossary of payments through settlement on its balance sheet.
The central bank can also promote innovation in this bustling payments marketplace, where the network effects can be channelled towards achieving a virtuous circle of greater participation, lower costs and better services. Table III. Several similarities, but also differences, emerge. They both enable competing providers to offer new services through a range of interfaces — including in principle via prepaid cards and other dedicated access devices, as well as services that run on feature phones.
Such arrangements not only allow for lower costs to users, but also afford universal access, and could thus promote financial inclusion. Moreover, as the issuers of CBDCs and operators or overseers of FPS, central banks can lay the groundwork for assuring privacy and the responsible use of data in payments. The key is to ensure that governance for digital identity is appropriately designed. An open system that gives users control over their data can harness the DNA loop, breaking down the silos and associated market power of incumbent private firms with exclusive control over user data.
Funds do not pass over the balance sheet of an intermediary, and transactions are settled directly in central bank money, on the central bank's balance sheet and in real time.
By contrast, in an FPS the retail payee receives final funds immediately, but the underlying wholesale settlement between PSPs may be deferred. In an FPS with deferred settlement, credit exposures between banks accumulate during the delay, for example over weekends.
This exposure may be fully or partially collateralised — an institutional safeguard designed by the central bank. Nevertheless, a CBDC allows for a more direct form of settlement, eliminating the need for intermediary credit and hence simplifying the architecture of the monetary system.
An example of the potential benefits, to be discussed in a later section, is the potential to address the high costs and inefficiencies of international payments by extending these virtues of greater simplicity to the cross-border case.
At a more basic level, CBDCs could provide a tangible link between the general public and the central bank in the same way that cash does, as a salient marker of the trust in sound money itself.
This might be seen as part of the social contract between the central bank and the public. CBDCs would continue to provide such a tangible connection even if cash use were to dwindle.
Ultimately, whether a jurisdiction chooses to introduce CBDCs, FPS or other systems will depend on the efficiency of their legacy payment systems, economic development, legal frameworks and user preferences, as well as their aims. Based on the results of a recent survey, payments safety and financial stability considerations also in the light of cryptocurrencies and stablecoins tend to weigh more heavily in advanced economies.
In EMDEs, financial inclusion is a more important consideration. These are shaped by the central bank itself. Vital to the success of a retail CBDC is an appropriate division of labour between the central bank and the private sector. CBDCs potentially strike a new balance between central bank and private money. Central banks and PSPs could continue to work together in a complementary way, with each doing what they do best: the central bank providing the foundational infrastructure of the monetary system and the private PSPs using their creativity, infrastructure and ingenuity to serve customers.
Such a shift would detract from the role of the central bank as a relatively lean and focused public institution at the helm of economic policy. Equally important is the long-term impact on innovation. Banks, fintechs and big techs are best placed to use their expertise and creativity to lead innovative initiatives, and integrate payment services with consumer platforms and other financial products.
Central banks should actively promote such innovations, not hinder them. Most fundamentally, a payment system in which the central bank has a large footprint would imply that it could quickly find itself assuming a financial intermediation function that private sector intermediaries are better suited to perform. By Eva Taylor , Andreas Framke. As memories of the financial crisis fade and market confidence soars, policymakers have warned that investors desperate for any return on ultra-cheap money could be creating yet another bubble to go bust.
Now the chief economist of the body bringing together global central bankers has warned that while banks are still repairing the damage of the last crisis, pension funds have cast off their risk aversion in the hunt for profit. The BIS advised governments that reforms to boost economic growth are the best way to reduce their debt relative to the size of their economies, but will not be sufficient by themselves.
It said history showed that governments usually need to run budget surpluses to reduce debt, not just rely on the economy growing faster than interest rates. We acknowledge Aboriginal and Torres Strait Islander peoples as the First Australians and Traditional Custodians of the lands where we live, learn, and work.
Key points: The Bank for International Settlements is optimistic the global economy has weathered the worst of the COVID storm The BIS warns that a global surge in house prices may lead to lower economic growth in the medium term It also warns governments not to count on continued low interest rates to stay on top of their growing debts. Chances are that the timing on rate hikes will be much sooner than we have been led to believe.
Interest rates to rise next year, CommBank warns. Inflation 'rebirth' threatens central banks' low rates for longer plans. There's an extraordinary wealth transfer happening right now and the RBA has played a part.
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It would require payees and payers around the world to all use the same PSP, which would be a coordination challenge and lead to concentration risk. Closed loops are mainly improving particular niche cross-border payments. AliPay and WeChat Pay are increasingly partnering with overseas payment operators to allow Chinese travellers to use their mobile payments application whilst abroad.
Other fintech firms, such as Revolut and Transferwise, provide services in currency pairs for which there is high turnover, using incoming payments to fund outgoing payments in the same currency to minimise costs.
As the name suggests, the infrastructure model involves building a payment system or linking payment systems to operate cross-border.
The link facilitates remote access to domestic systems for banks located abroad. Bech, Faruqui and Shirakami , in this issue explain the different ways infrastructure can be used to facilitate cross-border payments. In contrast to the other models, peer-to-peer arrangements cut out the financial intermediary PSPs between the payer and the payee.
There are some private initiatives. So-called "stablecoins" such as Libra are examples of the genre. Libra is a consortium led by Facebook that proposed a private global stablecoin. Libra's initial proposal involved creating its own unit of account, avoiding the need to deal with different currencies when settling cross-border payments.
Further detail and analysis of these initiatives is set out in G7 In addition, central banks are undertaking extensive work on central bank digital currencies CBDCs that could support cross-border payments.
The Bank of Thailand and the Hong Kong Monetary Authority recently completed a proof of concept to that effect for wholesale payments. In a recently published survey, central banks rated improving the efficiency of cross-border payments as a "somewhat important" reason for establishing CBDCs. However, in general, the safety and efficiency of domestic payments were the most highly rated motivation Boar et al Bech, Hancock, Rice and Wadsworth , in this issue also analyse peer-to-peer arrangements, focusing on how their use could change the clearing and settlement arrangements for securities.
Innovation in domestic payments continues to occur. Wholesale systems are opening up access to non-banks, extending operating hours and improving the interoperability of systems. Fast or instant retail payment systems have been or are being developed in many jurisdictions. However, shortcomings in access and cross-border payments remain. Access issues can be addressed through targeted interventions in individual jurisdictions.
Quantification of the extent and relative importance of the various drivers facilitates such interventions. Fintech is also likely to improve universal access to and frequent usage of transaction accounts. The way to address the problems surrounding cross-border payments is less clear. First, more data are needed to help understand the extent and the drivers of the problems. Initiatives to improve cross-border payments would benefit from being able to quantify both the relative importance and the costs and benefits of the various types of back-end arrangements.
Second, coordinating efforts to address the issues besetting cross-border payments is more challenging. There are more stakeholders involved and no organisation with a clear leadership role. In , the G20 took on a leadership role when it decided to give priority to enhancing cross-border payments Carstens , in this issue. Bank of Thailand and Hong Kong Monetary Authority : Inthanon-LionRock: leveraging distributed ledger technology to increase the efficiency of cross-border payments , January.
Committee on Payments and Market Infrastructures : Fast payments - enhancing the speed and availability of retail payments , November. Committee on Payments and Market Infrastructures and World Bank Group forthcoming : Payment aspects of financial inclusion in the fintech era.
The Economist : "The cost of cross-border payments needs to drop", 13 April. Financial Stability Board : FSB action plan to assess and address the decline in correspondent banking: progress report to the G20 Summit of November , November.
G20 : "Building our common future: renewed collective action for the benefit of all ", Summit Final Declaration. Klein, A : Is China's new payment system the future? McKinsey : Global payments strong fundamentals despite uncertain times. Financial intermediation in an era of transformational technology", Geneva Report on the World Economy , no World Bank : Financial inclusion and inclusive growth: a review of recent empirical evidence , April.
Two notable exceptions are Mexico and Switzerland, where both retail and wholesale payments are processed by the same system. Depending on when the failure occurs and the relevant legal arrangements, settlement risk may be borne by the payee, one of the PSPs or the payment system operator if that operator guarantees settlement.
For further details on the settlement arrangements for FPSs, see Bech et al They can be domestic, but for the purposes of this article the term is used to refer to cross-border ones.
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