Welcome to our new blog series on “Central Bank Digital Currencies for Financial Inclusion” co-authored by Professor Heng Wang of the Yong Pung How School of Law, Singapore Management University.
In this series, we delve into the world of central bank digital currencies (CBDCs) and their potentially profound implications for financial inclusion. What are CBDCs? CBDCs are digital versions of countries’ official currencies issued by the central bank or similar. They can be the digital representation of physical cash. To date, more than 110 central banks around the world are engaged in some form of CBDC-related work, and the Eastern Caribbean Central Bank, and the central banks in the Bahamas, Jamaica and Nigeria have already issued CBDCs.
With more and more governments exploring the potential of CBDCs, there is a greater need to engage in various aspects of this emerging topic, including design, especially given its potential to promote financial inclusion. UNDP has a long history of promoting technological and digital financial innovations that help advance financial inclusion and the SDGs more broadly. For example, his teams have worked with several countries on digital finance and infrastructure innovations that enable underserved business segments, such as MSMEs, to access more sophisticated financial services or to enable micro-savers to become micro-investors in green infrastructure projects. becoming, or to harness the developments in Distributed Ledger Technologies to promote innovative financial instruments for private capital mobilization for nature. Given UNDP’s expertise and leadership in this space, UNDP’s involvement in this discussion will help better support Member States as they navigate this changing landscape.
This first blog serves as a fundamental exploration of this emerging area of finance. It describes the challenges and opportunities to drive financial inclusion, and how CBDCs can serve as an important mechanism to ensure that no one is excluded from financial services – or our increasingly digital economies and societies.
Stay tuned for our upcoming blogs, where we will delve deeper into specific aspects of CBDCs, such as their deliberate design and practical tips to promote financial inclusion. Join us on this journey towards a more inclusive financial landscape.
Achieving financial inclusion through digital currencies
Individuals and small firms face challenges related to financial inclusion, including limited access to and high cost of banking services, lack of financial literacy and informal financial practices, among other issues. Despite the progress made in addressing financial exclusion, these challenges persist: 18% of people around the world still do not have a bank account. A significant proportion of micro, small and medium-sized enterprises – many of which are led by women – are unable to access funding or financing. And amid this backdrop, the annual SDG financing gap – the funding needed to achieve the Sustainable Development Goals by 2030 – has now widened to an annual shortfall of US$4 trillion.
The digital divide further exacerbates these challenges – for example, 2.6 billion people, or about one third of the world’s population, still do not have internet access. But it’s not just about access. The ‘usage gap’, the population living within the footprint of mobile internet coverage but not using this potentially game-changing connection, is now eight times larger than the total number of people without coverage. Limited digital skills, unaffordable data and devices, safety and security concerns, and a lack of relevant content and services prevent people from participating in our increasingly digital societies and economies. Financial inclusion is a complex and multifaceted issue – can CBDCs contribute to addressing some of these challenges?
What are central bank digital currencies?
Unlike e-money, stablecoins or private digital assets such as Bitcoin, central bank digital currencies (CBDCs) are digital forms of national currencies (“fiat currencies”) issued by central banks. CBDCs can serve as a new form of central bank money and function as new financial infrastructure. A CBDC can take two forms, retail CBDC (designed for broad public use in retail transactions) and wholesale CBDC (tailored for financial institutions and wholesale markets to facilitate large value interbank transactions and settlements). In particular, retail CBDCs are used by the public and businesses for transactions and storing value. The potential use cases for CBDCs are diverse, including salary payments, taxation and e-commerce. CBDCs can also use the technology of “smart contracts”, which are automated and enforceable agreements. Smart contracts hold promise to fulfill a wide range of functions, such as the delivery of public services to remote (underserved) areas and the management of prepaid funds.
Regarding the current development of the CBDC, 93% of 86 central banks surveyed by the Bank for International Settlements (BIS) worldwide are engaged in some form of CBDC-related work, including the central banks of Sweden, China and the euro area. Among the 30 respondents to the recent International Monetary Fund (IMF) survey on sub-Saharan Africa, 23 said their central bank had either started or planned to start research, experiments or development related to CBDCs. The Bahamas, Eastern Caribbean, Jamaica and Nigeria’s central banks have already issued retail CBDCs, but currently face challenges such as adoption rates. For example, the SandDollar, the Bahamas’ CBDC, represents a small fraction of the currency in circulation, with the number of registered wallets equal to about 25% of the population.
Several countries are actively exploring the potential use of CBDCs, particularly retail CBDCs, to improve financial inclusion. CBDCs, if properly designed and managed, can have the potential to improve financial inclusion by addressing access and price barriers. In terms of improving access to financial services, CBDCs can be designed to reduce identity management requirements (especially Know Your Customer [KYC]) in low-risk contexts. It can allow the use of digital currencies without the need for bank accounts or minimum balances and provides offline functionality to mitigate the impact of physical remoteness. Additionally, by lowering transaction costs for financial services and providing cheaper payment services, CBDCs have the potential to address price barriers and make financial services more affordable for underserved populations.
Chart 1. Examples of how a CBDC can drive financial inclusion Created by Author
Potential for development
Understanding the costs, benefits and feasibility of CBDCs helps countries to influence and prepare for the changing financial landscape. This understanding informs their decisions in developing infrastructure, improving efficiency (e.g. facilitating faster cashless payments) and meeting other user needs (e.g. reducing transaction costs and providing digital financial services to vulnerable populations).
However, this potential comes with a caveat. Although CBDCs hold promise for improving financial inclusion, they are still in the early stages of development and are not a panacea for financial inclusion. Other barriers to financial inclusion should not be overlooked (such as financial and digital literacy gaps). CBDCs also bring new risks and challenges. These include cyber security threats, identity theft, privacy concerns, cost recovery, carbon emissions from infrastructure such as data centers and e-waste. With smart contracts as an example, it is crucial to address issues such as privacy concerns and possible technical errors. In addition, technical challenges (such as the risk of devices being tampered with during offline payments) will be carefully addressed.
The complexity of these challenges highlights the need for a conceptual framework for examining the relationship between CBDCs and financial inclusion, as well as forums where countries can share and learn from each other experiences and lessons learned. In the following sections, we explored a conceptual framework through three main questions (and such a framework will be explored in more depth in our next blogs). The framework places users, including individuals and traders, at the heart of CBDCs, while recognizing the crucial roles of other actors, including CBDC issuers and industry participants.
Do users understand CBDCs?
Users of retail CBDCs, businesses and individuals, will have access to not only the infrastructure but also the necessary knowledge about CBDCs. For example, the public needs to understand how to open a CBDC wallet and use a CBDC without a bank account. Access to the knowledge and infrastructure needed for CBDCs can vary based on factors such as offline or online functionality, access to data, and of course cell phone ownership.
Do users know how to use CBDCs?
Key issues regarding CBDCs include convenience (e.g. seamless conversion between CBDCs and cash), and the technological readiness of users (e.g. mobile phone ownership). Further questions arise, such as what happens to a user’s CBDC if a user’s device is lost? Can CBDCs maintain privacy for small and low-risk transactions? Can CBDCs easily operate offline, even during disasters? The CBDC access through feature phones and other hardware (such as cards) helps drive the adoption of CBDC. This will require maintaining adequate coverage and capacity of digital infrastructure (including POS and last-mile connectivity) over time.
Do users want to use CBDCs?
Individuals and businesses will weigh factors such as privacy protection, cost, reliability (e.g., user support, dispute resolution), accessibility, and security when considering retail CBDCs. Users often compare CBDCs to traditional methods such as cash and credit cards, highlighting challenges such as CBDC dispute resolution mechanisms that currently fall short of those in global card payment systems. Essentially, building trust in CBDCs and the issuing central bank is crucial. Trust is influenced by transparency, resilience (both digital and operational), legitimacy and security of CBDCs, all of which significantly influence adoption rates.
As we conclude this first chapter on what CBDCs are and why they are relevant in the financial inclusion discourse, we look ahead to the next chapter of this blog series, which explores the deliberate design of CBDCs for financial inclusion. Achieving the latter depends on secure and resilient technology, accessible infrastructure (including digital identification) and effective governance. It also requires sufficient financial and institutional resources to address challenges and sustainably deploy CBDCs, if implemented.
This is the first blog of the CBDCs for Financial Inclusion Series. A second blog will be published next month on “How CBDCs should be designed to drive financial inclusion”.
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