The International Monetary Fund has warned that central bank digital currency (CBDC) may pose a risk to the banking industry and domestic currency of a particular country, urging central banks to come up with a policy to mitigate excess use.

Tommaso Mancini-Griffoli, who heads IMF’s monetary and capital-markets department, said CBDC would make particular currency become cheaper and easier to hold, including to non-citizens.

When people from other countries trade more often with foreign-digital currency, it reduces the role of their domestic currency in the process.

“There is a big risk of currency substitution. That is where citizens will start to hold a foreign currency in digital form while transacting foreign currency in digital form,” Mancini-Griffoli said on Tuesday during a discussion in a side event of Group of 20’s Third Finance Ministers and Central Bank Governors (FMCBG) Meeting in Bali.

Migration has a higher chance to occur in countries with high inflation and high exchange-rate volatility, as people will desire more stable alternatives to store value, he said, adding some countries that need a lot of time to adjust their policy may also see a similar trend.

“Once currency substitution happens, it’s very hard to go back,” he said.

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Markus K. Brunnermeier, an economics professor at Princeton University, said that it was possible for a foreign currency to take over, prompting a country to lose its monetary sovereignty. This would prevent a country from exercising its policy, as people pay with another country’s currency.

“If you increase interest in your currency or lower it in order to stimulate a slowdown in the economy, you cannot actually do that,” Brunnermeier said in the same discussion.

He added that many developed and developing countries have worried about these issues, especially in the event of digital dollarization, in which the most-used currency in the world would finally have digital form.

Mancini-Griffoli said these risks had inspired many countries to prepare stringent policies to prevent too much currency substitution, a contradiction to the spirit of digital currency that enables a much easier flow of money.

“That is the irony. We are working very hard so that you can trade and hold foreign currency much more easily, but we're contemplating reintroducing frictions in the form of capital controls to allow countries to maintain monetary-policy independence,” Mancini-Griffoli said.

Risk to commercial banks

Mancini-Griffoli said the introduction of CBDC may also cause a run risk in the banking industry, a condition when people move their money from bank deposits to central-bank-issued digital currency. This could be slow or fast depending on the situation – faster movement being more likely during a financial crisis.

Many have feared that the diminishing balance sheet in banks would disrupt their intermediary roles, which have mostly related to loan disbursement needed in the economy.

However, Mancini-Griffoli said such a risk is currently not a cause for concern, arguing banks still had more advantages.

“If CBDC doesn't offer interest rates and commercial banks have good deposit guarantees, commercial-bank deposits may be just as safe, but offer a higher reward. In that case, you might decide to hold commercial-bank deposits,” he said.

Alternatively, governments and central banks may set a limit on the amount each person could own in digital currency over a period of time, which could be subject to a fee for exceeding a certain threshold.

Read also: BI head calls for global principles on CBDCs

Many countries were exploring the possible adaptation of CBDC with varied stages. The development has recently gained significant traction, as people are getting more used to making online transactions accompanied by digital payment.

Digital currency has also become one of the main issues to be addressed under Indonesia’s G20 presidency.

Bank Indonesia deputy governor Doni P. Joewono said that it would remain prudent and continue to explore the potential impact of CBDC, adding it would also continue research digital currency.

This year, BI plans to issue a white paper by the end of this year concerning the development of digital rupiah, he said, adding this paper is a big step before entering the proof of the concept and piloting the pace.

“The issuance of CBDC must do no harm to monetary and financial stability, but rather support the fulfilment of the central-bank mandate and bring the benefits of the commodity,” Doni said during his remarks.

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