Fast Payments and Central Bank Digital Currencies: Some Key Distinctions

The Federal Reserve has recently announced its FedNow^® service, which allows banks and credit unions who have signed up to transfer money for their customers instantly, 24/7, any day of the year. The system is still being phased in. But in theory, it will become possible, for example, for someone to get a paycheck, put it in the bank immediately, and then spend it immediately–without fear that delays in moving money around in the banking system will lead to a costly overdraft fee.

In the jargon, FedNow^® is called a “fast payment system”–but it’s really just the same banking system working more quickly. How does the existence of a fast payment system affect the case for a slightly different innovation, a “central bank digital currency”? Anneke Kosse and Ilaria Mattei describe the thinking of central banks on this overlap in “Making headway – Results of the 2022 BIS survey on central bank digital currencies and crypto” (BIS Papers No 136, July 2023).

What exactly is a central bank digital currency? It comes in two forms, retail aimed at individual households and firms, and wholesale aimed at banks and financial institutions. The report says:

A CBDC is a digital payment instrument, denominated in the national unit of account, which is a direct liability of the central bank. If the CBDC is intended for use by households and firms for everyday transactions, it is referred to as a “general purpose” or “retail” CBDC. A retail CBDC differs from existing forms of cashless payment instruments (i.e. credit transfers, direct debits, card payments and e-money), as it represents a direct claim on a central bank rather than the liability of a private financial institution. In contrast to a retail CBDC, a wholesale CBDC targets a different group of end users. Wholesale CBDCs are meant for use for transactions between banks, central banks and other financial institutions. So wholesale CBDCs would serve a similar role as today’s reserves or settlement balances held at central banks. However, wholesale CBDCs could allow financial institutions to access new functionalities enabled by tokenization, such as composability and programmability.

One big difference between fast payments and central bank digital currencies is that most central banks around the world already have fast payment systems (indeed, the Fed was probably slower to get such a system in place in the US than it should have been), but central bank digital currencies are mostly still in the experimental stage. Kosse and Mattei describe the thinking of central banks on the overlap between topics based on a survey conducted in late 2022 by the Bank for International Settlements:

Over the last two decades, fast payment systems (FPS) have spread around the world. … The current availability of FPS is higher in AEs [advanced economies] (84%) than in EMDEs [emerging market and developing economies] (70%) … Owned and operated by central banks, private sector entities or a combination of these, FPS process small-value account-based transactions such that the funds are made available to the payee in real or near real time and on a 24/7 basis (or close to it). In addition to providing users with high speeds and 24/7 availability, FPS can provide value-added services, such as request-to-pay functionalities or the possibility to initiate payments using a mobile number or an e-mail address, so-called proxy identifiers or aliases, instead of a bank account number. …

Depending on their design, FPS and retail CBDCs can achieve similar objectives, such as enhancing financial inclusion and promoting faster and more efficient
domestic and cross-border payments. In addition, they both enable broader innovation and enhanced competition, which can increase the availability and accessibility of cheaper payment products and services. More diversity and competition can also lead to a more resilient payments ecosystem.

The general hope of central bank digital currencies is to improve the efficiency and safety of payments. It is unclear in the context of an advanced economy like the United States how much it would actually matter, in practice, to have a payment happen as a liability of a central bank rather than a liability of a regular bank. After all, in advanced economies, private-sector banks are generally quite safe and can be made near-instantaneous with fast payment systems–which may not be the case in all countries. (I wrote about Brazil’s fast payment system here.) The report says “currently four central banks have issued a live retail CBDC: The Bahamas, the Eastern Caribbean, Jamaica and Nigeria.”

However, the BIS survey of central banks suggests that many of them see fast payment systems and some form of a central bank digital currency as complements, not substitutes. The report explains:

This is mainly because they believe that a CBDC has specific properties and may offer additional features, such as being a riskless form of digital money and allowing access to a wider set of financial institutions and the unbanked population. Also, programmability and offline payments were mentioned as features that an FPS may not provide. About 9% of central banks that see value in having both an FPS and a retail CBDC believe that this could benefit the efficiency and resilience of the payments market. Depending on the design of each, several central banks believe that an FPS could also complement a CBDC, for example when targeting different use cases or offering additional services.

At least to me, many of these goals remain uncertain in practice. In practical terms, for example, how will the “unbanked” (those without bank accounts) obtain the central bank digital currency, carry it around, and use it? I suppose this could happen through a debit card with pre-loaded amounts, but for advanced economies, that innovation already exists. The idea that digital money could be “programmable” is both intriguing and a little ominous. For example, it might be possible to track exactly how the CBDC is spent, or even to have a feature that if it is not spent in a certain time, it expires. The purpose of the programming will presumably matter.

Some distinctions seem to be emerging. About two-thirds of central banks say in the survey that they are unlikely to have a retail CBDC and more than half say they are unlikely to have a wholesale CBDC in the next few years. However, central banks from emerging and developing market economies are showing a greater eagerness to try such policies. The optimistic interpretation here is that in a country where financial systems are not well-developed and a large share of the population doesn’t have an account at the back, perhaps the central bank digital currency can help the population and the banks become more connected to a smoothly functioning financial system. The pessimistic interpretation is that some of these central banks are getting in over their heads.