Strengthening the financial inclusion of the retail segment through the use of central bank digital currency – Retail account servicing and opportunities beyond

X. Strengthening the financial inclusion of the retail segment through the use of central bank digital currency – Retail account servicing and opportunities beyond

András Szabolcs Csonka – Bálint Danóczy – Péter Sajtos

Globally, several types of friction can be identified in the market for retail financial services, to address which digital development may provide new opportunities. One radically new and innovative approach could be the introduction of central bank digital currency (CBDC) for the retail segment, which is being prepared or examined in an increasing number of international projects, while some central banks have already reached the test phase. This study describes in detail the possible social objectives of the introduction of retail CBDC at international level, as well as the main international examples where consideration has been given to the introduction of such a framework along the lines of specific public policy objectives. It then presents the design aspects of a retail CBDC framework geared towards financial inclusion, drawing on the findings and design structure presented in the chapter outlining the conceptual framework. Finally, in addition to the theoretical possibilities of an introduction in Hungary, we present a pilot project that is already underway in Hungary, which can provide important lessons and insights for the implementation of any larger scale concepts in the future.

1. Frictions in the retail financial services market

1.1. Bank account access and coverage issues

The number of people without a bank relationship remains

high globally. Despite the increase in bank account access in recent years and the emergence of various mobile money services, primarily in African countries, nearly 1.7 billion people worldwide (around 30 per cent of the adult population) do not have access to banking services (Global Findex, 2017). Therefore, universal access to banking services is not ensured, as opposed to cash. The absence of bank relationships in the retail segment is due to a number of reasons, including income situations considered insufficient for the purposes of opening a bank account, unfavourably priced related services, and the unavailability of banking channels (for example, there are areas where there are no banks and physical branches at all). It should also be pointed out that among residents who do not have accounts, a high proportion have reported lack of trust as a reason to avoid opening an account with a financial institution (Global Findex, 2017).

Bank access is restricted by the fact that cash remains the only universally available means of payment. Cash offers consumers several advantages that make specific user groups unmotivated for replacing it. Functions preferred by both service providers and users include anonymity and general acceptance. Protected from cyber risks by completely offline operations, while its use does not require any special tools or software solutions. Although the cheaper and more accessible financial services provided by the FinTech sector had appeared to relieve the problem of the lack of digitally accessible payment solutions, the poorer financing situation caused by the COVID-19 pandemic made these very companies more vulnerable and thus the long-term sustainability

of the previously followed competitive model became uncertain (Sahay et al., 2020).

There are several consumer groups that are adversely affected

regarding the availability of financial services. Among the adult working-age population, banking services are typically not used by segments with lower levels of education and lower incomes. In their case, the effects of the limiting factors listed above are compounded in relation to the establishment of banking relationships, and neither are financial service providers interested in providing a full range of services to these segments, as these consumer groups would typically be given more disadvantageous risk ratings and would be less compatible with banks’ business models that are based on high profit expectations. Providing a full range of services to people above retirement age is also less attractive for financial institutions, which raises the possibility that supplying banking services to this social group proves to be expensive relative to their income situation (MNB, 2019). Similar sub-optimal operations in terms of the supply of financial services may also occur with younger age groups, especially students, who have no earnings of their own, or are low earners; however, it should be noted in that regard that the legal environment may also restrict independent disposal of bank accounts for underage customers, despite which schemes specifically developed for students could nevertheless be implemented. This recognition has produced an increasing number of initiatives with such a focus, but the penetration of these service types remains low.

1.2. Need for the sovereign management of payment systems

Technological development contributes to the increasing use of electronic payment systems. Thanks to the advances in information technology in the 21st century, internet coverage has increased significantly, and the advent of smartphones has brought about the uptake and increasing use of online services, which are typically available through applications. These trends

fundamentally change consumer expectations: fast and convenient services, accessible from anywhere, or real-time messaging have become essential. These digital needs are also relevant in the market for financial services, and from a consumer perspective they mainly concern the area of payments, whereby a significant number of digital developments have already been implemented (e.g. real-time and interactive expense tracking, cross-border money transfers, online retail currency exchange, etc.). The digitalisation of the payments market and the development of electronic data transmission systems are increasingly driving consumers towards convenient, favourably priced electronic payment methods (Vennli, 2016). Furthermore, in the context of this development, it should be noted that restrictions to curb the spread of the Coronavirus have contributed globally to achieving a higher level of technological maturity in all age groups, i.e. it is no longer only younger generations that have a definitive digital and online presence.

At the same time, in electronic payment systems, which are used on an increasingly wide scale and are essentially operated by the private sector, a sovereign mandate serving public interests

cannot prevail. With the steadily increasing uptake of digital financial services, consumers tend to focus on commercial bank money, or on some form of digital instrument (e.g. e-money) (OMFIF, 2019). There has been a significant increase in the influence of enterprises that are typically involved in electronic payment flows, and, in the provision of services, primarily have business interests in mind (e.g. the execution of payment card transactions). Thus, in the digital space, which is increasingly preferred by consumers, operational shortcomings may occur at any time, which, given the decline in cash-based transactions, cannot be remedied by direct intervention by the central banks. In this way, the possibility of ensuring smooth payment flows may be restricted in the absence of direct central bank access.

Active, comprehensive sovereign involvement is also needed

in the electronic space. With the potential decline of cash and the connected payment systems, it may therefore be necessary to maintain an alternative supplementary system that takes into account the public good and consumer interests in the provision of payment services, and can also function as an efficient backup payment system in the digital space in the event of potential malfunctions of electronic payment systems, or in other crisis situations. In addition, a sovereign payment system can contribute to a high level of trust in digital payment services.

1.3. Efficiency problems with the operation of the cash payment system

As far as retail participants are concerned, the use of cash entails

costs that are not perceived directly. Obtaining the cash required for the execution of transactions tends to be a time-consuming and costly process for individuals. Converting commercial bank money to cash typically requires personal attendance, which potentially results in higher indirect opportunity costs, while access to cash sometimes entails significant direct costs such as ATM and withdrawal fees (N26, 2016). However, due to its physical nature, cash is exposed to a number of risks, which are often more difficult to mitigate compared to electronic payment methods: it can be lost without trace, stolen by unauthorised persons, damaged or destroyed; while the risks of these events are difficult or impossible to quantify, they are essentially present thanks to the physical form of cash. In addition, the costs of the activities of merchants accepting cash related to the operation of the cash-based payment system (e.g. acceptance, storage, provision of change) are typically also paid by consumers, incorporated into the prices of the individual products and services.

Although those who do not have a bank relationship typically do not open an account on the basis of high costs, the costs

of using cash may be higher for these segments. Notably, for example, where various allowances (e.g. pensions, state aid) are available to consumers without bank accounts, the distribution costs typically have to be paid by consumers in connection with their delivery, and the time required for these distribution tasks may also be significant, and possibly disadvantageous to consumers (Weisbaum, 2013).

The execution of cash transactions also raises efficiency issues

in the operation of businesses. By holding cash for transaction purposes businesses will also need to provide for cash payment facilities and the smooth execution of these types of transaction. In addition, regarding all physical facilities (e.g. chain store units, branches and ATMs for banks) businesses require significant resources to estimate cash demand as accurately as possible and to optimise the tasks of cash storage and transit between units (Denecker et al., 2018). In enterprises creating added value, holding an excessively high level of cash may carry a high opportunity cost (e.g. by preventing investments), while holding an excessively low level of cash may hinder the completion of transactions.

The production, storage and transportation of cash not only entail costs, but also raise sustainability issues. The production of physically available banknotes and coins requires a significant amount of raw materials, and in a variety of forms (e.g. banknotes can be paper or polymer based, whereas coins tend to have varying components of non-ferrous and precious metals). This diversity involves a significant environmental burden, while in the production of bank notes and coins, paper mills, banknote printing companies and mints are constantly seeking to renew their technology in order to reduce environmental harms. The logistics tasks involved in the use of cash, mainly for merchants and banks, also have a significant ecological impact. Surprisingly, the energy demand of ATM networks is also high, as installed ATMs tend to have a variety of typically different functions,

must provide continuous availability (e.g. even at night, which requires lighting), and must maintain constant synchronisation with central systems. Although the increasing use of modern technologies and digitalisation, possibly also through CBDC, can increase energy consumption and environmental burden, especially if a CBDC runs in parallel with the cash payment system, the development of a digital alternative to cash offers the opportunity for efficiency gains and to mitigate adverse ecological impacts in many processes (IFoA, 2018).

At the level of national economy, the excessively high level of

cash usage for transaction purposes is not optimal either. Cash transactions cannot be monitored or controlled directly by any sovereign actor, and it is also difficult to ensure the monitoring of cash movements. The wide coverage of ATMs has significantly simplified access to cash. Furthermore, if the oversight of highvalue cash movements is limited, their overall economic relevance cannot be measured effectively either, leading to anomalies in tax planning and tax revenues (OECD, 2017). In addition, although direct monitoring is constantly improving due to the increasing use of online cash registers, the full coverage of this monitoring activity is not yet resolved, which also limits the enforcement of consumer protection interests, and may also cause losses to the retail customers if people are not sufficiently conscious and careful when purchasing a product or service.

2. Possible social objectives of retail CBDC

The introduction of central bank digital currency can be instrumental in the achievement of several social objectives, some of which can be considered quite timely, while others may serve to proactively solve the challenges that arise in the medium and long term. The possible social objectives of a CBDC accessible to the retail segment may, include (i) to significantly reduce the

social costs typically associated with high cash usage; (ii) to provide a solution, as a more effective financial stimulus tool in unprecedented and sudden periods of stress such as the pandemic situation in 2020; (iii) to provide an excellent opportunity to develop a new platform to increase the efficiency of all economic participants in relation to everyday payments, thereby giving significant competitive advantage to both the private sector and the state; (iv) not least, instead of a reactive regulatory response, that only hits the target partially, CBDC could represent a highly proactive step forward, even over a horizon of several decades, ahead of the increasingly drastic expansion of alternative payment methods.

The motivating factors to be listed below may give rise to the consideration of introducing CBDC, while the social objectives (excluding central banks’ monetary policy objectives) discussed later provide guidance on the choice of the specific method of implementation.

2.1. Fixing issues with bank account access and coverage

Of the many positive outcomes of central bank digital currency, one of the most welcome benefits is the improvement of opportunities for unbanked and under-banked social segments (FDIC, 2017). The former term denotes a group of consumers who do not have access to basic financial services. In principle, members of the latter group could have access to such services, but do not use them for some reason, either because they find the services expensive, or they have no adequate income, or they are unaware of the associated benefits. For this reason, they either continue to make all of their payments relatively expensively in cash, or use alternative financial services, which are not subject to direct supervision in Hungary. Although the latter can theoretically contribute to the development of their financial awareness, this is not the case for cash-only payment habits. Furthermore, while using alternative solutions, the existing

financial vulnerability of these groups, which is significantly higher than the average, constitutes an additional risk factor (for example, if they do not have a bank account and thus fall outside the scope of domestic consumer protection), which could also be remedied by the establishment of a wide network of payment service providers linked to central bank digital currency.

With the introduction of central bank digital currency, account servicing and payments can essentially be transformed into

public goods (Szabó–Kollarik, 2017). Central banks could provide the necessary infrastructure to all households (and even companies) with more favourable conditions and easier access than at present. Key target groups include retail participants who do not have a payment account and do not use electronic payment services. In Hungary, the relative banking burdens are the highest for consumers who already appear in the banking system, but represent the lowest-income group therein (Kajdi et al., 2019). This group could therefore derive major benefits from central bank digital currency, or even its initial use for basic payment services.

2.2. Reducing the fragmentation of payments and the possibility for the design of a robust system

The introduction of central bank digital currency available to the retail segment may allow a more targeted and effective implementation of a possible financial stimulus, either for immediate assistance or to address prolonged market failures. In the event of a possible stress situation, it can provide a rapid and effective means for the immediate delivery of aid granted as temporary compensation for lost incomes, and thus for the maintenance of household consumption. In view of the fact that, at present, electronic transactions either in the digital space or at physical merchants cannot effectively fulfil the role of a means of payment that is viable in all circumstances, even in the event of natural disasters or possible cyberattacks, with the steadily increasing uptake of digital payment solutions, there is greater

need for a reliable central infrastructure that is capable of ensuring that electronic payment transactions are carried out at all times, even under extreme conditions, without any profit considerations. If specific social groups or even all individuals had a central bank digital currency account, the fiscal authority would have direct (and cost-effective) access to the retail segment through this channel. In principle, direct access could also pave the way for account servicing, or credit lines that can be drawn quickly and easily, for retail participants. This could possibly enable crisis management measures to be executed even more effectively. However, it should be noted in connection with this suggestion that the aim is not for economic agents to maximise their deposit holdings with the central bank, and thereby to compromise the stability of the banking system. Furthermore, it should be pointed out that the implementation of this concept requires further indepth research on the effects on the banking system. Decision on this typically goes beyond the mandates of the central bank and may require legislative changes.

2.3. Remedying efficiency problems resulting from the operation of the cash-based payment system

The use of cash generates social cost, the extent of which is difficult to predict for the long term. In the early stages of crises, as a result of a kind of instinctive reaction the amount of cash held by the population tends to surge, as it happened in the case of the coronavirus pandemic. In March 2020, cash in circulation in Hungary increased by HUF 250 billion (about 4 per cent) over 8 working days, which historically reflects approximately six months’ increase (Végső–Bódi-Schubert, 2020). In the medium term, however, the pandemic situation also accelerated the trend observed over the past decade: in 2020 the rate of decline in transactional cash usage increased by approximately five

times globally (McKinsey, 2020). At the same time, it is part of the realistic assessment of the situation that demand for cash increased strongly in almost all countries following the outbreak of the coronavirus crisis. An increase in cash holdings was observed even in countries where demand for cash had stagnated or declined for years, such as the United Kingdom or Norway. Although for the first time in the second quarter of 2020 the value of card payment spending in the retail segment exceeded the amount of cash withdrawn (Végső–Bódi-Schubert, 2020), even in the period of the most stringent lockdowns, three-quarters of the transactions recorded by online cash registers were still made in cash.

The majority of the society do not perceive the social cost of using cash. Consumers frequently assume that cash transactions are effectively free of charge, as opposed to electronic payments which they consider expensive. This perception stems from the fact that the related costs in this latter case are charged directly on the individual, even on a per-transaction basis, although cash withdrawal is not necessarily free of charge either. Probably also partly because of this, the value of cash in circulation in Hungary was close to HUF 7,000 billion at the end of the third quarter of 2020, of which more than three-quarters may be held by the retail segment (MNB, 2020a). Although cash demand in Hungary is indeed high, it is not outstanding by international standards, in addition, the main driver for the use of cash is savings and not transaction purposes; moreover, the share of the latter has been decreasing for years (Végső, 2020). Since 2010, the volume of cash in circulation has tripled, despite the improving trend in the share of card transactions. This costs the society about HUF 400 to 450 billion annually (Government of Hungary, 2019). On the one hand, this is an enabler for the activities of the shadow economy, while the production, holding and handling of cash and related indirect activities entail high national economy and social costs.

According to the 2019 calculations of the Hungarian Banking Association, on a social level a significant reduction in cash in itself would help achieve savings of up to 0.4 per cent of

GDP. In practice, this would essentially go hand in hand with the shrinking of the shadow economy, which – according to the example presented –, could increase the revenues of the budget by an additional 1.3 per cent of GDP in the case of a black economy falling to 10 per cent in the total economy (Hungarian Banking Association, 2019). By reference to the social cost quantified previously, assuming that all economic agents use cash to a similar extent, the social cost of this may exceed HUF 40,000 per year for every individual. At the same time, it is important to see that the preferences of the population for payment methods are determined primarily by long-term and only slowly changing sociodemographic factors (education level, economic activity, etc.). For this reason, the continuous but gradual introduction of CBDC may be the most appropriate, while ensuring continuous cash supply. The successful introduction of central bank digital currency could lead to a stable future growth in cashless payment methods. This could help to achieve significant cost savings on social level and, with the uptake of electronic payment and savings solutions and the strengthening of social confidence in them, even a part of the cash held for savings in the retail segment (if only in the form of commercial bank deposits) could return to the economy (Hungarian Banking Association, 2019). Importantly, however, introducing central bank digital currency could, in the first place, be expected to have a desirable effect on transactional demand for money, and is not aimed at replacing cash. Consumers would thereby still have a choice to decide whether to use cash or electronic methods in specific payment situations.

Reducing the ecological footprint associated with cash logistics

can also be an important social objective (ECB, 2020). Although a sufficiently detailed analysis of the Hungarian forint is not available, the 2018 study of the Dutch central bank shows that cash has a significantly greater impact on the environment and

climate change than bank card payments. According to the results of the transactions examined by De Nederlandsche Bank, the ecological footprint of cash payments was 36 per cent higher than that of card payments, while their impact on climate change (average carbon emissions per payment) was 21 per cent higher (Hanegraaf et al., 2018). Based on the available Hungarian data, it can be concluded that besides cash logistics, the entire cycle from banknote production through destruction to pressing and transformation into brick-shaped briquettes, representing the end of the cycle, does not only have significant annual costs, but also a significant environmental effect. The MNB has been continuously striving to reduce this for years as part of its environmental strategy, and as a result of the significant reduction so far, the Hungarian Banknote Printing Company and the MNB have obtained their EMAS97 certificates.

2.4. Developing and expanding the financial services market and driving competition

As a percentage of their incomes, Hungarian retail customers’ cost of payments is outstanding by European standards, even when controlled for transaction fees, which greatly hinders the uptake of electronic payment methods in Hungary (Kajdi et al., 2019). Overall, a “clean-up” and simplification of the entire ecosystem may be justified if the cost to individuals and society can be substantially and simultaneously reduced. Moreover, the current situation is particularly disadvantageous for consumers who are already banked but have lower incomes. The introduction of central bank digital currency available to the retail segment as a public good could create an electronic payment system that would provide free or low-cost payment transactions similar to cash (BoE, 2020). Optimally, merchants could also be incentivised

97 This certificate may be awarded to companies complying with an environmental management system certified under the Eco-Management and

Audit Scheme (EMAS) Regulation issued by the European Union.

through a scheme that is more favourable than the fees currently applied to help redirect consumers from cash payments to digital ones.

One of the advantages of central bank digital currency, if not

the greatest, could be in the future that it can be incorporated into everyday life on a widening platform, essentially functioning as an enhanced and integrated customer portal, providing a kind of starting point for smart contract schemes (Chamber of Digital Commerce, 2016). This would significantly reduce the amount of resources spent on administration, while it would also increase efficiency and transparency.

The implementation of smart contracts could bring progress

in many areas. For example (i) in a car purchase, all information would be transferred to the competent bodies and authorities immediately upon completion. Neither the seller nor the buyer would have to go from authority to authority with stacks of paper, because everything from the transfer of ownership through the subject of the vehicle tax, optionally including even thirdparty liability insurance, could be automatically administered in a very short time. Another example (ii) is a home purchase where the transaction would allow the registration process of the property; moreover, in the case of a related mortgage loan, even the entry of the bank’s lien. May also be a related use case the repayment of the last instalment could automatically notify the competent authority that the mortgage could be cancelled, and the contract could be closed. It may also be more common (iii) to issue and send invoices electronically attached to physical transactions, or, in the case of a given product range, for example, to provide warranty certificates. The potential of such a platform and the resulting synergies go far beyond the digitalisation of the processes currently in place. The number of administrative steps could be drastically reduced, while the time requirement of these processes and the possibility of errors could also be minimised. Ultimately, the creation of such a platform – one of the pillars of

which could be the central bank digital currency –, could lead to extraordinary improvements in competitiveness for the entire national economy.

3. International examples of retail CBDC driven by specific public policy objectives – similarities and differences

Central bank digital currency is increasingly appearing in international literature and among leading central banks as

a potential direction for future development. Digital money issued by a central bank would be a major innovation both in the form of money made available to the public and in the operation of payment infrastructure. The possibility of central bank digital currency is therefore being examined by an increasing number of central banks. In addition, some central banks and international organisations have also outlined conceptual, and representative operating models to fully assess the potential impacts in order to evaluate how CBDC fits into the wider payment environment and how it works with other initiatives on improved payments, or with ongoing or already implemented digital developments.

Although CBDC research is already being actively conducted in several countries, no major central bank has committed itself to

extensive live operation. Several major central banks have already started testing a CBDC-based business concept (Figure 1), but they stand at different levels, and no launch decision has been made or official launch date has been set for any CBDC (Auer–Böhme, 2020). Some central banks have only started the corresponding dialogues, and they are currently conducting research, without any specific commitments. Most retail initiatives essentially seek local implementation within a given country. Exceptions are the ECB’s and the Caribbean’s digital money initiatives.

Central banks see significant potential in the business model based on the use of Distributed Ledger Technology (DLT).

In the longer term, this would probably add more value to the introduction of a digital currency, but its role in short-term planning remains modest (for example, not even the Chinese pilot that has already started relies primarily on the use of DLT).

Figure 1: Retail focused international CBDC research and pilots

Live retail Retail research Ongoing retail pilot Completed retail pilot

Source: BIS; central bank websites. Status as of 30 April 2021.

3.1. Representative operating models

In international central bank discourse, there is a lively theoretical debate on the need to introduce CBDC on a wide scale, while the development of conceptual operational models has also started. Most CBDC research addresses the advantages and risks of CBDC in addition to mapping possible objectives for introduction, delivering the actual standpoint of its central bank as well. In contrast, some central banks have already gone

as far as outlining possible operational frameworks as the next step on the road to implementation. In the vast majority of cases, these theoretical frameworks are geared towards the development of systems for retail payment transactions to be operated in collaboration with external partners. They all agree that a number of open questions still need to be answered before CBDC is introduced extensively. With the aim of creating a coherent framework, the Bank of International Settlements, in cooperation with representatives of seven central banks,98 published its first joint report on 9 October 2020 focusing on the principles and basic features of the functioning of central bank digital currency (BIS, 2020).

The Bank of England has long been addressing the options for introducing central bank digital currency. The analytical framework defines the central bank needs, user considerations and market expectations that a CBDC scheme must meet. The BoE is actively examining a platform-based indirect solution in which intermediaries would play a prominent role in the operation of CBDC. In the platform model, the BoE would provide a fast, secure and flexible technology infrastructure that operates in parallel with the central bank’s RTGS service and provides the minimum functionality required for CBDC payments. In the envisaged layered, two-tier model, the supervised Payment Interface Providers (PIP) operating on a market basis are in contact with the customers. In this concept, although the BoE seeks to establish an appropriate level of transaction anonymity, it does not consider its task to provide completely anonymous payment option. In their view, the use of the distributed ledger system (DLT) is not necessary either, and the same result can be achieved with a conventional, centralised technology within a secure, tried and tested framework. They give consideration to the application

98 The group consisted of the Bank of Canada, the European Central Bank, the

Bank of Japan, the Swedish Riksbank, the Swiss National Bank, the Bank of

England, the Federal Reserve System and BIS, which published the report.

of DLT only in the interest of the flexibility and programmability of CBDC.

The digital euro of the European Central Bank would contribute to the standardisation of payment systems in euro area countries and reduce the dominance of foreign payment systems (ECB,

2020a). According to a study published by the ECB, the main objective of the digital euro would be an even stronger integration of European economies. One of the principles associated with the design of the digital euro is that it would be fully convertible into other forms of the euro. This means full convertibility with cash and commercial bank money. Second, the digital euro would be risk-free euro area money as a liability of the central bank. Third, it would have to be widely and equally accessible throughout the euro area. Fourth, it must be market-neutral, i.e. it must not crowd out market-based solutions in the private sector. Finally, it must be a robust payment system that operates reliably and strengthens social confidence in digital payment options. A decision is expected to be taken in mid-2021 on whether to launch a project to explore the possibilities for introducing the digital euro.

3.2. Relevant international projects already being in test phase

In addition to theoretical research, several central banks around the world are also conducting practical tests. In terms of central bank pilots, several approaches can be observed in Europe: in France, opportunities for the development of interbank settlements are being examined as part of the CBDC project; in Lithuania, the possibilities of DLT are being tested through the issuance of commemorative coins; and in Sweden, a digital cash substitute was tested in a restricted fashion. The launch of pilot programmes is also receiving increasing focus on the American continent (Ecuador, Uruguay, Bahamas) and Asia (China, Japan). In Sweden, the fact that the amount of cash in circulation accounted for only 1 per cent of the country’s GDP in 2018

is a significant motivator in the context of CBDC research.

This indicator averaged at 11 per cent in European countries, 8 per cent in the USA, and 4 per cent in the United Kingdom (Fulton, 2020). In parallel with the increasing uptake of electronic payment solutions, the central bank seeks to provide a digital but generally accessible central payment system for the elderly, the disadvantaged, or those excluded from traditional digital solutions. Based on distributed ledger technology, the testing of e-Krone was launched in February 2020 and was completed in February 2021. According to Riksbank, the Swedish central bank, this step can also reduce the threat posed by competitive, private alternative forms of money and can be a digital alternative to cash (Riksbank, 2020). Research has shown that the e-Krone can be implemented both as a value-based payment instrument similar to electronic money and as an account-based payment instrument similar in character to a commercial bank deposit. Although with respect to both concepts the practical insights are to be gained from a pilot, the former version is clearly feasible legally (the central bank has the appropriate powers for its issuance), whereas in the case of the latter, the possibilities of the central bank under law are not clear, which may call for legislative changes. For this reason, consultations have already started with the Swedish Parliament (Riksbank, 2018).

Globally, one of the most advanced projects is China’s e-Yuan project. That said, the People’s Bank of China (PBoC) has not yet adopted an official position on the schedule foreseen for nationwide introduction. In a test launched in 2020, DC/EP99 was used in more than 3 million transactions worth a total of RMB 1.1 billion (approximately HUF 49.5 billion) in large cities such as Shenzhen and Xiong’an (Bray–Tudor-Ackroyd, 2020). During the test, the digital money balance can be topped up regularly and purchases and transfers can be made with digital money. Some government officials already received reimbursements for their

99 Digital Currency Electronic Payment

trips in the form of digital renminbi, while McDonald’s fast-food restaurants in Xiong’an are already known as locations accepting e-Yuan. Similarly to mobile payment, the scheme uses digital wallets that can be downloaded to phones, and users can register in the account-based system by verifying their identities. Digital money is valued at 1:1 against physical renminbi, and during the test period PBoC transfers the central bank digital currency to real economic operators in a two-tier system through dedicated partners. To be tested in a self-limited arrangement, central bank digital currency is an alternative to cash in all possible dimensions: in terms of anonymity, a concept called controllable anonymity is applied, which means that the use of digital wallets during the test period is linked to different identification levels, and certain customer identification steps will enable users to increase the amount of the budget that can be kept in their wallets, along with transaction volumes (Bloomberg, 2020).

The most advanced stage of CBDC has been reached by Sand Dollar in the Bahamas, which has already been formally

launched. In contrast to other countries, the motivation for launching the project was not the declining use of cash, but rather the promotion of financial inclusion. The Bahamas is a country of 690 islands, from which several large international banks withdrew after the global economic crisis, and the remaining banks have not been able to implement digital developments quickly and effectively enough. The national bank seeks to provide all residents with access to online payments and basic financial services. Mobile phone usage is high, around 90 per cent, enabling identities to be verified quickly on service platforms that comply with KYC and AML requirements (Haig, 2020). For the time being, six financial institutions have been licensed to operate digital wallets, but the central bank has plans to expand the distribution network over time. There are three types of wallets, in which different user limits are available, with the corresponding different KYC controls. The aim of the differentiated solution is to prevent a reduction of the banks’ intermediary role. The Sand

Dollar is a direct claim on the Central Bank of The Bahamas and its value, like that of the Bahamian dollar, is pegged to the US dollar. Currently, Sand Dollars can only be used within country borders, but the central bank also has plans to develop a crossborder payment system that would allow conversion into other digital currencies. According to a statement from the central bank, Sand Dollar’s gradual national issuance was launched on 20 October 2020, making it the first CBDC in circulation in the world (Larsen, 2020).

4. Technology and design aspects of CBDC aimed at financial inclusion of the retail segment

4.1. Fundamental goals, accessibility criteria and monetary policy-related features

The main objective of a CBDC with a retail focus can be to

improve access to basic financial services. The provision of better access to bank accounts and payment services may justify central bank participation, and may also be a key motivator for the development of CBDC. Furthermore, from a central bank perspective, the general improvement of financial awareness may play an increasingly prominent role. The introduction of CBDC and targeted awareness-raising via a dedicated central bank channel may be justified in the context of this stronger participation.

The introduction of a retail CBDC could help create a central

bank electronic cash substitute payment system. Another key motivating factor for improving access to financial services is the digitalisation of cash functions and the creation of a new digital cash substitute payment system. In addition, CBDC-based retail account servicing and the related framework, whether in

a direct or indirect model, can also be an effective channel for the direct delivery of government transfers to residents. CBDC can be universal in terms of access, accessible to all, or specifically targeted at certain groups of consumers (for example, those in lower income categories, pensioners and young people), while the possibility of broadening its scope gradually is provided.

Monetary policy implications may be more pronounced if deposit-taking or lending functions are also assigned to retail

CBDC. While the impact on monetary policy in the case of account servicing is moderate and mostly addresses frictions in access issues, in the case of retail account keeping combined with other functions that have to date been available at commercial banks, such as deposit taking or lending, this can also have a significant impact on monetary transmission. With these functions, retail CBDC can both increase the central bank’s room for manoeuvre in monetary policy and have a positive impact on the intensification of market competition. Notwithstanding that, with the long-term persistence of cash holdings, the viability of these effects can only be considered clear on tightening paths.

The potential monetary policy and financial stability impacts

of retail CBDC should also be addressed as a priority. The disintermediation effect of active central bank participation may lead to the exclusion of certain actors from the retail banking and savings markets. The banking system may see its profitability and liquidity levels undermined as a result, which also increases stability risks due to a shift towards a less prudent business policy. Furthermore, a number of risks may be transferred to the central bank that commercial banks are likely to have more advanced mechanisms and expertise to deal with effectively. Taking these aspects into account during the design process is of key importance, and matters concerning stability must be factored in with regard to both objectives and to specific design aspects.

4.2. Possible restrictions related to the use and convertibility of CBDC

Ensuring interoperability between different forms of money

is essential for use in the retail segment. In retail payment transactions, convertibility between individual forms of money (commercial bank money, e-money, cash, etc.) is an important design aspect due to heterogeneous user needs. Since the role of cash remains decisive in many payment situations, it is of paramount importance for the substitutability of cash functions to ensure that users are able to perform conversions between CBDC and cash. However, this aspect also entails important tasks for central banks (such as the deployment of an ATM network), but the specific development needs are issues to be examined only after the operating model (direct, indirect, hybrid) has been determined. The involvement of commercial banks for creating interoperability with commercial bank money may also arise as an option.

Offline operations and the possibility to handle international currencies may also be relevant in order to adapt for retail needs

and for alignment with the fundamental goal. For CBDC to be an effective cash substitute and an alternative that is resilient to a variety of operational disruptions, it must also be available to users offline. Uninterrupted internet access is not necessarily available to all consumers or in all walks of life, which is why CBDC must be designed to be accessible in any situation with the right tools at hand. In addition, in the case of retail CBDC, for the longer term central banks should also consider tasks related to handling foreign currencies (for example, accounting for the transaction of products with prices determined in foreign currencies, or receiving and converting foreign currencies).

The incorporation of a certain level of qualitative and quantitative restrictions may be justified when introducing

retail CBDC. Quantitative restrictions may be justified as regards the reliability of offline operations, the identification

of potential risks and the mitigation of the impact on monetary policy and on the stability of the financial intermediary system. In addition, a properly targeted retail CBDC focusing on a narrower social group can effectively support the fundamental goals set for the introduction and be better justified in terms of addressing the identified frictions. A focused business model targeting a narrower range of users may also be useful in the light of the fact that a highly heterogeneous consumer base, such as the entire population of a country, may have different needs and capabilities, allowing for the creation of a business model best suited to the groups through targeted and restricted implementation. In this case, retail CBDC can be sufficiently flexible and go beyond the current functionality of cash, while allowing for the implementation of a variety of aspects on access holders of different characteristics, and ensuring an adequate level of interoperability.

4.3. Options for the establishment of the operational framework and the involvement of market participants, functions related to CBDC issuance and distribution

While CBDC issuance is a task of the central bank, several operating models may arise in connection with allocation and

the operation of the payment system. In the case of retail use, alignment is needed with a number of specific needs, and in the case of retail financial services, the need for convenient, fast and personalised services is becoming increasingly dominant. On account of the development options for retail payments and of the development trends in the provision of digital services, it is recommended to develop platform-based business models that allow the involvement of multiple market participants (Figure 2). The retail customer base of market participants is significant, while central banks are likely to encounter capacity problems in the short term as far as full direct access is concerned; however, direct access cannot be excluded for specific narrowed consumer groups.

Cooperation between market participants and the central bank supports the identification of standardised development

directions. In terms of retail payments, the application of uniform standards is of paramount importance in order to ensure the highest possible quality of customer experience and to minimise market fragmentation. Setting system-level development directions will support the integration of future innovations as well as efforts to increase efficiency in general.

Figure 2: Possible residential CBDC implementation models

Central Bank retail account management

1.0: Direct access 1.5: Hybrid access (via PSP) Central bank nostro account 100% collateral

2.0: Indirect access

Central bank application PSP application Banking application

Source: Authors’ compilation.

4.4. Issue of anonymity and the management of money laundering and terrorist financing risks

In the retail segment, it is recommended that a customer identification and due diligence system is in place that is

differentiated according to several criteria. In the case of regular or low-value ad hoc transactions, speed and instant settlement are essential for consumers, which in such situations calls for the development of features similar to cash also from a due diligence perspective. At the same time, in cases of emphasis in terms of national economy and tax planning (in the case of major transactions or above a certain monthly limit), and in order to comply with anti-money laundering and counter-terrorist financing rules, it is also necessary to implement traceability and to control and approve the movement of transactions. Separate identification procedures based on transaction size, regularity and customer type (e.g. adult or student, consumer or merchant) should therefore also be considered.

Specific identification steps and the degree of anonymity are also

partially determined by functionality. For credit functions, full customer due diligence and identification is required, which may have an impact on the business model around implementation (determining which actor should perform these tasks, whether a significant capacity upgrade is required for the central bank). In the case of the provision of account keeping, the differentiated, gradual principle outlined above can be effective, where the interests of both consumers and the national economy can be upheld.

4.5. The technology applied, expectations for the operational framework, options for the use of distributed ledger technology

In the context of the technological development required, the relevant decision-making criteria are the possibility to exploit innovation opportunities and interoperability with existing systems. Speed, transparency, and ease of access and usage are of paramount importance on account of the retail target group. In this respect, the CBDC framework should be based on a technology that supports the servicing of modern user needs on the one hand,

and on a sufficiently flexible and innovative approach on the other, so that further innovation opportunities can be exploited in the future. At the same time, in the case of retail focus particular attention should be paid to various interoperability issues (cash conversion, commercial bank money conversion, interoperability with certain payment and e-money systems). Taking these issues into account may require the deployment of a new system, either on traditional or innovative basis (e.g. distributed ledger, DLT).

The intended user base and its characteristics are decisive for

the choice of technology. In the context of widespread retail use, the significant heterogeneity of the potential user base should be taken into account along a variety of characteristics. Furthermore, in terms of the social perception of a payment system and the achievement of the fundamental goal foreseen, it is particularly important that a high level of trust towards the system and the currency develops on the consumer side. Social perception and the expected substantial increase in complaint handling resulting from innovation are likely to support the development of a “new traditional” system. This line of direction is also supported by the fact that the existing systems of central banks were designed for a considerably smaller number of customers, so that their expansion may prove to be limited, or would significantly increase the complexity of the system. At the same time, innovative technological foundations should be considered in the selection process by narrowing the user base and designating special target groups. Through the involvement of more restricted groups, the potential benefits of innovative technologies could be tested effectively, and, in the case of certain innovations, advanced technology could be of paramount importance in view of the fact that retail payments are an important innovation area for market participants worldwide.

Testing DLT-based technology in a narrower target group can improve the acceptance of technology and help to understand

its possibilities. In addition, in the case of groups open to innovation, more additive functions resulting from the novelty of the technology could be tested. After a successful test phase, social perception can be improved step by step, and consideration should be given to implementation on a wider scale. This continuous introduction may also be supported by global processes: if DLTbased technologies and related business models enter a more mature phase, their acceptance improves, and their specific areas of use become more accurately definable, then, incorporating these in addition to the experience of the central bank concerned, implementation may become possible on a wider scale.

4.6. Additional opportunities for innovation – options for artificial intelligence and smart contracts for CBDC with a retail focus

Innovation opportunities can be decisive in the retail segment,

which should be taken into account for CBDC design. In addition to fast and convenient usage, the possibility of personalised services is a priority aspect in relation to retail solutions.

As part of a CBDC project, a new approach to the provision of services can be developed in the financial system, which

may justify active central bank participation. One reason to consider the use of DLT-based technology for the longer term is that the feasibility of the platform-based operations projected in connection with the future of financial services should also be tested in this system. Technology solutions built around DLTbased, distributed systems can significantly shorten the protracted processes arising from the different data and information usage needs of market participants, while value and supply chains can also be shortened and reconstructed. These innovative approaches

typically operate on an ecosystem basis, and once an item of data is included in the system, it can be used uniformly and quickly by other actors (BIS, 2017). This is a remarkable and forwardlooking aspect also in terms of financial services (for example, in the case of real estate sales, reading the title deed or notarial deed directly, etc.). Thus, while a new centralised system based on traditional foundations and a DLT-based but partially centralised technology (e.g. CLT) can deliver similarly high performance and rapid execution at transaction level, maximising the exploitation of the potential for innovation may also warrant steps in the latter direction. Innovative technologies also offer a number of other possibilities to renew service provision (e.g. micro transactions in the case of media consumption, automated transactions, automated decisions that can be implemented through smart contracts), which proves to be particularly relevant in the retail segment.

5. Options in Hungary for central bank account keeping and credit facilities targeting the retail segment

In Hungary, access to financial services should be developed in certain consumer groups, while it is also necessary to encourage the conscious and active usage of these services among users in general, with special attention to the opportunities available digitally. According to data based on international research, the proportion of people with bank accounts in Hungary is fair by global standards, although it ranks in the lower third in the EU (World Bank Group, 2017). At the same time, despite a good international ranking at the overall economy level, several types of consumer groups can be identified in Hungary whose account and card coverage is significantly below the average (e.g. lowincome, young people, retirement age) (MNB, 2019), in which

case improving access is justified. In addition, the utilisation and use of (digital) financial services should be generally improved along with the development of financial awareness, so that users can choose the appropriate service packages, possibly in digital form, by exploring their possibilities, knowing their regularly incurring costs and their financial situation, having the necessary basic financial knowledge, and applying it in practice (OECD, 2020). In this respect, the pricing practice of payment services is also not ideal for several customer groups and incentives for digital use tend not to be universally present (MNB, 2020b), which is also reflected in high transactional cash use. In Hungary, a solution based on account keeping and payment services may be a relevant direction of development within the framework of a CBDC project, aiming to improve access to financial services and fostering the development of conscious financial thinking.

Focusing on a number of clearly identifiable target groups and product types, a specific retail CBDC could be introduced in

a targeted manner. Several target groups can be identified in Hungary (e.g. secondary school students, university students), whose access problems could be solved by active central bank participation and the digitalisation of many cash functions. Introducing younger age groups to financial services can fundamentally support financial awareness efforts, and novel and innovative approaches and design aspects can also be effectively tested on such groups.

The design of a lending based CBDC solution could also be

envisaged in principle. By European standards, the level of retail indebtedness as a percentage of GDP is seen as particularly low (Figure 3). Furthermore, given the pro-cyclical functioning of the financial intermediary system and the low supply of credit to certain social groups according to traditional lending criteria, direct retail lending by the central bank may also arise as an option in the event of a clear market failure. In addition, it may be useful to develop the scheme also in concert with a national

economy objective (for example, family policy or the promotion of sustainable, modern developments) in order to ensure that the social objectives of CBDC are well defined and forward-looking and that the need for legislative changes related to this form of implementation can be initiated on sufficiently concrete grounds.

Figure 3: Stock of household loans as share of GDP in European countries (2020 Q2)

0-25% 25-50% 50-75% 75-100% 100%+

79%

36% 88%

66% 61% 110%

110% 92% 68%

39%

21%

24%

66% 103% 65% 69% 56%

33% 35%

46%

52% 129% 20% 44% 27% 36% 121%

16%

24%

56%

Source: ECB, BIS, central bank websites

52% 92%

In the case of a potential retail CBDC in Hungary, several factors may justify the implementation along with the indirect or hybrid operating model. In general, in alignment with the heterogeneous needs of retail participants, the development of a multi-stakeholder model may prove forward-looking. In order to exploit innovative capabilities and reduce capacity constraints, it is worth involving domestic market participants in the operation of the payment system. In this respect, the Hungarian market has significant comparative advantages, on the one hand through the joint ownership and experience surrounding the establishment of the Instant Payment System, while on the other hand, developed and well-functioning advocacy bodies operate in Hungary, which not only support the cooperation and joint initiatives of incumbents (Hungarian Banking Association, Association of Hungarian Insurance Companies), but also of innovative enterprises (Hungarian FinTech Association, IT Association of Hungary).

5.1. Potential effects on the financial intermediary system

The implementation of a CBDC with a domestic retail focus can significantly affect the operations of the financial intermediary

system. The launch of CBDC affects both consumers and all actors of the financial intermediary system. It is important to take into account the impact on the central bank’s core mandate, i.e. ensuring price stability and financial stability, the additional functions involved, the new types of risk, and their impact on the current functioning of the market. When designing CBDC, it is necessary to carefully identify which market friction the central bank seeks to respond to, and to devise a solution so as not to compromise the functioning and stability of the financial system in areas where its institutions operate properly. This approach may also be supported by carefully targeted introduction, the active involvement of market participants and the incorporation of restrictions appropriate to the desired functionality.

6. The first Hungarian central bank digital currency pilot project: The Digital Student Safe

6.1. Supporting financial inclusion and education as relevant public policy objectives for a specific target group

The Digital Student Safe can serve as an experimental field

for the introduction of CBDC. On the one hand, it provides an opportunity for restricted and controlled testing, but in realistic circumstances. On the other hand, it facilitates the gamified inclusion of young people mainly between the ages of 8 and 14 who are not included in the formal financial system (Figure 4).

The application seeks to achieve several relevant public policy objectives already in the pilot phase, while as a restricted retail account keeping system it can also be considered as the

first domestic manifestation of the CBDC framework. These include (i) the development of a novel digital savings product for young people, which is of particular importance: certain forms of financial behaviour, financial planning and regular savings activity, budgetary plan creation can already be established in childhood. It also (ii) facilitates the development of digital competences and skills that participating students can exploit in many places in everyday life during the accelerated digitalisation caused by the pandemic. Finally (iii) the establishment of an ecosystem that is viable in the long term, and preparing the younger generation for financial independence are also among the primary objectives.

Figure 4: Development of banking relationships and financial behaviour by age group

MNB Digital Student Safe

First bank card payment

Occasional contact with money

First savings account („baby bonds”) Savings, first payment faced on their own

Regular allowance, First smart phone

Children under 8 years Pre-teens (8-14 old)

First salary

Regular cashflow (rent etc)

Personal loan

Investment account and small investments

First mobile banking app

First bank card and payment account

Teenagers (14-18 old) Young adults (19-24 old)

First apartment purchase, mortgage

Bigger investments

Adulthood (24 old and above)

Dependent on the family

Source: Authors’ compilation.

Shared responsibility

Financial independence

6.2. Importance of pilot projects in preparing for CBDC introduction

The MNB Digital Student Safe provides a gamified opportunity to transact in virtual assets (medals) using mobile phones. The complexity of a CBDC project requires low-coverage and continuous testing prior to the wider introduction of such a system, and also that as many potential obstacles should be identified as possible. It is also necessary to explore potential consumers’ attitudes towards the technology in the production

phase, and to examine whether it will be possible to incorporate into consumers’ daily lives sufficiently. The service provider manages virtual accounts for participating children, who can set savings targets, earn and collect digital medals denominated in Student Taler (e.g. by successfully answering quizzes). Students can transact and exchange their medals with each other, and finally redeem for real gifts in the dedicated webshop (Figure 5).

Figure 5: Demonstration of the CBDC characteristic of the Digital Student Safe

Ordering the service, providing statistical data

Transaction service provider Central bank Money creation

Data flow

(balance of coins)

Money Compass Foundation

Financing

e-Wallet service

Students Webshop

Gifts (physical)

Source: Authors’ compilation.

The medals available in the Digital Student Safe can also be interpreted as central bank digital currency available on a limited scale. In addition to supporting financial education, the programme is suitable for testing the concept of central bank digital currency in pilot form, since (i) in economic terms, through the support provided to the Money Compass Foundation, the MNB is the ultimate financier of the medals that can be awarded to students, and (ii) it is able to fully control the supply of

Student Taler, and, furthermore, (iii) the central bank finances the operation of the user interface. At the same time, it is important that further planning will be based on real experiences rather than on assumptions. The current solution is closer to the so-called account-based solutions: accounts are managed in a central system and the other party participating in the transaction is identified through parental registration. At the current stage, the project operates in limited manner, involving mostly schools participating in the pilot programme.

Later on, the mobile application can be extended and upgraded

as required. The modular structure of the application enables the enhancement of functionality and upgrades in several ways, thus the achievement of the public policy objectives can be improved by incorporating new functions if needed. The lessons learned from the first period of implementation and user feedback both support the MNB’s subsequent decisions concerning developments and the extension of the application.

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