Effects of central bank digital currency on payments

VIII. Effects of central bank digital currency on payments

László Kajdi–Lóránt Varga

In our study we first examine the objectives and future development scenarios for which the introduction of central bank digital currency (CBDC) may be theoretically justified from a payments perspective; second, given the current situation of Hungarian retail and corporate payments, we review which of these objectives may also be relevant to these actors; and third, we explain the effects that the various possible operating models would have on the payments market if CBDC were to be introduced. With almost all international CBDC research and projects currently underway, payment objectives of some sort have been formulated, but these are very diverse: they can be linked to reducing the use of cash or to preserving the role of generally available central bank money in payments, enhancing financial inclusion, increasing the development and security of electronic payments, reducing payment service charges, or, as the case may be, addressing the challenges posed by FinTech and BigTech operators. Although, theoretically, several of the above objectives could be relevant in Hungary based on the characteristics of domestic payments, they can apparently be achieved more quickly or more efficiently by other means, such as the development of already available electronic payment solutions and payment services in the market. However, that situation may change at any time in the future. For example, if the increase in the proportion of electronic payments stalled, or BigTech operators carved out a more significant share of domestic payments in an uncontrollable manner, or the package-based, transaction fee-free pricing of retail electronic payment services failed to be taken up at an adequate rate, consideration should be given, inter alia, to the possibility of introducing CBDC as a means to address the situation at hand.

Regardless of the reason for the introduction of CBDC, the chosen operating model would definitely have major implications for the payments market. In this context, primary consideration should be given to what payment services the central bank seeks to take over from market participants and to what extent, as well as to the impact this is expected to have on the costs of introduction, the stability of the domestic financial intermediary system, or the future innovation of payment solutions.

1. Introduction

Ensuring the efficient and reliable functioning of payment systems and the payments market is one of the core tasks of any central bank. There are already various types of money circulating in the economy, in the form of cash, money held in commercial banks’ accounts, electronic money, or other digital currencies73 . Payment transactions carried out in these assets are all part of the payments market, the rapid, cost-effective and reliable operation of which is of paramount importance for the performance and competitiveness of the economy. Therefore, in addition to the operation, oversight and supervision of critical financial infrastructures, such as central bank and clearing house systems, central banks are actively involved in initiating, coordinating and regulating payment flows and developments in almost all countries of the world. While supporting more efficient monetary transmission and maintaining financial stability, this also carries additional benefits: it can strengthen competition and innovation in the market, and due to more transparent processes, the increasing share of electronic payments can also lead to a reduced level of tax avoidance. Another important aspect is that, as demonstrated by a number of studies (Danish Payment Council 2018, Schmiedel et al. 2012, Turján et al. 2011), the widespread use of electronic payment methods entails lower social costs compared to cash.

73 For example, different types of cryptocurrencies or virtual currencies.

The 2008 global economic crisis also brought about a number of new phenomena in payments, such as the emergence of digital currencies like Bitcoin, which, however, had only a moderate impact on the payments market precisely because of their limited performance of the functions of money. Of much greater significance, however, has been the emergence of FinTech and BigTech companies74, whose main area of market entry was precisely in payment solutions. This could be traced back to several reasons, such as to the increasing consumer demand for innovative payment solutions, to the data-driven business model of BigTech companies, whereby – preferably increasingly frequent – payment transactions can not only be monetised on their own, but also allow for an even more accurate understanding of customers, and to the failures and specificities of the payments market such as network effects and economies of scale, which constitute obstacles to market entry, and, therefore, to competition. In recent years, central banks and regulatory authorities have responded actively to all these changes. On the regulatory side, regulations on interchange fees introduced in Europe75 (and one year earlier in Hungary), the SEPA End Date Regulation76 and the new European Payment Services Directive (PSD2)77 all aimed at stronger competition. Of these, PSD2 is expected to have the greatest impact going forward, providing regulated conditions

74 In literature, global technology companies with a very large number of customer relationships, such as Facebook, Amazon, Apple, Google or Alibaba, are typically referred to as BigTech or Tech Giants. 75 Regulation (EU) 2015/751 of the European Parliament and of the Council (29

April 2015) on interchange fees for card-based payment transactions. 76 Regulation (EU) No 260/2012 of the European Parliament and of the Council (14 March 2012) establishing technical and business requirements for credit transfers and direct debits in euro and amending Regulation (EC) No 924/2009. 77 Directive (EU) 2015/2366 of the European Parliament and of the Council (25 November 2015) on payment services in the internal market, amending

Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU)

No 1093/2010, and repealing Directive 2007/64/EC.

to support the market entry of new non-bank FinTech payment service providers. In an another important step forward, major infrastructure developments have been carried out to complement regulations, especially in the field of instant payments: in addition to the European TIPS system already in operation,78 the new infrastructure planned in the United States,79, and instant payment systems already in place or underway in many countries around the world, the Hungarian instant payment model should be highlighted as the first one to require payment service providers mandated by regulation to offer instant payments as a basic service.

Figure 1: Instant payment systems operating and under implementation or planning in the world in 2020

Instant payment systems in operation Instant payment systems under introduction or planning

Source: FIS 2021, MNB collection

78 https://www.ecb.europa.eu/paym/target/tips/html/index.en.html 79 https://fasterpaymentstaskforce.org/

The major changes listed in the foregoing therefore show that the development of payments is a high priority for central banks worldwide. Recently, this process has been given another boost by two additional factors. Launched by Facebook, the Diem (formerly known as Libra) project seeks to provide payment services at a global level, which, taking into account the company’s outstanding customer base of several billion users, poses a significant challenge both to participants in the traditional payments market and to central banks. On the other hand, the coronavirus emerging in 2020 and the restrictive measures taken in response have prioritised cashless, preferably remote, payment solutions that do not require personal presence. As a result, central bank projects and research exploring the possibilities of using central bank digital currency (CBDC) have begun, or respectively have already reached an advanced stage in several countries. Furthermore, as highlighted by BIS (2020a), at their current stage, these explorations tend to be motivated by payment objectives. Indeed, technological development has enabled central banks to keep a dedicated account for every citizen or company. That is, while the physical form of cash was primarily determined by the technological level available, with the removal of such barriers, it is a fair question to ask whether there is an advantage for society as a whole from the claim on the central bank also becoming available in digital form to a wide range of users. While central bank digital currency has long been available to participants in the financial system, especially to commercial banks, the rollout of CBDC to a wider scope of stakeholders would be equivalent to the emergence of a new form of money for the public and for companies. This would automatically extend the payments mandate of central banks, bringing about new challenges in this area, given that, going forward, payment transactions carried out in CBDC would also become part of payment flows, requiring central banks to ensure their efficiency and reliability as well.

Arguably, on the side of central banks too, current CBDC research also tends to be motivated by payment objectives. That said, other objectives such as those related to monetary policy may gain prominence over the medium term, as CBDC could have a direct impact not only on the financial sector, but also on other economic agents such as consumers and non-financial enterprises. At the same time, it should be pointed out that even if introduced in pursuit of objectives other than payments, CBDC may have major effects on the functioning of the payments market and on financial infrastructures, which calls for an examination of these aspects for any underlying objective. In our study, therefore, we present the effects on payments, focusing primarily on the Hungarian situation. We seek to determine whether there is a payment objective justifying the introduction of CBDC in the present situation and, were it to be introduced with any objective in mind, what the optimal way to do so would be from a payments perspective. Our discussion is strictly limited to “retail” CBDC, i.e. the case of central bank money becoming available to companies and/or consumers. Accordingly, “wholesale” CBDC, being the form of central bank money available to actors in the financial system, is not addressed here as it is already widely accessible by these actors, which makes CBDC an issue concerning the development of technology and financial infrastructure, rather than one of public policy. The study is structured as follows: in the second chapter we review the payment objectives that may justify the introduction of CBDC, and in the next we evaluate these objectives in the light of the present situation in Hungary. Chapter four presents the possible effects of the introduction of CBDC on the payment services market, while the last chapter summarises the main conclusions.

2. Possible scenarios where the need to introduce CBDC may arise in order to achieve payment objectives

The introduction of CBDC allows for direct central bank intervention in the functioning of the financial sector and of the economy, which naturally has diverse effects. For this reason, the application of CBDC may be justified by a number of objectives, a common element in virtually all of them being the presence of a payment dimension: either the aim to address a problem or market failure already identified in the payments market, or the pursuit of another objective, nevertheless subject to the requirement to ensure a payment function. Below we have gathered how CBDC can support the achievement of certain payments-driven public policy objectives. For that purpose, we defined scenarios for the future development of the payments market, and examined how CBDC can be used to address the problems that may arise if the corresponding conditions are satisfied.

1. The use of cash does not decrease, causing the related social

costs to remain high. Previously, a number of central bank studies (Danish Payment Council 2018, Schmiedel et al. 2012,

Turján et al. 2011) concluded that the increased use of electronic payment methods would enable significant cost savings at the level of society at large. Indeed, the production, transit and safekeeping of cash, as well as cash transactions involving personal presence have a much higher time requirement compared to electronic payment methods, which tend to rely only on IT infrastructure in most cases. It is therefore appropriate to redirect payment flows towards the latter, one possible means of which being the introduction of CBDC as a new cashless alternative to existing electronic payment methods.

2. Cash-dominated payments lead to significant levels of tax

avoidance and money laundering risks. One of the advantages of electronic payment methods over cash is that they make transactions much easier to track, which in turn makes it easier for public authorities to enforce the legislation in place. One consequence is that re-channelling current cash flows, at least in part, to electronic CBDC, makes it possible to counter the grey economy and thereby increase budget revenues. Compared to physical cash, CBDC also has benefits in terms of antiterrorist financing and anti-money laundering. Obviously, all these benefits can only be exploited if users are not granted anonymous access to CBDC.

3. Acceptance of cash loses prominence, with most locations offering only the electronic payment solutions of payment

service providers in the market. This scenario assumes trends contrary to the processes described in the previous points, but in the case of the Swedish model, one of the most advanced, the specific situation of payments in the country justified an examination of the possible introduction of CBDC. In recent years – in no small part due to the uptake of instant payments on a large scale – the use of cash has been reduced enormously, accounting for about 15 per cent of all transactions in 2018 (Sveriges Riksbank, 2019). This has several important consequences. On the one hand, an increasing number of merchants are refusing to offer the option of cash payment, primarily because of the significant resource requirements associated with it, which makes consumers dependent on electronic payment methods. However, the latter are provided only by market participants, at the rates fixed by them.

Consequently, if someone is unable to pay the fees of the market service providers, or if the market service providers refuse to serve them for some reason, they will be virtually excluded from the economy and their daily life may become impossible to conduct. It should be noted that while merchants

in Sweden and in some other European countries have the legal means to refuse cash payments, in many countries they do not, because in many places the law or even the Constitution provides for the mandatory acceptance of cash. Even if cash is accepted in a person’s environment, it can typically only be withdrawn from teller machines and at branches operated by market service providers, in decreasing numbers due to economic considerations. As a combined result of these factors, the Swedish central bank considered it important to start exploring ways to continue providing payment opportunities for everyone, including persons who do not want to or cannot contract with market service providers.

4. A significant number of consumers still do not have bank accounts (low level of financial inclusion), which prevents

them from using electronic payment methods. Due to the considerations already mentioned above, in almost every country priority is given to increasing the use of electronic payment methods, which requires that the greatest possible number of consumers have payment accounts to initiate or receive transactions. This amounts to strengthening financial inclusion or, as often termed, to an increase in the number of bank relationships. Although there are countries (for example, the United Kingdom) where basic payment services, such as account keeping or the initiation of credit transfers, are typically available free of charge, in many places, including

Hungary, such services carry substantial fees (Kajdi et al., 2019). Obviously, not everyone can afford to pay these, which is addressed, along with a range of similar problems, through the concept of basic payment accounts, set out in the

European Payment Accounts Directive (PAD). Typically in less developed countries, financial inclusion can also be impeded by the absence of a sufficiently extensive market-based system of financial institutions, for example where many people do not have access to a nearby bank branch where they can open

a bank account to establish a banking relationship. In theory,

CBDC offers the possibility for the central bank to intervene directly by leaving out market participants, rather than the regulator expecting or requiring payment service providers to provide basic payment services on a large scale for moderate fees, or free of charge.

5. Market participants do not develop electronic payment solutions that can be used widely, or they do not provide them

at favourable prices that are affordable for all. As explained above, cashless payment solutions have several advantages at the level of society at large. At the same time, payment service providers may not develop such solutions on their own due to the lack of infrastructure (possible factors include internet coverage in addition to infrastructure elements linked to finances, such as terminals allowing electronic payments to be made with merchants), or lack of solvent demand, or market failures (such as high market entry barriers). Among others, this is a possibility in developing countries or in small countries where, for payments otherwise based on economies of scale, market participants do not see sufficient business potential in a small number of customers. For example, the e-Peso project in Uruguay also aimed primarily to ensure a more efficient payment system and wider access to electronic payment services (Barontini-Holden, 2019). However, in Denmark, which has advanced electronic payment solutions, the central bank does not see a way forward in CBDC on the payments side (Danmarks Nationalbank, 2017). It is also possible that electronic payment services are also available from market participants, but are offered for fees that make their use impossible or unreasonable for a significant proportion of users.

In this case, the basic payment services offered with CBDC can support stronger competition and the availability of an electronic payment method for a wide range of users.

6. The security of payments decreases, with a major increase in the number of fraud cases, and in the operational risks

of critical financial infrastructures. While this aspect was considered the most important by a majority of the responding central banks according to a BIS survey (Barontini-Holden, 2019), the pursuit of this objective may have multiple motivations. On the one hand, there may be types of fraud and trends for market services that justify the central bank providing a safer alternative than market solutions, thus strengthening confidence in electronic payment methods. On the other hand, the introduction of CBDC could also pursue the objective to strengthen the resilience of critical systems in the country concerned, i.e. to reduce operational or cyber risks, by building a new infrastructure that is independent of current financial infrastructures. Indeed, this would allow electronic payments to continue to be ensured through CBDC, and thus the functioning of the economy to be maintained in the event of the outage of traditional banking systems and payment solutions for any reason. This can be complemented by the fact that CBDC also makes it possible to carry out transactions offline, at least up to a certain value limit, which, in addition to supporting electronic payments in remote areas with poorer internet coverage, enables the continued operation of payments even if the electricity network and internet service become inoperable.

7. BigTech operators and their payment solutions (such as stablecoins) take over a significant share of the payments

market. BigTech operators are increasingly entering the payments market as well, since the ability to monitor customer transactions can be integrated well into their data-driven business models.

– One example could be the Chinese market, where Alipay and Tencent/WeChat, the two most important non-bank service providers, have effectively taken over the retail payment

business from Chinese commercial banks (Kajdi, 2017). In addition to monetary policy and financial stability risks caused by re-channelling some of the bank liquidity provided by the population, this also carries operational risks. Indeed, the high level of market concentration also implies that a major part of the retail electronic payments would become unavailable in the event of the outage of any market service provider. In addition, there are also competition drawbacks from the duopolistic market situation and the use of selfcontained, non-interoperable market solutions, which do not allow other service providers to enter the market with new innovative payment solutions. In addition to the main goal of reducing the use of cash and spreading electronic payment methods, this may also have been one of the drivers for the

Chinese central bank’s establishment of its dedicated digital currency research institute in 2014 (China Banking News, 2018). As a result of the developments carried out here, a pilot program was launched in China in 2020, as part of which testing will cover four districts (Shenzhen, Suzhou,

Xiong’an, Chengdu) and foreign companies (e.g. McDonald’s,

Starbucks) will participate as merchant acquirers, while the intermediation of CBDC to customers will involve the four largest state-owned commercial banks (Central Banking, 2020;

Finextra, 2020; Payments Cards and Mobile, 2020). – Another important development in this area is the launch of

Facebook’s Diem (formerly known as Libra) project. Published in 2019 (Libra, 2019) the first “whitepaper” was followed by a second, revised version a year later (Libra, 2020). Regulators and central bankers in a number of countries have called for a thorough examination of the parameters foreseen, as they could have major implications for the effectiveness of monetary policy, and also for financial stability. At the same time, it should be pointed out that the basic objective of the

Diem project, at least nominally, is to provide electronic

payment services to those for whom this is not currently available. Importantly, therefore, Facebook – following the strategy of Chinese BigTech companies – seeks to acquire additional users through payments and to extend the range of data it has about existing ones. In several countries, the resulting conclusion has been that the threat posed by Diem to the financial sector can be addressed, inter alia, by the introduction of a CBDC that would ensure that those who do not have access to or prefer not to use banks’ payment services should opt for the central bank solution.80

8. Modern and convenient electronic payment solutions are limited to the field of public sector collections and

disbursements. One possible situation is where CBDC is introduced for a somewhat more limited purpose, and offers an alternative to cash only in terms of public sector collections and disbursements. This provides for a means to handle the collection of taxes, fees, commissions and fines on a new infrastructure, for example in cases where market participants do not develop in this field. Conversely, CBDC may be limited to public sector disbursements, i.e. to direct payments of aid or subsidies, for instance. Since aid primarily affects people in poorer financial situations who do not necessarily represent a business opportunity for market service providers, this objective can be linked to strengthening financial inclusion.

9. Cross-border electronic payments are dampened by expensive

and slow solutions. Cross-border credit transfers still tend to be highly complex and are carried out through a chain of correspondent banks, which makes them slow and costly in most cases. Interconnecting individual countries’ CBDC systems could provide support for making these processes significantly simpler, faster and cheaper. The European Central

80 See ECB President Christine Lagarde’s speech https://www.ecb.europa.eu/ press/key/date/2020/html/ecb.sp200910~31e6ae9835.en.html

Bank (ECB) has already taken a number of infrastructural and regulatory steps in the area of traditional payment methods based on commercial bank money, with the aim of eliminating or at least reducing the disparities between domestic and crossborder payments. For its part, the CPMI (2020) identified 19 development points for the improvement of cross-border payments, one of which is CBDC. An initiative of an even wider scope involving the English, Japanese, Canadian, Swiss and

Swedish central banks, the ECB and the Bank for International

Settlements (BIS) was announced in 2020 (BIS, 2020b). However, the ECB also points out that access by nationals of countries outside the euro area should be restricted when adopting a possible digital euro, as the risk of exchange rate fluctuations may otherwise increase (ECB, 2020b). It should also be noted that even if CBDC is not primarily intended to serve payment objectives, its introduction is almost certain to have a considerable payments dimension. For example, any central bank lending (to consumers or corporates) requires developments in the financial infrastructure, and even possibly in the market for payment services if the utilisation of the loans in CBDC is also to be ensured. Similarly, even for CBDC of a “helicopter money” nature, serving mainly monetary policy objectives, the utilisation of the funds disbursed should be ensured, and the effects on the payments market examined.

3. Overview of the Hungarian situation in light of the possible objectives of introducing the central bank digital currency

This section reviews the extent to which the possible future scenarios presented in Chapter 2, and the payment objectives that may be put forward for the introduction of CBDC for each

scenario, could be relevant in Hungary. In this regard, on the one hand, it should be examined which of the problems presented in each scenario could reasonably occur in our country in the future. On the other hand, it should also be taken into account that a number of individual factors will influence which of the theoretical solutions that can be given to a payments market problem will actually work in practice. 1. Encourage greater uptake of electronic payments. Electronic payment methods are associated with predominantly fixed costs, i.e. those related to infrastructure deployment, which may be “evaporated”, that is, unit cost may be reduced, by increasing the number of transactions. Accordingly, CBDC could drive a major reduction in social cost if the transactions were re-channelled from cash flows rather than from already electronic payments, and if a sufficiently large number of transactions were carried out on the CBDC infrastructure. This may, of course, also depend on the CBDC operating model (see

Chapter 4), as it is not absolutely necessary to build a completely new infrastructure. An assessment of this objective thus needs to examine whether CBDC has any feature or function that cannot be provided by existing electronic payment methods. In

Hungary, market-based electronic payment solutions can now be used in basically every conceivable payment situation thanks to the widespread use of contactless card payments and to the instant payment system launched under the leadership of the

MNB on 2 March 2020 (MNB, 2020). If those payment solutions continue to develop at the pace seen so far, the introduction of

CBDC would probably not be sufficient to drive a meaningful improvement in the quality of electronic payment services; therefore, in this regard the introduction of CBDC alone would not significantly increase the uptake of electronic payments.

Consideration may be given to the question of whether an anonymous CBDC, specifically defined as an alternative to cash, could nevertheless be successful in terms of this objective.

Indeed, it cannot be ruled out that some people’s aversion to

using the existing electronic payment methods is primarily explained by the lack of anonymity, whereas an anonymous CBDC could already be a real cash alternative for them, too. However, this effect is weakened by the fact that consumer attitudes towards payment methods are typically the result of complex effects, and apart from the lack of anonymity, the rejection of electronic payments is very often due to other factors such as lack of digital skills and awareness, and mistrust of digital solutions. These barriers will not be addressed by CBDC either.

2. Support reduction of tax avoidance and money laundering risks. As in the previous point, with this objective the benefits to be derived from introducing CBDC will be substantial only if a significant proportion of cash flows can be re-channelled.

While this may be possible through additional regulatory steps restricting the use of cash, it should be noted in this regard, too, that the functions that can only be achieved with CBDC and not with existing electronic payment solutions are currently not apparent. Moreover, contrary to the previous point, this objective would require the introduction of a non-anonymous

CBDC.

3. Preserve the role of generally available central bank money in retail payments. As explained above, this objective forms the basis of the Swedish central bank’s project, as cash use has fallen to about 15 per cent of transactions in the country. By contrast, Hungarian data show the rates in reverse: according to the highly granular online cash register (OPG) database of the National Tax and Customs Administration (NAV), which contains more than 4 billion records, in 2019 nearly 82 per cent of transactions were in cash (MNB 2020), and similar rates were shown in the MNB’s previous survey of retail payment habits (Ilyés−Varga, 2015). Although, according to OPG data, recent years have seen a steady decrease in cash use and the rate of that decrease has accelerated due to the lockdowns imposed and to

consumer habits changing due to the coronavirus outbreak in the first half of 2020, the likelihood of a similar cash flow rate emerging in the next decade to that in Sweden is low, even by reference to the current path. 4. Increase financial inclusion. According to the MNB’s previous representative retail survey (Ilyés−Varga, 2015), no general problem is apparent with the coverage of the population in terms of accounts and payment cards, which was already around 80 per cent at the time of the last survey. While this does not yet reach the average of the most advanced economies, which is above 90 per cent according to the World Bank’s 2017 analysis, it is a high rate in global comparison (World Bank

Group, 2017). At the same time, groups such as aid recipients, the unemployed and pensioners can be identified as having significantly lower rates of bank relationships. These are also groups where, due to their poorer financial situation, members generally do not represent significant business opportunities for market participants, rendering a market-based change unlikely in this regard. Therefore, addressing this problem should involve an assessment of whether CBDC is the most suitable and most effective tool, or other means (for example, requiring payment service providers to provide a free social payment account by regulation) would be more appropriate.

This is also highlighted among other points in the IMF’s study (Mancini–Griffoli et al., 2018). 5. Increase the security of electronic payments. The operation of payments and financial infrastructures in Hungary is extremely secure (MNB, 2020). This is also true by international standards: in 2018, Hungary was one of the countries of the

European Union with the lowest fraud rate as a percentage of total turnover for card payments, which is currently the most widespread retail electronic payment method (ECB, 2020a).

On those grounds, no problem is apparent in this area which would require immediate intervention and could only be solved

through the introduction of CBDC. The introduction of offline transactions may carry additional advantages in terms of the

Hungarian financial infrastructure’s resilience, but this may have the opposite effect when it comes to fraud.

6. Ensure the availability of cheap and innovative electronic

payment solutions. In recent years, card payments in Hungary have shown an annual growth rate of 20 to 25 per cent, and within that, contactless transactions account for the vast majority of the turnover. In addition, the instant payment system was launched on 2 March 2020, and market participants started to develop various innovative payment solutions (online and physical acceptance, QR code handling, mobile applications, etc.). Accordingly, no substantive problem appears to exist in terms of the intensity of market developments. However, the transaction pricing of credit transfers is a problem that has been communicated by the MNB for a long time, and may hinder the spread of instant payments. Indeed, our previous analysis found that the monthly fee burden from the use of retail electronic payment services in Hungary is one of the highest among European countries (Kajdi, et al., 2019). Accordingly, the introduction of CBDC may be conceived of either as implemented through the instant payments infrastructure, or as a solution offering a customer experience similar to instant payments, enabling users to use basic payment services on more favourable terms than current market-based transaction pricing. In this context, however, it should be examined whether there are other ways to achieve this objective more effectively. This is particularly important from the point of view that if a CBDC service were to be launched solely on the basis of pricing considerations, market participants, in theory, could respond flexibly through pricing adjustments. Although this would help achieve the desired objective, it is expected to do so at substantial cost, since the deployment and launch of a CBDC system is very resource-intensive. Moreover, if price adjustments by market participants ultimately resulted in

a low uptake of CBDC, it would in fact be difficult to maintain a favourable pricing for the CBDC service itself in the longer term, due to economies of scale. However, it is definitely to be noted that according to our analyses, the pricing of retail credit transfers in Hungary, which is very expensive even by international standards, indicates a failure in the Hungarian market that must be addressed, and that the introduction of

CBDC must be taken into account as one of the possible means of doing so. 7. Address the challenges of BigTech operators. While BigTech operators (e.g. Apple Pay, Google Pay, Alipay) are already present in the Hungarian payments market, a truly significant impact could be made through the implementation of projects such as Diem, providing, in a short timeframe, a significant proportion of customers with access to the payment function of a service they already use frequently, which would rechannel the retail and corporate payment flows and liquidity of the Hungarian banking system to the systems of other nonbank service providers. In that regard, further examination is needed, on the one hand, of the probability of Diem (or other

BigTech payment solutions) actually entering the market, and of the boundary conditions and timeframe within which this may occur. In addition, further examination is also needed of the reasons for which users may opt for a new solution, and whether this can be addressed by the introduction of CBDC.

Namely, it should be taken into account that creating CBDC as an alternative to the new BigTech payment solutions is not necessarily sufficient in itself; it should also be understood why users might choose these new solutions instead of the existing market services, and how CBDC can be more competitive in this regard. As market participants already have much more experience than central banks in product development and in customer experience and relationships, the conditions under which CBDC can successfully compete with BigTech solutions pose a question yet to be answered.

8. Support the electronic transformation and modernisation of public sector payments. In practice, re-channelling to

CBDC the payments made to the State would mean that the

MNB would take over the central role of the Hungarian State

Treasury (MÁK) in public sector payments, and it would service accounts for the MÁK (as is already the case for handling the foreign exchange flows of MÁK), treasury institutions, local authorities, NAV and other public bodies. In that regard, it is important to see that on the recipient side MÁK has already joined the Hungarian instant payment system, and that the development of the new treasury account servicing system is ongoing, as a result of which no efficiency or service level gains from such re-channelling are readily apparent. Public sector disbursements, such as those in aid and subsidies, could also be made directly on CBDC foundations. As already explained in the assessment of financial inclusion, this is an option to be considered, but can also be achieved by other means, for example by providing support to payment service providers for all accounts provided to those in need. It should also be noted that in the case of CBDC services provided to socially more disadvantaged groups, intensive communication and education efforts must also be reckoned with in order to ensure that for less digitally skilled people, electronic transformation does not have the opposite effect of financial exclusion.

9. Ensure cheap and fast cross-border electronic payments.

In 2019, cross-border credit transfers accounted for a mere 1 per cent of all credit transfers (MNB, 2020b). Additionally, complementing euro-based payments, in theory cross-border payments in other European currencies (including HUF) could also be possible through the ECB TIPS system, which would help to eliminate the slow and expensive correspondent bank model for cross-border payments within Europe. A number of non-bank FinTech payment service providers, such as PayPal,

Revolut and TransferWise, are already offering solutions that can be used to send money to other countries in seconds, for

a fraction of the bank transfer fees. Accordingly, for Hungary, the problems encountered in conducting cross-border transactions do not appear to warrant the introduction of

CBDC. Importantly, however, if CBDC were to be introduced in Hungary in pursuit of any other objective, it should also be examined whether interconnection with international financial infrastructures may become necessary in the foreseeable future, and whether there may be international standards that would be appropriate to apply, for example in the context of the BIS (2020a, 2020b) cooperation referred to earlier. The above considerations suggest that at first glance, on the basis of the characteristics of electronic payments in Hungary, several theoretical payment objectives of introducing CBDC could be relevant in Hungary, such as encouraging the uptake of electronic payments (given the still relatively high rate of cash use in retail payments), ensuring the availability of cheap and innovative payment services (since the fees of retail payment services in Hungary are high by international standards), or increasing financial inclusion (as Hungary has yet to reach the average bank account coverage rate of the most developed economies). However, these objectives can apparently be achieved more quickly or more efficiently by other means, such as the development of already available electronic payment solutions and payment services in the market. This is also highlighted among other points in studies by the central bank of New Zealand (Wadsworth, 2018) and Spain (Nuno, 2018). For this reason, the introduction of a broad retail and corporate CBDC does not seem urgent from a payments perspective. It should be added, though, that the situation may change in the future. For example, if the increase in the proportion of electronic payments stalled for any reason, or BigTech operators carved out a more significant share of domestic payments in an uncontrollable manner, or the package-based, transaction fee-free pricing of retail electronic payment services failed to be taken up at an adequate rate,

careful consideration should be given, inter alia, to the possibility of introducing CBDC as a means to address the situation at hand.

4. Effects of central bank digital currency on the payments market

Whether carried out with payment considerations in mind or in order to achieve other objectives, such as those of monetary policy, the introduction of CBDC will certainly have a large and complex impact on the system, market and actors of payment services as we know them today. In this respect, the precise extent of the impact depends on the role that the CBDC to be introduced would play in the execution of payment transactions related to economic transactions. The extent of the uptake of CBDC in payments will be influenced by a number of factors, which can be considered as input parameters that can be “adjusted” by the central bank to influence the effect on payments and other effects (marked green in Figure 2): – range of access – whether CBDC is accessible to the whole population or only to a specific group (e.g. recipients of aid); – range of auxiliary services offered, e.g. whether an easy-to-use mobile payment application is available; – the price at which CBDC is offered, i.e. whether an account servicing fee or transaction fees apply, for example; – any limits to the value or number of transactions or the amount that may be held in each account; – whether transactions are anonymous and, consequently, the extent to which CBDC can support transparency, such as the prevention of tax avoidance or of money laundering. The range of CBDC access (which is fundamentally influenced by the objective for which it is introduced) also affects the infrastructure to be deployed; consequently, the extent of the

development required will be largely determined by factors such as the number of customers the central bank will need to service accounts for. In turn, infrastructure influences the range of services provided: it determines whether anonymous transactions are possible, while it also has a direct impact on service development opportunities. The characteristics of the infrastructure to be deployed determine the development costs incurred by the central bank and by market participants, as the case may be. The implementation (and operating) costs for market participants and the extent to which CBDC is used give an indication of the market effects; in practical terms, of the share of the payments market that CBDC can acquire. Finally, the development costs, possible central bank revenues from CBDC fees, and the use of CBDC (such as the payment methods the turnover of which is re-channelled to CBDC) collectively make up the effects of introducing CBDC on payments, i.e. the amount of social cost savings that can be achieved through the introduction of CBDC.

Accordingly, in this theoretical framework, from a central bank perspective pricing, any restrictions applied, anonymity, range of access, CBDC infrastructure and the range of services provided are the initial parameters to be decided depending on the objective, which then determine the actual use of CBDC, which in turn will primarily determine market impacts and the amount of cost savings that can be achieved at the level of society. This model therefore includes the achievement of the CBDC objectives and the resulting (social) benefits only partially, at the level of the social costs of payment methods. This is because when introducing CBDC, the first aspects to be reviewed should also include the decision points from a central bank point of view, and how they will affect CBDC uptake and, consequently, the payments market.

Figure 2: Effects of introducing CBDC from a payments perspective

Goal of CBDC

CBDC architecture Anonimity

Reachability Central banks’ decision points

CBDC service levels Transaction limits

Pricing

Development costs Use of CBDC Central bank revenues

Changes in social costs Market effects

Increasing transparency

Source: Authors’ compilation.

Continuing this line of thought, a review is appropriate of the options available in terms of infrastructure and operations. The introduction of CBDC can be envisaged in a variety of ways depending on what portion of the tasks is to be performed by the central bank, in other words, what part of the market services the central bank seeks to take over. In the literature (Auer–Böhme, 2020) three basic models are outlined in this regard; accordingly, we will examine the market effects along those lines, as this greatly affects how much of the payment services the central bank is to take over from market participants.

Direct CBDC In this case, the central bank issuing the CBDC is also in direct contact with the consumers, whereby the central bank provides the payment services and the consumers have claims on the central bank. This also requires the central bank to build new capacities for the additional processes that are currently managed

by market participants and are closely related to payments, such as customer identification (Know-Your-Customer i.e. KYC) and authentication, the provision of customer service and branch administration, fraud and anti money laundering monitoring, development of the acceptance network, development of customer interfaces (e.g. internet bank, mobile application), etc. Depending on the extent of the uptake and use of CBDC, this may in practice steer this segment towards the operating model of the one-tier banking system, where market participants do not have, or have a much more limited opportunity to participate in the provision of payment services than at present.

Figure 3: Schematic diagram of the direct CBDC operating model

Central bank

Assets

600

CBDC

A: 200 B: 100 C: 300

Consumer A

Consumer B

Consumer C

Source: Authors’ compilation based on Auer–Böhme 2020, p. 89.

In this case the central bank provides a full service covering not only account servicing but also other services (such as mobile payment), accordingly the greatest market impact can also be expected here. As explained earlier, the actual impact will obviously depend on a number of factors, such as who can access the CBDC, or at what fees. The most extreme case would be for the central bank to take over the entire payment services market. In 2019, the revenues of Hungarian financial institutions from payment services amounted to HUF 587 billion (MNB, 2020b),

which is already comparable to the HUF 698 billion profit generated by the Hungarian banking sector in the same year. This is obviously a scenario that is not viable in practice, but can provide a reference point by way of an upper limit. If CBDC was only used to re-channel the credit transfer service from the banks (whereby the banks would continue to provide card services and service the corresponding accounts), the revenues of the banking sector could decrease by HUF 146 billion in total. It should be noted that the takeover of the payments business by the central bank, and the resulting very significant decrease in the revenues of the banking sector would not necessarily entail comparable cost reductions, as the branch network, customer service and the vast majority of banking systems would still have to be maintained due to other business lines (lending, savings, etc.). Overall, therefore, the full takeover of the payment business would also pose significant financial stability risks in the banking sector, the quality of market services would deteriorate due to the decreasing operating and development costs, and the costs of other financial services would also increase for customers.

However, the direct model would not necessarily cover the whole range of retail and corporate customers, so it is possible, for example, to limit its scope to the launch of services for people who are socially more disadvantaged, in poorer financial situations. Given the business aspect that members of this group tend not to use banking services anyway, the profitability of the Hungarian banking sector would probably be significantly less affected by the introduction of this type of CBDC. The challenge in this area would rather be posed by development costs, i.e. in a business otherwise strongly reliant on economies of scale, it would be necessary to build a stand-alone infrastructure covering all elements of the payment chain for a limited customer base where transactions are also presumably less frequent. This includes the need to ensure the acceptance of CBDC by online and physical merchants, as well as by public bodies, for example. If this were to happen on a completely new infrastructure, that is, on

a network developed from scratch rather than on the systems and communication networks currently used by market participants, it would entail extremely high development and operating costs. At the same time, no recovery of such costs is apparent – whether considering the lower social costs of switching from cash to CBDC or the increased tax revenues due to a more transparent payment method compared to cash. In terms of competition and innovation in the market, other negative effects may result from the fact that while credit institutions have additional services other than payments, which may partly compensate for the loss of revenues, the operations of market service providers engaged only in payments would become largely impossible. This would reduce the very competition that e.g. the PSD2 is supposed to strengthen by helping the market entry of new service providers. In the long term, therefore, payments innovation and the emergence of new services would depend solely on the intentions and capabilities of the central bank.

The significant market risks described above are also indicated by an ECB study (ECB, 2020b) explicitly underlining that noncore activities should be provided by market institutions, but supervised by the central bank.

Indirect (synthetic/two-tier) CBDC In this model, CBDC is issued by the central bank, and is intermediated to consumers by market participants (e.g. commercial banks). Rather than on the central bank, consumers have claims on commercial banks, which are also responsible for “onboarding” (e.g. KYC tasks), and for the additional tasks mentioned in the direct model, i.e. customer relations would remain with market participants. Based on its description (Sveriges Riksbank, 2020), the Swedish pilot programme examines such a model and the Uruguayan e-peso programme also includes such an element. At the same time, the model differs from the current solutions based on commercial bank money in that commercial

banks have to keep CBDC (any central bank money) funds at 100 per cent to secure each consumer claim, which means that the novelty of this model does not primarily lie in the field of services, but in the fact that it can provide a new central bank guarantee on each CBDC in addition to the state deposit insurance, regardless of any value limit. Obviously, this would also have an impact on banks’ liquidity management, with several available options, of course, for example, depending on whether the MNB pays interest on the liquidity set aside as collateral, and if so, at what rate, or whether that liquidity counts in the reserve requirement. It should also be noted that the literature is unclear as to whether this solution may be regarded as CBDC at all; for example, it is not classified as such by BIS (2020a), inter alia because claims are not on the central bank.

Figure 4: Schematic diagram of the indirect CBDC operating model

Central bank

Assets

600

CBDC

A: 200 B: 100 C: 300

Bank X

CBDC

300

Liabilities

A: 200

B: 100

Bank Y Consumer A

Consumer B

CBDC

300

Liabilities

C: 300

Consumer C

Source: Authors’ compilation based on Auer–Böhme 2020, p. 89. For the sake of simplicity, the figure uses the name bank, which can denote any type of account servicing payment service provider.

Accordingly, the expected market effects are also moderate for this modality of implementation, as it would not fundamentally deviate from the ways in which payments currently function. This also means that, for example, there would be no improvement in the cyber-resilience of infrastructure. In another possible arrangement, the central bank would provide payment initiation services in relation to accounts held with market participants. This could provide benefits if market service providers, for example, were not to develop easy-to-use payment solutions that could also be used by less digitally skilled target groups. However, the current situation in Hungary implies that market participants have started intensive developments in the field of solutions based on instant payments, which are expected to be capable of serving a wide range of customers.

Hybrid CBDC In operating terms, it is similar to the indirect model, with payment service providers in direct contact with consumers, although central bank onboarding is also possible, when only the development of submission channels is outsourced to market participants (in which case they practically act as payment initiation service providers). One difference with the indirect model is, however, that here consumers have claims on the central bank. Market participants provide only services (e.g. mobile wallets), but CBDC is neither included in their balance sheets nor is part of the liquidation assets, and the central bank has the right to re-channel the customers of a failing financial institution to a properly functioning market participant.

Figure 5: Schematic diagram of the hybrid CBDC operating model

Central bank

Assets

600

CBDC

A: 200 B: 100 C: 300

Payment service provider

Payment service provider Consumer A

Consumer B

Consumer C

Source: Authors’ compilation based on Auer–Böhme 2020, p. 89.

In the hybrid model, therefore, CBDC accounts are serviced by the central bank, but the business opportunity for market participants in developing related services is questionable. In one possible arrangement, the end-user or a group of end-users would pay a fee to market participants for the transactions. In this case, however, the role of CBDC in facilitating financial inclusion may be undermined, because presumably people in more socially disadvantaged situations will continue to be prevented from using electronic payment services. Alternatively, CBDC services, such as the mobile payment application, could be offered free of charge for end-users, with the central bank paying reimbursement to service providers for the development and operation of those services. In that arrangement, compared to the direct model, the central bank outsources certain functions to market participants, which can determine the operating costs for a long time ahead. In this case too, it may be more cost-effective to facilitate financial inclusion by making accounts serviced in commercial bank money available to disadvantaged groups, i.e. the objective itself cannot be seen as explicitly requiring the application of CBDC.

From a market effects perspective, it can therefore be argued that payment service providers would only develop solutions for the use of CBDC if they were able to retrieve development and operating costs, any revenues that may be lost due to their turnover being re-channelled from commercial bank money, and gain a certain profit margin. In terms of specific submission channels, the optimal way to achieve this would be to incorporate a CBDC module into existing market mobile applications so that users can manage both their commercial bank and CBDC accounts within one application.

5. Conclusions

Essentially, our study served a triple purpose: (1) to examine the objectives and future development scenarios in connection with which the use of CBDC may appear reasonable from a payments perspective; (2) to review the objectives that may be relevant in the light of the current situation in Hungary; (3) to explain the effects that the various operating models would have on the payments market if CBDC were to be introduced for any reason. For the interpretation of the conclusions, two important facts should therefore be highlighted. First, our analysis was restricted to payments only, i.e. in connection with specific CBDC scenarios or implementation models we did not address other aspects such as those related to monetary policy and financial stability. Second, our examination of market effects was based on the assumption that the central bank would provide payment services with CBDC, so we did not examine, for example, the market effects of possible central bank lending activities. A review of the international literature shows that for the most part, current projects and research efforts tend to be motivated by payment considerations. However, these can be extremely diverse and largely depend on the characteristics of the given

country. Swedish research, for example, is mostly motivated by the fact that with cash use reduced, people will only have access to (electronic) payment methods provided by market participants. Consequently, the extent to which a particular person is enabled to participate in everyday life and economic processes will depend mostly on whether market participants are willing to provide payment services to everyone, and at what price. In the case of the other advanced project, the Chinese “digital yuan”, the fact that a significant part of electronic payments has come to be controlled by two non-bank service providers (Alipay and Tencent/WeChat) is an important underlying motivation, which makes it necessary to provide a central bank alternative in order to strengthen competition, and to ensure the wide availability and reliable operation of electronic payment solutions. A mention is also warranted of central bank cooperation, primarily coordinated by BIS, which primarily explores ways to make cross-border payments more efficient through CBDC. A closer examination of the Hungarian situation reveals that the current main directions for payments development in Hungary are primary set by problems other than these. Despite a steady decline in the use of cash in recent years, cash clearly remains the dominant payment method in terms of the number of transactions (especially in the retail segment). At the same time, the use of payment cards has increased dynamically in recent years, and the instant payment service launched in Hungary on 2 March 2020 also offers a wide range of options for the electronic transformation of payments. Recognising this, market service providers have also embarked on their developments based on instant payment. All this indicates that electronic payments in Hungary continue to evolve and are moving in the right direction; accordingly, over the short term, the introduction of CBDC does not appear warranted from a payments perspective. Neither are any general problems apparent in terms account coverage of the domestic population; in this area, it is particularly the socially disadvantaged and the elderly that are seen as lagging

behind. However, there are a number of effective tools available to improve that, regardless of CBDC. It nevertheless deserves to be noted that the continuous monitoring of the situation is also necessary, as events such as an emergency like the coronavirus pandemic, the emergence of solutions like Facebook’s planned Diem (formerly known as Libra) project on the Hungarian market, or the disruption of efforts to reduce charges for retail payment services, may occur in the near future, which may justify the introduction of a widely available Hungarian CBDC under certain circumstances.

This leads us to our third main theme, the operating model to be applied in the event of CBDC getting introduced for whatever reason. In our study, we sought to demonstrate that the introduction of CBDC should be preceded by very thorough analyses – for several reasons. First, for certain models (for our purposes, particularly the direct model), the central bank may incur extremely high costs from the introduction of CBDC. This is also partly due to the possibility that the central bank may be required to provide services in lieu of market participants (e.g. customer service and branch network, fraud monitoring, customer identification and authentication, development of mobile applications) for which it has no previous experience or existing infrastructure at its disposal. Another important aspect is that if a significant proportion of electronic payments were to become re-channelled into CBDC, this would also seriously affect the revenues and profitability of market participants, already pointing to financial stability issues. It should also be examined how the central bank would influence the innovation of payment solutions if it handled a significant part of electronic payments, what the motivation would be for market participants to carry out new developments, and whether innovation based on CBDC would be more efficient than primarily market-driven processes.

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