Deposit insurers need to contend with the possibility that during crises triggering depositor panic, central bank digital currencies (CBDCs) could be perceived as a safe haven, thus rendering bank deposits, particularly uninsured deposits, more prone to withdrawal and hence the risk of bank runs, according to RBI Deputy Governor MD Patra.
“The impact of CBDC on deposits and hence deposit insurance is largely unknown as of today. The operating models and design features of each individual jurisdiction’s CBDC will be a crucial factor in expanding our understanding of the balance of risks. For deposit insurers, factors of key interest would be the degree of replacement of bank deposits by CBDC, the division of labour between central and commercial banks and the degree of privacy attached to CBDC usage,” Patra said.
Two digital innovations in currencies and payment systems merit special attention as both have implications for deposit insurance, the Deputy Governor said in is keynote address at the International Association of Deposit Insures (IADI) Asia Pacific Regional Committee (APRC) International Conference at Jaipur.
Advantages of CBDCs
The major advantages of CBDCs (legal tender or fiat currency issued by a central bank in a digital form) are the finality of transactions (settlement risks is eliminated as there is no bank intermediation) and real-time and cost effective globalisation of payment systems. In the medium term, adoption of CBDCs by unbanked people could enhance financial inclusion.
Patra observed that as an increasing number of central banks face the risk of large-scale use by the public of private or digital instruments that may not be backed by or denominated in the domestic currency, CBDCs may assist in mitigating this risk by being a central bank liability and a form of digital cash.
To the public, they would be an alternative to central bank issued cash and – to a certain extent – to private money, such as bank deposits.
The Deputy Governor underscored that deposit insurers are having to re-evaluate operational risks posed to depositors and member banks from the emergence of these 24/7 payment systems.
“While digital innovations can ease cross-border supply of financial services, they can also increase the likelihood of deposit insurers exposed to member banks with a significant share of non-domestic depositors and additional challenges in the case of a payout following bank default,” he said.
In fact, the increasing ambit of cross-border banking activities makes cross-jurisdiction cooperation between deposit insurers and other financial safety net participants all the more relevant.
Tokenised deposits
Patra said deposit insurers must remain in readiness for tokenised deposits (or digital representations of traditional bank deposits hosted on a secure blockchain) by reflecting on how to modify their mandates and coverage, considering that these deposits are essentially claims on issuing banks like other forms of deposits.
Moreover, the risks posed by tokenised deposits have to be modelled for determining fund size and premium rates.
They will also have a bearing on the choice of modalities for resolution and claim processing, with different banks using different technologies as also the possibility that tokenised deposits could be held by depositors who are not KYC compliant and not clients of issuing banks.
Consequently, verification of the authenticity and genuineness of claims may prove to be a testing challenge, Patra said.