The introduction of a Central Bank Digital Currency (CBDC) is a complex issue with far-reaching implications for the financial industry, including commercial banks. In this article, we highlight an emerging situation in The Bahamas and explore whether commercial banks are catalysts for CBDC adoption or potential victims of that disruption.
The advent of Central Bank Digital Currencies (CBDCs) has ignited a complex interplay between financial institutions and central authorities. Commercial banks, the traditional pillars of the financial system, might be finding themselves at a crossroads.
In The Bahamas, which is the most advanced in the Caribbean region in deploying a CBDC, the Government intends to pass regulations requiring the country’s commercial banks to provide access to the Sand Dollar, the Bahamian CBDC (Source: WKZO). A known challenge for many CBDCs has been its limited take-up, and in The Bahamas, it appears the country will be changing tact: from a posture of just encouraging Sand Dollar adoption, to forcing the banks to distribute it.
This change in approach and attitude in The Bahamas seems to highlight a strained relationship between the Central Bank of The Bahamas and local banks. Moreover, this dynamic may also be present in other countries with a CBDC, such as Jamaica, though the tensions may not yet have bubbled to the surface. Nevertheless, it begs the question, Are commercial banks catalysts for CBDC adoption or potential victims of that disruption?
The benefits of CBDCs to commercial banks
First, it should be highlighted that commercial banks stand to benefit significantly from the integration of CBDCs. One of the arguments made for introducing CBDCs is its ability to increase the customer base by providing the unbanked and underbanked segments of our society an avenue through which to join the formal financial system. In turn, commercial banks have an opportunity to expand their customer base and deepen market penetration.
Second, by leveraging CBDC technology, banks can offer innovative financial products and services, such as smart contracts and tokenization, stimulating growth and profitability. Additionally, the potential for streamlined payment processes and reduced operational costs can boost efficiency and competitiveness.
Finally, having a collaborative relationship with central banks, fostered by CBDC initiatives, can lead to better policy alignment and support. Such a relationship can mitigate risks and create a more stable operating environment for commercial banks.
The drawbacks of CBDCs to commercial banks
On the other hand, the allure of these benefits is tempered by potential challenges. First, and perhaps the most significant concern is the erosion of the deposit base at commercial banks. As consumers and businesses increasingly adopt CBDCs, commercial banks may witness a decline in deposits, if their customers choose to hold CBDC instead of traditional bank deposits, thus directly reducing the funds available for banks to lend. A reduction in commercial banks’ lending capacity directly affects a key source of revenue and consequently, their profitability. Hence, such a change could require banks to adjust their business models and search for alternative revenue streams.
Second, increasing the take-up of CBDCs could result in intensified competition from both the central bank and other financial institutions, with the latter feeling at a disadvantage. CBDCs could offer more attractive features and lower fees, potentially luring customers away from traditional banking services.
Third, the complexities of integrating CBDC technology into existing banking systems should not be underestimated. Though common operating standards may exist in the banking and financial services sector, exactly how they are implemented may differ from institution to institution, with the attendant cost and modifications to be borne by each institution, which ultimately may result in certain banks dragging their feet in adopting or otherwise encouraging the use of CBDCs.
Are commercial banks a friend or foe of CBDCs?
At this juncture, it cannot be decisively stated whether commercial banks will ultimately be friends or foes of CBDCs. The outcome will depend on several factors, including the design of the CBDC, the pace of adoption, and the regulatory environment. In the case of The Bahamas, the Sand Dollar was launched in 2020, and with still limited adoption, estimated at less than 1% of the currency in circulation in The Bahamas (Source: WKZO), the pressure is on to improve that outcome.
Having said this, the potential for disruption is undeniable. However, it requires banks to be forward-thinking to position themselves as leaders in the CBDC ecosystem by embracing innovation, focusing on customer needs, and building strong partnerships with central banks. Unfortunately, history has shown us that all too often, incumbents regardless of sector or industry, spend way too much time trying to maintain the status quo than being proactive in navigating the inevitable change that is occurring.
Ultimately, the future of banking lies in a delicate balance between adaptation and resilience. By carefully navigating the opportunities and challenges presented by CBDCs, commercial banks can emerge as key players in the evolving financial landscape.
Images credit: Tumisu from (Pixabay); maitree rimthong (Pexels); Photo by Eduardo Soares (Unsplash); Joshua Hoehne (Unsplash)
