Recent technological innovations and increasing demand for convenience and security have expedited the shift to digital systems, including financial systems. This has become the catalyst for people and businesses to find new ways of interacting and conducting transactions digitally.

As a result, central banks have shown increasing interest in the central bank digital currency (CBDC) concept to accommodate this demand. Central banks see CBDCs as not only meeting evolving needs of their constituents, but also as a way to drive financial inclusion, thereby levelling the financial playing field.

Additionally, the emergence of cryptocurrencies and stablecoins has highlighted digital currencies’ potential benefits – as well as their drawbacks and central banks are keen to consider the role that CBDCs could play in the broader financial system. Central banks want to be relevant in the digital world with their “brands” such as Dollar, Euro, Sterling, as it provides a digital answer to Crypto payments. The European Central Bank (ECB) is no exception and has been exploring the use of blockchain technology and CBDCs to improve the speed and efficiency of its payment systems.

Innovation in Payments

In recent years, the European payments industry has undergone significant changes, driven by advances in digital technology, the emergence of new payment providers and increasing consumer demand for faster, more convenient and more secure payment options.

In response, European authorities and financial institutions have been working to create an environment that fosters innovation in the payments sector while also striving to ensure the safety and stability of the financial system.

The European Commission has been supporting innovation in the payments industry through initiatives such as the Payment Services Directive (PSD2), which aims to create a more open and competitive market for payment services in the European Union.

Whilst the European Union has yet to issue a digital euro, it is exploring the possibility of doing so as a way of  ensuring the euro remains a stable and trusted currency in the digital age. The ECB, in leading this exploration, is doing so in a way that a CBDC would complement, not replace, cash. 

According to the ECB, which expects to introduce a digital euro across its 27 member states by mid-2023, “Central bank money is a risk-free form of money that is guaranteed by the state”. That said, the EU still needs to address the change of status of legal tender so as to lay the ground for mass acceptance. 

CBDC spurring financial innovation for local startups and the regional economy

Implementing a CBDC could help spur financial innovation and financial inclusion in several ways.

Improved access to finance as a CBDC could make it easier for local startups and small businesses to access the funds they need to grow and innovate. This is particularly beneficial in situations where access to traditional forms of finance, such as bank loans, can be limited by a lack of historical financial data.

As long as allowances are built to safeguard users’ privacy and digital identities, an individual’s CBDC account and profile data could be distributed even to providers of traditional financial instruments. For instance, the individual’s CBDC credit information could be shared with lending platforms to supplement traditional credit information like income history, debt, and repayment records – the sort of information unbanked people might otherwise not have access to.

Another benefit is lower transaction costs. CBDCs could reduce the costs of making and receiving payments, particularly for small businesses and underserved consumers, who currently pay disproportionately high fees for using traditional payment systems for domestic and cross border transactions.

The implementation of CBDCs could also promote financial inclusion for marginalised individuals and communities by making it easier for underserved or unbanked populations to access financial services by creating digital financial identities. A digital wallet could allow unbanked or lesser-banked individuals to have access to money movement and credit, establishing a track record of lending in the process if required.

CBDCs could further enable new business models and financial products that are not currently possible with existing payment systems. For example, a classic role of central banks has been to eliminate or reduce credit and get legal tender flowing within their economy. CBDCs encourage this role by making it easier to create liquidity, where physical assets like property can represent by a digital marker on the blockchain and can be moved around or used as collateral to secure a loan.

Monetary policy could also be potentially improved as CBDCs could provide central banks with additional tools to manage the economy and support financial stability. This could assist in economic growth and support the development of local startups and the regional economy.

Finastra’s expertise in financial technology and payments is well-suited to support this technology’s future growth. The company will continue to monitor and adapt to developments in CBDCs and may explore opportunities to offer solutions and services that support the implementation and use of CBDCs in Europe and other regions. 

The CBDC Race and upcoming trends

The global race to issue a CBDC is heating up. With four central banks, the Central Bank of The Bahamas, the Eastern Caribbean Central Bank, the Central Bank of Nigeria, and the Bank of Jamaica leading the pack, other countries are close behind, with several central banks actively working on CBDC pilots. 

Across Europe, many governments are exploring the feasibility and potential benefits of a CBDC. These include France, Norway, the United Kingdom, and Sweden.

It is difficult to predict the exact trends that will shape the development of CBDCs in Europe in the coming years. However, some potential emerging trends include continued exploration and experimentation by central banks to assess the feasibility and potential benefits of issuing a CBDC. 

This also includes the development of industry standards and guidelines to support the smooth operation of CBDCs and ensure interoperability with existing payment systems.

Meanwhile, other trends include the adoption of CBDCs by governments and other authorities to improve the efficiency and accessibility of public services, such as welfare payments and tax collection, and to use CBDCs by businesses and other organisations to facilitate transactions and reduce the need for cash.

Cooperation between fintechs and central banks

Europe has always been a driver of fintech investment. Today, it makes up 17 percent of the global cumulative valuation of fintech companies which totals around USD 2.26 trillion.

Not only that, fintech adoption across Europe, particularly in nations like the Netherlands, the United Kingdom, Germany, Sweden, and Switzerland, is significantly above the global average of 64 percent.

Fintech companies can play a valuable role in facilitating the adoption and integration of CBDCs by providing expertise, technology, and support to central banks and other stakeholders. 

One way that fintechs can cooperate with central banks to facilitate the adoption and integration of CBDCs is by working together to develop and implement technical standards and protocols for using CBDCs. T

This can help ensure that the different systems and platforms used by fintechs and central banks can interoperate smoothly and efficiently. Additionally, fintechs can educate the public about the benefits of CBDCs and how to use them, which can help to increase their adoption and integration into the broader economy.

Fintechs can also provide expertise and advice to central banks on developing and implementing CBDCs. This could include guidance on the technical aspects of designing and implementing a CBDC and advice on engaging with stakeholders and promoting the currency’s adoption.

In addition, fintech companies can help to ensure that CBDCs are integrated seamlessly with existing payment systems and infrastructure. This could include developing APIs and other technical solutions to enable the smooth flow of information and transactions between CBDCs and other payment systems.

Finastra’s vision and pioneer in innovation 

The Bank of England’s announcement of introducing the ‘Digital Sterling’ by 2025 has created a buzz in the financial industry, with many entities working towards making it a reality. 

One such consortium is Project New Era, in which Finastra, a leading financial services software, and cloud solutions provider, is leveraging its expertise in payments to support the consortium’s efforts.

Finastra believes that CBDCs have the potential to bring many benefits, including greater financial inclusion, faster and cheaper cross-border payments, and enhanced security and resilience. 

The design of CBDCs is still in its infancy, with several experiments ongoing and various approaches being studied. Several technical, economic, legal, and governance challenges must be addressed before any CBDC is fully launched.

Finastra is committed to working with all stakeholders to understand the opportunity CBDCs present and how we can collectively shape the future of money.

Due to its deep understanding of the financial services sector, Finastra can anticipate bank needs and develop solutions that help them stay ahead of the curve.

Further, central banks are continuing to explore options for distribution of CBDCs, such as the idea of non-bank financial institutions as custodians/distributors of CBDCs, unlike cash which is reserved only for licensed banks. These options would have implications for interoperability between CBDCs and cash.

As such, Finastra is also exploring options to enhance its payments platforms to enable the seamless interoperability as they serve their bank and non-bank clients. 

Finastra considers it a privilege to work with some of the most forward-thinking organisations in the industry. It is committed to helping these organisations drive change and shape the future of financial services. 

The landscape of CBDCs will change dramatically in the next two to three years. Although currently, only a handful of countries have actively launched CBDCs among the 100 exploring the technology, this is set to change in the near future as more and more central banks begin to recognise the potential benefits of having a digital version of their country’s currency.

Featured image credit: Edited from freepik here and here