Abstract
The e-CNY pilot tests have been expanded to more regions and scenarios, including in rural areas and across borders, although there is still no timetable for the official national rollout. This chapter discusses the recent e-CNY developments and explores the key macro-financial benefits and risks from its domestic and cross-border uses, which should be carefully studied and assessed before the official rollout.
Recent Developments and Macro-financial Implications of the E-CNY1
The e-CNY pilot tests have been expanded to more regions and scenarios, including in rural areas and across borders, although there is still no timetable for the official national rollout. This chapter discusses the recent e-CNY developments and explores the key macro-financial benefits and risks from its domestic and cross-border uses, which should be carefully studied and assessed before the official rollout.
A. Recent Developments
1. The development of the e-CNY continues, including additional pilot tests.
More regions. Previously, the e-CNY had been tested in four cities and regions (i.e., Shenzhen, Suzhou, Xiong’an, and Chengdu) since end-2019, and planned for foreigner-use scenarios in the 2022 Beijing Winter Olympics. As the pandemic was largely under control, the PBC has expanded the e-CNY pilot tests since November 2020 to more than ten cities and regions in total. At the same time, the PBC has also expanded the pilot tests to rural areas and Hong Kong SAR (as a cross-border test). The e-CNY pilot program currently covers a wide range of regions in China, taking into account China’s coordinated regional development strategies and preparing for a nationwide rollout in the future.
More scenarios. As of end-June 2021, e-CNY has been applied in over 1.32 million scenarios, covering utility payment, catering service, transportation, shopping, and government services (PBC, 2021a). Meanwhile, the plan for foreigner-use scenarios in the 2022 Beijing Winter Olympics has been progressing as devices with e-CNY payment functions are being deployed in the Olympics venues, and the ongoing pilot program in Hong Kong SAR would test the cross-border payment scenarios.
2. The PBC published a White Paper to communicate with the public the key design and features of the e-CNY, helpfully clarifying objectives and key design issues, including data privacy (PBC, 2021a).
Objectives. Domestically, the main objectives of the e-CNY include meeting public demand for digital cash, supporting financial inclusion, and facilitating fair competition and increasing the efficiency and safety of retail payment services. From a cross-border perspective, the PBC also aims to explore the e-CNY’s potential in improving cross-border payments through collaboration with other central banks and international organizations.
Key design and features. The e-CNY is the digital version of the RMB, characterized chiefly as a substitute for cash in circulation (M0) but not M2, and will coexist with the physical RMB. The e-CNY adopts a two-tiered system under the centralized management of the PBC, where the PBC is in charge of issuing and disposing the e-CNY (first tier) while the authorized operators, including commercial banks, payment service providers, and telecom operators, provide the e-CNY account opening and exchange services within the PBC-managed e-CNY quota (second tier). The e-CNY differs from the other electronic payments in the following key aspects: i) it will be a legal tender being instituted by the revised draft Law of the PBC (revised draft for comments), ii) it is a form of money while the private payment service providers (PSPs) such as Alipay and Tenpay are payment platforms where the e-CNY could also be used, iii) it can be transferred without bank accounts and hence can support financial inclusion and achieve higher anonymity, as private digital payments usually rely on bank accounts which require KYC procedures,2 and iii) it supports off-line transactions and has the “settlement upon payment” feature.
E-CNY wallet structure. PBC (2021a) presented the matrix structure of the e-CNY wallet, which aims to strike a balance between anonymity and AML/CFT needs and satisfy the needs of different users (e.g., young vs. old individuals, and corporates). In particular, the e-CNY wallets could be classified by ID requirement (wallets with different transaction and balance limits), by the type of holder (personal or corporate wallets), by the carrier (software or hardware wallets), or by the authorization (parent or sub-wallets). Although the first-level wallet (under the classification by ID requirement) does not require ID information, it still requires a valid mobile phone number which is usually required to be linked to a real ID in China. The hardware wallet— by using security chips or other technologies—can be supported by IC cards, mobile phones, and wearable objects (e.g., badges and clothes with payment functions), some of which are being deployed in the Beijing Winer Olympics venues.
Data privacy (“managed anonymity”) and security. The e-CNY transactions will have “managed anonymity” in the sense that small transactions will be largely anonymous but large ones are traceable for the AML/CFT purpose. The WP also clarified that the ID information that e-CNY collects is less than the other electronic payments (e.g., credit cards or private digital payments) and will not be shared with other government agents. In terms of data security, the PBC has built a preliminary multi-layer security system and introduced frontier technologies (e.g., decentralized identity service) to strengthen privacy data protection for e-CNY users. Moreover, a “firewall” is being built inside the PBC to separate the e-CNY related information and help implement security and privacy protocols.
B. Key Macrofinancial Benefits and Risks in Domestic Use …
3. The e-CNY, similar to other retail central bank digital currencies (CBDCs), promises to lower payment service costs and enhance financial inclusion and the efficiency of fiscal support.
Lowering payment service costs by promoting competition and innovation in the payment industry. Alipay and Tenpay have dominated China’s nonbank payment market in recent years, with the market share of both accounting for over 90 percent of the total market in 2020 (Peng, 2021). The combined market share of the two was above the threshold to be determined as market dominance, established by the recently proposed Draft Regulations on Nonbank Payment Institutions.3 The e-CNY is a new interoperable means of payment that is free of charge to users by the PBC or second-tier operators and can be used in digital payment platforms such as banks’ e-CNY apps, which could potentially help diversify payment instruments and reduce the current market dominance by a few market players, promoting competition and innovation in the payment industry.
Enhancing financial inclusion and fiscal support efficiency. Given that private digital payments were already advanced and widespread in China compared to international peers, the marginal benefits from the domestic retail use of the e-CNY to financial inclusion are likely to be relatively less.4 However, one near-term potential of the e-CNY in this regard might be to bring targeted fiscal support and payment services to the unbanked population in rural areas or those in the remote areas without effective internet services (IMF, 2020a). For example, some rural regions have been facing difficulties in transferring fiscal support or healthcare refunds to the unbanked population in remote areas (usually low-income individuals), where the e-CNY might help make the fiscal or healthcare transfers to these people more efficient and timely, including through the hardware e-CNY wallets (e.g., IC cards) for those who cannot afford smart mobile phones. More recently, some pilot cities have distributed fiscal subsidies to local financial institutions and guarantee firms via their corporate e-CNY wallets as a reward for their efforts in supporting SMEs during the pandemic.
4. However, retail CBDCs, including the e-CNY, could also bring operational risks for data privacy/security, bank run risk from competition with bank deposits, and potential financial integrity risks depending on the design.
Ensuring data privacy and security of CBDCs has many aspects, including, for example: i) ensuring the security of users’ CBDC wallets against cyberattacks, ii) preventing fake CBDC wallets, iii) ensuring secure collection, storage and usage of private data from CBDC accounts and transactions, iv) ensuring the cybersecurity of second-tier operators particularly smaller banks and nonbank institutions (in the case of a two-tiered system), and v) ensuring the business continuity and security against weather-related disruptions from climate change. All of these could incur significant operational risks and challenges, particularly in a large-scale or nationwide issuance in the future.
Competition with bank deposits could happen if CBDCs are positioned as the most secure digital payment instrument which makes it attractive as a savings vehicle, although the impact is still largely uncertain at present. On the one hand, household savings in the form of the CBDC could increase the central bank’s balance sheet and crowd out deposits at commercial banks, which could put the business models of commercial banks at risk since their source of funds would become more expensive. Such a run from bank deposits to the CBDC could affect monetary policy effectiveness and financial stability, and have a potentially negative impact on the economy (Andalfatto, 2020; Fernandez-Villarverde and others, 2020). On the other hand, as the central bank receives a massive inflow of funds, it would have to reinvest these funds, thereby assuming a role as investor it was not set up for (Auer and Böhme, 2021).
Financial integrity, including AML/CFT rules among other things, could be strengthened or undermined, depending on the design of the CBDC. On the one hand, financial integrity could be strengthened if the authorities impose strict limits on the size of transactions; on the other hand, CBDCs offering full anonymity and large-value transactions would undermine financial integrity relative to cash and current non-cash fund transfer systems (IMF, 2018).
5. The PBC has taken measures to mitigate these potential risks, while more efforts could be made to strengthen the regulations and data governance for the e-CNY.
For data security and privacy, the PBC has made efforts to establish a multi-layer security system to contain potential risks and has also built an internal “firewall” inside itself to separate and protect e-CNY related information. Moreover, the e-CNY is supposed to comply with the recently adopted Data Security Law (DSL) and Personal Information Protection Law (PIPL), under which telecom operators are not allowed to share the user identity data collected from e-CNY apps to third parties including the PBC, and the sharing of such data for wallets with higher Know-Your-Customer requirements will require individuals’ permission first. To this end, establishing a prudent and transparent regulatory and data governance framework for the e-CNY in line with the DSL and PIPL would help protect data security and user privacy to increase public confidence, and facilitate the implementation of security and privacy protocols. Given that many smaller banks that are or will be involved in the e-CNY distribution usually have weaker cybersecurity architectures than large ones, it is important to test and strengthen their capability in addressing the potential operational risks from the e-CNY, including through the ongoing pilot tests.
For the bank run risk, the PBC has announced to apply zero interest rate to the e-CNY and impose limits on the amount of transaction and balance for e-CNY wallets. These measures should help increase the frictions for conversion from bank deposits to e-CNY, thus reducing the potential competition with bank deposits and the associated bank run risk. Having said that, the run risk cannot be completely ruled out by the frictions (Carstens, 2021) and the imposition of such frictions would need to strike a balance between reducing the exposure to bank run risk and enhancing competition within the payment system.
Measures to address financial integrity concerns of the e-CNY include conducting a money laundering/terrorist financing risk assessment on the domestic and cross-border uses of e-CNY, putting in place risk-sensitive mitigation measures, and ensuring risk-based supervision of e-CNY operating institutions. The steps taken by the PBC in this regard and the planned AML/CFT guidelines for e-CNY operating institutions are welcome.
6. In the longer term, the e-CNY may also contribute to the ongoing changes in fintech firms’ business models as the payment functions are being separated from their lending business. Some of the large fintech firms were reportedly required by regulators to create separate platforms for their lending business, but it remains unclear whether and how the user data that underpins the firms’ lending decisions will be shared between the firms’ payment and lending arms. The e-CNY could bring more uncertainty to the payment data collection and sharing, which may challenge the existing business models of fintech firms. In principle, as the e-CNY encourages competition and innovation in the payment market, the payment data collected by individual PSPs would become less complete, leading to fragmented payment “big data” at each individual PSP assuming no data sharing among PSPs (as is the case now). Since the payment data have been particularly important for the credit risk analysis and lending decisions given the highly integrated online businesses in China, the segregated payment data may become less useful and could accelerate the change in the fintech business models. However, at the same time, commercial banks may revitalize their diminished role in the payment market and the collected payment data may also help enhance their credit risk assessments in credit provision (Huang and others, 2020). In addition, more business opportunities may arise in the area of payment data collection and compilation. This also underscores the importance of having prudent and transparent regulations for the usage of the e-CNY payment data collected by the PBC.
C. … and in Cross-Border Use
7. In principle, CBDCs used across borders could bring extra benefits beyond those from domestic use, particularly further cuts in transaction costs and providing access to a wider range of cross-border financial services. According to the Bank for International Settlements, the average total cost of a US$200 bank-based cross-border remittance is over 10 percent of the remittance value based on a sample of 112 countries (BIS, 2020). Much of the cost reflects service charges and cost recovery by financial intermediaries, which can be significantly reduced by CBDCs through flattening the multi-layered correspondent banking structure and shortening the payment chains (IMF, 2020b). Moreover, cross-border use of CBDCs could make it easier for household and corporates to access a wide range of other cross-border financial services leveraging the big data generated from individual transactions.
8. However, cross-border use of CBDCs could also bring additional risks and policy challenges. Although CBDCs are unlikely to qualitatively change the economic forces that lead to the international use of currencies, they could quantitatively reinforce the incentives behind currency substitution and currency internationalization (IMF, 2020b). In particular, foreign CBDCs could i) raise pressures for currency substitution, which could worsen vulnerabilities from currency mismatches and reduce the ability of local authorities to run monetary policy, and ii) facilitate illicit flows and make it harder for regulatory authorities to enforce exchange restrictions and capital flow management measures without appropriate safeguards. Moreover, the data privacy and security concerns would likely be higher in cross-border transactions than domestic use, as it is more difficult to monitor such risks or conduct regulatory coordination across borders. Multilateral collaboration to agree on design principles will be key to addressing concerns of central banks regarding currency substitution risk, capital flow volatility, and contagion risk (BIS and others, 2021).
9. Similar to many other central banks, the PBC has been actively exploring the cross-border use of CBDCs, including the e-CNY. Given the potential complicated issues involved in the cross-border use of CBDCs, including, for example, monetary sovereignty, foreign exchange policies and arrangements, as well as foreign regulatory and compliance requirements, the PBC has started a technical pilot test of the e-CNY in Hong Kong SAR and collaborated with other central banks and the BIS to further research wholesale CBDCs in the Multiple CBDC (mCBDC) Bridge project.
E-CNY cross-border test. The e-CNY, despite being mainly used for domestic retail payments at this stage, is technically ready for cross-border use as well (PBC, 2021a). The PBC has signed an MOU with the Hong Kong Monetary Authority (HKMA) to technically test the use of the e-CNY in Hong Kong SAR through PBC-designated banks. The technical test reportedly includes exploring ways to minimize the potential disruptions to the Hong Kong dollar (e.g., currency substitution risk) and achieve interoperability with the Faster Payment System in Hong Kong SAR, a local payment system that connects banks and digital wallet operators.
mCBDC Bridge project. The PBC has also been researching the cross-border use of wholesale CBDCs with other central banks and the BIS in the mCBDC Bridge project.5 The project explores the capabilities of distributed ledger technology (DLT) and CBDC in facilitating real-time cross-border foreign exchange payment-versus-payment transactions in a multi-jurisdictional realtime context. More specifically, the project has been developing a DLT-based cross-border corridor network prototype to support multiple currencies and interface with new or traditional domestic payment systems. This aims to alleviate the pain points in cross-border fund transfers (e.g., inefficiencies, high cost and complex regulatory compliance) and evaluate the feasibility of CBDCs for cross-border fund transfers, international trade settlement, and capital market transactions. It has adopted three general principles: (i) no disruption to other monetary authorities or international monetary system, (ii) compliance with local regulations, and (iii) interoperability between different CBDC systems as well as between CBDC and traditional payment systems. Although the e-CNY is currently positioned as a retail CBDC, it uses a hybrid model, which is flexible and adaptable to any technology (including the DLT), and hence can be adapted to wholesale use in the mCBDC Bridge project.
10. In the case of the cross-border use of the e-CNY, the PBC has also committed to complying with the three general principles to minimize the potential currency substitution risk. These principles are essentially high-level objectives, and how to achieve these objectives remains an important issue that is being studied and tested, including in the ongoing pilot test in Hong Kong SAR. One key measure to implement the principles in the Hong Kong SAR test is the mandatory conversion between the e-CNY and Hong Kong dollar (HKD), i.e., e-CNY payments from a Mainland Chinese e-CNY wallet are automatically converted into HKD in the Hong Kong SAR receiver’s HKD account. It is up to the Hong Kong SAR authorities to decide whether their local individuals or corporates can open e-CNY wallets. For example, in the absence of local restrictions on e-CNY wallet opening, Hong Kong SAR merchants could in principle open and hold e-CNY wallets, which could make the mandatory conversion less effective in reducing the currency substitution risk. In this case, one way for the Hong Kong SAR authorities to enforce the use of HKD could be through checking IP addresses. Moreover, the capital account restrictions and capital flow management measures in China could pose technical and policy challenges for the e-CNY’s cross-border use given China’s largely closed capital account.
11. The e-CNY alone is unlikely to significantly push forward the RMB internationalization. In principle, CBDCs could quantitatively reinforce the incentives behind currency substitution and currency internationalization, but are unlikely to qualitatively change the economic forces that lead to the international use of currencies (IMF, 2020b). In the case of e-CNY, although it could help with RMB internationalization given the promised lower transactions costs, its digital form alone is unlikely to have a substantial impact, as the global demand for a country’s currency depends mainly on its economic fundamentals as well as financial market depth and openness, while the RMB or e-CNY is still not freely convertible under the capital account.
References
Andolfatto, D., 2020, “Assessing the Impact of Central Bank Digital Currency on Private Banks”, The Economic Journal, 131 (634), pp.525–540.
Auer, R., and R. Böhme, 2021, “Central Bank Digital Currency: The Quest for Minimally Invasive Technology,” BIS Working Papers No. 948, Monetary and Economic Department, Bank for International Settlements.
Bank for International Settlements (BIS), 2020, Annual Economic Report, Chapter 3.
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Carstens A., 2021, “Central Bank Digital Currencies: Putting a Big Idea into Practice,” Remarks for Peterson Institute for International Economics discussion on Central Bank Digital Currencies, Bank for International Settlements.
Fernández-Villaverde, J., Sanches, D., Schilling, L., and H. Uhlig, 2020, “Central Bank Digital Currency: Central Banking for All?”, University of Chicago, Becker Friedman Institute for Economics Working Paper No. 2020–04.
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Peng, L., 2021, “2021 Tencent Mobile Payment: Non-Bank Payment Market Competition and Cooperation,” Leadleo report (in Chinese).
People’s Bank of China (PBC), 2021a, “Progress of Research & Development of E-CNY in China,” Working Group on E-CNY Research and Development of the People’s Bank of China.
PBC, 2021b, “Inclusive Finance Index Analysis Report in China (2020),” Consumer Financial Protection Bureau of the People’s Bank of China.
Prepared by Fei Han (APD).
There is still some population in China (about 8 and 12 percent of urban and rural adults in 2020, respectively) that does not have active bank or nonbank payment accounts according to the PBC’s inclusive finance report (PBC, 2021b).
The Draft Regulations on Nonbank Payment Institutions were published by the PBC in January 2021 to seek public comments. According to the draft regulations, the PBC can request the anti-monopoly agency to review whether market dominance is achieved if one company reaches a market share of one half, two companies together reach a market share of two thirds, or three companies together reach a market share of 75 percent.
According to PBC (2021b), 89 and 83 percent of urban and rural adults had access to electronic payments in 2020, respectively.
The project was first initiated bilaterally by the HKMA and the Bank of Thailand under the name Inthanon-LionRock, and was renamed to m-CBDC Bridge when the PBC, the central bank of UAE, and the BIS joined. A wholesale CBDC can only be used by permitted institutions for settlements in the interbank market, whereas a retail CBDC would be used like a digital cash by the general public.