Are central bank digital currencies the key to unlocking financial inclusion in Africa?
Technology is changing money as we know it. Financial technology or fintech as a form of financial innovation has reshaped the financial services industry, especially in sub-Saharan Africa. More recently, the advent of central bank digital currencies (hereafter CBDCs) presents a transformational opportunity for the global financial industry. New analysis shows that over 90% of the global economy is exploring a CBDC. According to the Atlantic Council’s CBDC Tracker, nine countries have now fully launched a digital currency. Nigeria is the latest country to launch a CBDC, the e-Naira, the first outside the Caribbean. The e-Naira is expected to boost cross-border trade and financial inclusion, make transactions more efficient and improve monetary policy, according to the Central Bank of Nigeria.
So what exactly is a CBDC? Simply put, a CBDC is the digital form of a country’s fiat currency that is also a claim on the central bank. Instead of printing money, the central bank issues coins or electronic accounts backed by the full trust and credit of the government.
The idea of digital money is not new, many of us use debit and credit cards or payment apps for transactions. Africa’s reputation for innovation as a global leader in mobile money is a key driver of the continent’s booming fintech investment scene. The continent is already the largest adopter of mobile money transfer systems, comprising nearly half of the world’s registered mobile money customers, around 70% of global mobile money transactions and two-thirds of the volume of transactions in value.
But what would make a CBDC different? One of the big financial developments of recent years has been the growing popularity of cryptocurrencies – with one in particular, Bitcoin, standing out. Unlike traditional currency, cryptocurrencies are not issued by a central bank, but rather through a decentralized network of computers, usually using blockchain technology. Even behemoths like Facebook, now known as Meta, are trying to get in on the act with the announcement in 2019 that it would be developing its own digital currency, known then as Libra and now rebranded Diem. Central banks are experimenting with their own form of digital currencies, to counter the tsunami of cryptocurrencies we are currently witnessing. Generally speaking, central banks do not like decentralized private currency (like Bitcoin) because they cannot control the supply of it, and this also threatens the sovereignty of the national currency. Therefore, many central banks around the world, from China to Sweden to South Africa, are working on their own state-issued CBDC. According to the International Monetary Fund, about 100 countries are in various stages of exploring CBDCs.
Although still in its infancy, there are compelling reasons for central banks to issue CBDCs, including the need to support the digital economy and e-commerce that have been accelerated by the covid-19 pandemic. CBDCs can also provide a solution to overcome the risks associated with unregulated payment solutions, which are exploding both on the African continent and globally. Unlike public blockchains like Bitcoin and Ethereum, where the information recorded is available to everyone, CBDCs are private or permission blockchains, accessible only by the central bank and parties it chooses. There are two types of CBDCs. Wholesale CBDCs are used to facilitate payments between central banks and commercial banks or entities that hold their accounts with central banks. The other is retail CBDCs which can be used by businesses and individuals. It’s like currency in your mobile wallet issued directly by a central bank. This could be a game changer and have huge implications around the word. Retail CBDCs could advocate for financial inclusion, as a central bank could directly transfer funds to unbanked people as long as they have a cell phone. This is particularly promising in sub-Saharan Africa where the World Bank estimates that up to 65% of adults are unbanked. Imagine funds being transferred for covid-19 pandemic relief, natural disaster assistance, etc. The central bank could also use CBDCs as a tool to influence monetary policy and stimulate spending to revive the economy during downturns. The opportunities are many, but there are also risks.
If individuals could all hold their money at the central bank, why hold money at the local branch of a commercial bank? This could lead to a run on commercial banks and could have consequences for the entire banking sector. Central banks are highly unlikely to want to take this risk, as a strong banking sector is crucial to the financial health of an economy and central banks are simply not designed to deal with millions of retail customers. Thus, the approach of central banks is most likely at two levels. Issue the CBDC to banks who then issue it to retail customers. This would give the authorities the opportunity to experiment with this new financial tool without upsetting the entire banking model.
Additionally, there are a number of legal and regulatory gaps regarding the implementation of CBDCs in Africa that need to be addressed. A major hurdle is that identified accounts will likely need to be required in order to ensure compliance with anti-money laundering and the financing of terrorism (AML/CFT). Currently, the World Bank estimates that approximately 1 billion people worldwide and 45% of women in low-income countries do not have official identity cards. Regionally, sub-Saharan Africa has the largest coverage gap, where almost one in three people in the countries surveyed lack basic identification. Additionally, privacy and data protection laws may impact the deployment of CBDCs regionally. Over the past decade, African countries have steadily passed laws and enacted regulations on cybersecurity and data protection. To date, 33 countries have data protection laws and/or regulations. The fight against AML/CFT and the guarantee of confidentiality and data protection are not at the heart of the objectives of the central bank, which are generally price stability and financial stability. Ultimately, central banks will have to strike the right balance between protecting privacy and reducing illegal activity.
As countries begin to experiment with CBDCs, the design and implementation of these initiatives will likely vary around the world, in advanced and emerging markets. Kenya’s central bank recently sought the public’s opinion on the applicability of a potential digital Kenyan shilling, soon after it emerged that Zambia was also testing its viability. With the launch of Nigeria’s e-Naira in October 2021 and the fact that Ghana is said to be in advanced stages of launching its e-cedi, this can serve as a model for central banks across Africa and globally. who are preparing to launch their own CBDC – having a first-mover advantage may not be a huge advantage in this case.
Consideration of digital currencies by central banks has the potential to support financial inclusion and stability as well as increase operational efficiency and ensure financial integrity, particularly in cross-border payments. However, several important challenges and considerations loom on the horizon. The growth of cryptocurrencies coupled with the covid-19 pandemic has accelerated discussions on CBDCs globally with huge upside potential for the financial sector, especially in sub-Saharan Africa. What happens next is hard to predict, but a lot will depend on how it’s handled.
Iftin Fatah is Director of Financial Institutions at the US International Development Finance Corporation. The opinions expressed here are his own.