China's central bank digital currency and its impacts on monetary policy and payment competition: Game changer or regulatory toolkit?

Abstract

After carrying out some preparatory work for several years, China is likely to issue central bank digital currency (CBDC). Built upon the relevant experience and research in other countries, China has been carefully designing its own version of digital currency and issuance mechanism with a purpose of not disrupting financial intermediation. Nevertheless, it still leaves some residual issues unanswered, in particular, the narrow bank concern and application scenarios. While this article proposes to use interest rates as a policy solution to mitigate the narrow bank concern, the ultimate success of CBDC still depends on market competition. China's CBDC, while initially being used as a regulatory toolkit to compete with other digital currencies, has potential to become a game changer once used in a large scale.

Introduction

Ever since the emergence of the Internet in the early 1990s, technologies have become both a driving and disruptive force to transform the economic world. Every product and/or service, so long as information-based or -driven, is being affected with no exception. Numerous traditional industrial sectors have ever since been either remodeled or revolutionized, leading to platform economy and sharing economy.¹ However, the financial sector might not be a typical example, even though almost all the financial products or services are information-based. Stability, rather than innovation, has always been the core concern of the financial sector. As such, this sector is subject to heavy regulation from every perspective for more than a century.² To some extent financial regulation plays a controversial role in hampering the Internetization due to the so-called finance and innovation dilemma.³ Against this backdrop, innovations built upon Fintech have been slowly but consistently eroding this heavily regulated sector, while facing dynamic regulatory responses. Nevertheless, different from economic transformation in other sectors where the core business was immediately affected,⁴ the Internetization evolution in the financial sector at present is only taking place at the edge of the sector, such as third-party online payment⁵ and P2P lending.⁶ Alongside with this general trend, the recent couple of years have witnessed Fintech's initial invasion into the core of financial sector, namely, money. The process was initially activated by some money-like products, e.g. virtual currency, then moved to money equivalent products, such as cryptocurrencies and stablecoins, and finally touched upon the long-standing money base in the form of central bank digital currency (CBDC). The ultimate revolution of the financial sector may be counted on the coming up of the CBDC or Libra, a private equivalent.

The movement towards a cashless society seems to be inevitable, as what Internetization is heading for. The importance of CBDC has been well acknowledged by central banks in major economies, not only due to the impact of Internetization but also the declining use of physical cash. Thus far the CBDC remains one of hottest topics among central banks across the world. Many have been keeping a close eye on it for years, and some (typically small economies) even launched their own CBDCs, though most, if not all, have failed.⁷ It might be something historic that China, as the first large economy, experimentally launched the digital version of renminbi (RMB), termed as Digital Currency Electric Payment (DCEP) in April 2020. Commentators in China foresee its official issuance soon. Given the gigantic size of the Chinese economy, as well as the rapid internationalization of RMB, the DCEP deserves close investigation and analysis, particularly on its implications from the perspectives of monetary regulation and business competition.

Moving forward, Section II garners a number of concepts closely related to the CBDC, and then delves into the theoretical pros and cons of the CBDC in general. A brief introduction is given in Section III to the DCEP in China, as well as to its issuance structure. Section IV reviews the impact of the DCEP on the monetary policies in China, with a focus on the narrow banking issue. An examination is offered in Section V as to the competition relation of the DCEP with other payment solutions currently available in China. Section VI concludes.