Digital Frontiers: Capacity Building for the Central Bank Digital Currency Journey in Emerging Market and Developing Economies

Posted on Nov 25, 2021 by Nolwazi Hlophe, Deputy Director Financial Regulation and Supervision, Digital Frontiers

What is Legal Tender and What Does it Mean for a Central Bank Digital Currency in a Jurisdiction?

Central bank Laws/ Acts or Orders (laws) give central banks the power to issue legal tender, monetary units or the money (money) of that country. These laws detail the description of what they deem legal tender for their jurisdiction. But what is legal tender? According to the IMF, legal tender status is a key attribute of currency that entitles a debtor to discharge monetary obligations by tendering currency to the creditor.

So, why does this matter? In the Bank of Ghana’s Bank of Ghana Act 2002 (Act 612), this matters because of the definition of legal tender, “41. (1) Currency notes issued by the Bank shall be legal tender at their face value.” This means that any form of currency that the Bank of Ghana issues is recognized as legal tender, including a central bank digital currency (CBDC).

Now, What Exactly is a CBDC?

Defining a CDBC is no simple task due to the many dimensions that have to be considered in the layering of the definition. At the foundation of it all, a CBDC is a digital banknote and is legal tender that could be used as a means of exchange in a jurisdiction. There are three types of CBDCs:

  • Retail CBDCs: for use by individuals
  • Wholesale CBDCs: for use in the financial markets
  • Cross-border CBDCs: for cross-border payments

Using this table should help with understanding the differences between CBDCs, cash, commercial bank money, and private cryptocurrencies, which include stablecoins.

Why Does Capacity Building Matter on These Foundational Concepts Towards Understanding CBDCs?

This year, the Digital Frontiers Institute convened the first CBDC Workshop focusing on emerging market and developing economies. The workshop aimed to:

  • Firm up the understanding of the definition of CBDCs,
  • Increase understanding that the CBDC “pathway” is not a straight line, but that there are many considerations that need to be contextualized to each jurisdiction and,
  • Emphasize that financial authorities need to take a timely and strategic approach that keeps the central bank’s mandate of price and financial stability at the forefront whilst also building capacity to ensure robustness in the work conducted on CBDCs.

This workshop revealed capacity gaps that need to be addressed if we seek to have a global digital economy. Limited capacity to understand, design and implement forward-looking policy environments is often cited as a significant challenge by policymakers. Whilst there are several capacity building actors, many of them agree that the pace of change is not fast enough even when these actors work complementarily with each other.

To quote the Dalberg report, “Despite these efforts, there continues to be a mismatch of the type of capacity building activities that are supplied and what is demanded. This results in activities which are not tailored to policy makers’ context and needs. There is a missed opportunity to more effectively tailor knowledge and capacity building products to achieve more systematic transformation of the system.

The Digital Frontiers Institute is among the capacity building actors, offering courses curated for financial authorities.

Financial authorities, which include policymakers, regulators and supervisors, who have significant influence in the design of a jurisdiction’s CBDC have a different type of persona when it comes to capacity building. This needs to be sufficiently understood if any capacity building programs for them will succeed. For example, providing scholarships is an excellent tool to help financial authorities overcome the cost barrier to capacity building. Furthermore, consistent coordination between capacity building providers to reduce duplication of efforts in jurisdictions and the development of short-term peer working groups would facilitate peer learning for non-English speakers.

Lessons from Digital Frontiers’ CBDC Workshop and the Need for Capacity Building

The recent CBDC Workshop had three live discussions that covered different topics each day with a panel of experts.

CBDC and the Central Bank Mandate

The first day of the workshop covered how to ensure that in the exploration of CBDCs jurisdictions don’t have mandate creep. As most central banks’ mandates are monetary and financial stability, there remained the question of how much consumer data could be used for AML/CFT compliance. This was an identified capacity building gap, as financial integrity is a central bank function but not a central bank mandate. The privacy line is a thin line to balance to ensure consumer buy-in for a jurisdiction’s CBDC.

Furthermore, the discussions moved to the potential financial stability risks of a CBDC if it is not well designed or not launched carefully, as it may cause a digital bank run. Finally, we closed off the discussion with a very important point: a key feature of a CBDC is that it must be interoperable.

Many Considerations in the CBDC Pathway

On our second day, during three breakout room discussions, we discussed three important considerations in the CBDC pathway: stakeholder mapping, engagement and collaboration; commercial banks’ concerns and consumer buy-in; and potential financial inclusion opportunities of CBDCs. From these discussions came mixed outcomes, also alluding to some capacity gaps and limited understanding, especially of the importance of stakeholder engagement and collaboration.

Practical Next Steps

On our final day of the workshop’s live discussions, we discussed the practical next steps, given that most emerging market and developing economies do not have the prerequisite legal and digital infrastructure required to pilot a CBDC, which is where they would need to start.

But the main challenge is, do they know what they do not know? There are still so many other considerations that financial authorities need to consider with their stakeholders, but before they get there, they need to get their foundations right.

So, Where Do We Go From Here?

Financial authorities need to consider their next steps in an intentional and prudent manner to ensure that they build their CBDC well so consumers can trust and buy into it.

  • The first step is capacity building. Through the CBDC Workshop and many of our Digital Frontiers Institute courses, we have seen the capacity gaps and willingness to learn more about CBDCs by financial authorities. Through capacity building, financial authorities and their stakeholders will understand the key definitions, concepts and considerations needed for a CBDC.
  • The second step is stakeholder mapping. The governance of a CBDC is key towards its successful development, pilot and eventual launch. Therefore, each jurisdiction needs to understand the stakeholders that need to be in their governance team and not copy from other jurisdictions.
  • The third step is to conduct a diagnostic of their jurisdiction to understand how much needs to be done to meet the prerequisites of a CBDC regarding legal and digital infrastructure.
  • The fourth step is to conduct the foundational research, which is understanding the specific motivations for a CBDC in the specific jurisdiction. Many emerging market and developing economies use financial inclusion as the main motivation for a CBDC.

Financial authorities can learn from their peers when conducting each of these steps, but they must remember this important point: each context is different.

About the Author

Nolwazi Hlophe is the Deputy Director Financial Regulation and Supervision with Digital Frontiers. She obtained her MCom in Economics from the University of Pretoria in 2016. Hlophe previously worked for Cenfri as a Senior Researcher within the Risk, Remittances and Integrity Program and the Central Bank of eSwatini as a Macroprudential Analyst from which she moved on to Manage the CBE Intelligence Hub, which managed the activities of the newly established Fintech Unit.

About Digital Frontiers

Digital Frontiers is an African not-for-profit capacity building specialist, focused on building human capital aligned with the U.N. Sustainable Development Goals. Digital Frontiers incorporates the Digital Frontiers Institute (DFI) and Gateway. DFI is a digital-first-but-blended school that delivers the teaching and administration of portfolios of courses to thousands of students in low-and-middle-income countries.

Digital Frontiers was founded in 2015 by David Porteous, Gavin Krugel and Ignacio Mas, with seed funding from Omidyar and has since had long-term funding partnerships with Mastercard Foundation, FSD Africa, Bill and Melinda Gates Foundation and Flourish. Headquartered in Cape Town, South Africa, Digital Frontiers has a distributed team in over 18 countries focused on supporting our student base in the projects we deliver.

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CBDC, Education, Capacity Building, Digital Currencies