What impact could the introduction of central bank digital currencies have on the financial sector: analysis based on CBDC news

Information technology and digital finance, both centralized or decentralized, are becoming increasingly relevant and allow increasing financial inclusion among various segments of the population. Traditional financial institutions are being disrupted and face a shift in banking, investing and payment processing to become increasingly digitized and disintermediated. A wide range of new innovations in financial products and services (such as real-time payments, online lending and various financial services via mobile phones) have seen explosive growth. In turn, the digital transformation that occurred during the pandemic has accelerated the process of decentralization of finance. This rapid digitalization of the entire global financial system has called for the creation of a new form of fiat asset - central bank digital currency (CBDC) which is a centralized virtual currency. According to many regulators, its implementation can play a decisive role in ensuring financial stability. It can help to build a more advanced payment system and improve monetary policy.

The Federal Reserve System (FRS) defines  CBDC as “a digital obligation of a central bank that is publicly available to the general public”. CBDC is a form of digital currency, but it is different from numerous types of private digital currencies (cryptocurrencies), which are related to recurring price bubbles exhibiting extreme volatility and dynamic nature. By implementing CBDC, central banks can maintain government control over the money supply in the economy and, at the same time, benefit from digital technologies. A recent study by the Bank for International Settlements (BIS) found that 9 out of 10 monetary authorities are currently studying, and more than half are developing, CBDC. However, despite the potential benefits, the introduction of digital currencies outside the current financial system may reduce competition and create data privacy issues.

In the report, the National Bank of the Republic of Kazakhstan (NB RK) examined these difficulties associated with the introduction of the digital tenge (DT). NB RK excludes possible competition between the regulator and commercial banks, since in the long term, at a zero interest rate, the volume of demand for district heating will be in the range from 5.7% to 6.2% of GDP. The profitability of commercial banks and other financial organizations will not change, since DT is not an alternative to a bank deposit and does not affect lending in the economy, but will be used as a means of payment. In addition, the DT model is hybrid and is based on a two-tier banking system. Thus, NB RK will still not interact with consumers. All services will be provided by commercial financial institutions. As for confidentiality, NB RK notes this aspect as one of the three most important components when providing information security. So, NB RK conducts a thorough analysis of all possible threats. NB RK has tried to study in as much detail as possible what benefits and dangers DT includes, but the question of how its implementation will affect the economy of Kazakhstan still remains open.

Few studies examine how current discussions about CBDC among regulators and the media influence the behavior of financial markets. In addition, since the CBDC is in the early stages of development and implementation, there is a lack of data that could reflect the behavior of the CBDC, making it difficult to analyze the impact of CBDC on financial markets. A study (Wang et al., 2022) attempts to fill this gap. The authors developed two new CBDC indices: the CBDCI Uncertainty Index (CBDCUI) and the CBDCAI Attention Index (CBDCAI). It has been done to analyze quantitatively how discussions and news related to the implementation of CBDC affect the volatility of various financial markets. These indices not only track current CBDC news trends, but also present their changes over time and their relationship with other measures of uncertainty and attention. The study results show that both the aggregate positive and negative impacts of CBDCUI violations on financial variables are greater than the impact of CBDCAI violations. This suggests that the uncertainty surrounding CBDC news plays a larger role than just attention to these new digital assets, suggesting that the adoption of CBDC could lead to significant changes in the economy.

The authors examined how news of the implementation of CBDC affects the cryptocurrency markets, commercial banking sector, bond and gold markets, foreign exchange and stock markets. These studies cover the main period of development of CBDC and the period of the most active discussion of this new asset in the media, that is, from January 2015 to June 2021.

CBDC indices have a significant positive relationship with the volatility of foreign exchange markets. As increased uncertainty and attention to CBDC can motivate currency traders to reduce or increase their net long positions due to the characteristics of CBDC stablecoins. Thus, CBDC can directly cause exchange rate fluctuations. In other words, if uncertainty or attention to securities increases, then volatility in the foreign exchange markets increases. The authors note that CBDC can increase the liquidity of currencies, which also means that the cost of circulation of the currency decreases and foreign exchange transactions become easier to carry out. Thus, the cost of speculative activities in foreign exchange will decrease and speculative activities in foreign exchange will increase, leading to greater fluctuations in the foreign exchange markets. This is especially true for the yuan due to the development of cross-border transactions using the electronic yuan. The exchange rates of the yuan will definitely become more volatile.

In addition, since CBDC is a fiat currency, according to the authors, the influx of supply could lead to inflation. Undoubtedly, liquidity will increase due to the development of CBDC, but excess supply, in turn, will cause an increase in inflation rates. In these circumstances, an increase in one country's inflation rate will increase the volatility of its currency's exchange rate.

Considering the structure of Kazakhstan’s exports and imports for 2022 excluding oil and other minerals, it can be noted a significant excess of imports (46.7 billion US dollars) over exports (27.1 billion US dollars) in value terms. Given that Kazakhstan has a high share of imported goods in the domestic market, the volatility of the exchange rate (especially the tenge to the US dollar) is one of the main problems that should be taken into account when introducing DT. High volatility of the exchange rate causes uncertainty for business, a decrease in investment activity, a drop in the purchasing power of the population and financial instability.

CBDC indices have a significant positive relationship with gold market volatility. This empirical evidence supports the authors' idea that CBDC can lead to inflation, since favorable news about CBDC sharply increases CBDC indices as a whole, and gold is an inflation hedge asset. Nowadays there is a widely discussed point of view that CBDC can serve as a stable coin, and it is preferable to use CBDC as a protective asset rather than traditional gold. As the uncertainty of CBDC increases, speculative activity in relation to gold as a safe asset will increase, which will lead to fluctuations in gold prices.

In July 2023, the international reserves of NB RK contained gold worth 19.5 million US dollars, which is 56.5% of international reserves. In terms of gold reserves, Kazakhstan ranks 16th in the world. Given that gold accounts for more than half of international reserves, high fluctuations in gold prices could lead to significant uncertainty regarding the international reserves of NB RK.

CBDC indices have a significant negative impact on the volatility of the MSCI World Banks Index, which reflects the performance and price changes of banking companies around the world. This empirical finding allowed the authors to conclude that CBDC can balance the banking system, reduce shadow banking activities and the extent of irregularities.

There is a significant negative relationship between CBDC indices and the FTSE All-World Index, which includes companies from different countries, providing investors with an opportunity to gauge the performance and movement of global equity markets. In this way, CBDC can improve financial inclusion, mitigate systemic financial risk and increase GDP. However, at the same time, the CBDC indices have a significant positive relationship with the volatility of the VIX index, which, like the previous one, is associated with the stock market and measures the expected volatility of the market for a certain future time. The paper explains the differences in responses to CBDC shocks by the scale of the indices and the markets they represent. The VIX focuses on large companies in the US financial market, while the FTSE All-World Index is an international stock market index that covers more than 3100 companies in 47 countries.

CBDC indices have a positive impact on the FTSE World Government Bond Index, which the authors explain as follows. First, the CBDC could challenge the solvency of commercial banks, change the international monetary system and cause negative interest rates. Moreover, a CBDC issued by one country may increase asymmetries in the international monetary system, having a negative impact on monetary policy autonomy and welfare in other countries. These potential characteristics of CBDC could destabilize the financial system. The lower the financial stability, the higher the volatility of bond markets, especially government bond markets. Second, exchange rate mechanisms and regimes also have a positive impact on the volatility of government bond markets. Since CBDC indices have a positive impact on exchange rate volatility, they will certainly contribute a positive shock to the volatility of the FTSE World Government Bond Index. In addition, the positive relationship between CBDC indices and bond market volatility can also be interpreted as public concern regarding the implementation of CBDC.

The authors found that high values of the CBDC uncertainty index are caused by unfavorable news regarding cryptocurrency outbreaks. Noted that CBDC acts as a “cryptocurrency counter,” cryptocurrency investors may increase their transactional and speculative activity, which will increase uncertainty in the relevant markets. For example, during an all-time high and record high transaction volume for Bitcoin, the cryptocurrency markets experience extreme volatility and uncertainty, and these fluctuations may be transferred to CBDC.

The study of the impact of the introduction of digital currency exchange on the cryptocurrency market became the main goal of the article (Husam Helmi et al., 2023). The authors base the findings of the previous article and conducted their own analysis. The work aims to study how news about CBDC affects financial and cryptocurrency markets. The sample of assessments contains significant developments in the cryptocurrency market, news about countries' attempts to implement digital currency exchange rates, and the COVID-19 pandemic, which is leading to a devastating downturn in global economic activity. For the analysis, the authors use data from 2015 to 2021.

The key finding of the study shows that CBDC news has a negative and significant impact on the profitability of cryptocurrencies, particularly bitcoins. This effect is especially pronounced at a time when there is more news about the adoption or development of CBDC. The results also show that CBDC news shocks have a positive and significant effect on cryptocurrency uncertainty. Therefore, given this evidence, it is reasonable to conclude that widespread adoption of CBDC could help central banks and other regulators coordinate cryptocurrency markets, and, subject to these conditions, conduct independent monetary policy.