PART 4: Excerpt from Positive Money NZ’s submission to Parliament’s Finance and Expenditure Committee, September 2019.
At the core of our proposed system is the ‘unbundling’ of the payments and lending functions of commercial banks.
Instead of demand deposits being held in accounts at commercial banks, they are held in individual accounts (‘Transaction Accounts’) at the Reserve Bank. These funds — digital ‘Sovereign Money’ — are a form of Central Bank Digital Currency (CBDC).
A CBDC gets its value and trust from a central authority, i.e. the government through its central bank. Cryptocurrencies such as Bitcoin, on the other hand, are deliberately designed to sidestep central authorities. They use distributed technologies such as blockchain and distributed ledgers to provide trust where there is no central authority. As such, they are often seen as an electronic substitute for (anonymous) physical cash.
Unlike cryptocurrencies, CBDCs like the one described here can scale well. They do not require cryptocurrencies’ massive amounts of computing power and electricity. They mesh seamlessly with existing ways of doing things and they support the high transaction rates required for payment systems.
How Sovereign Money functions as a Central Bank Digital Currency
Under the current model, each (registered) commercial bank holds customer funds and runs its own payment system within the bank. The Reserve Bank then acts as a ‘clearing house’ to settle payments between banks.
With the proposed Transaction Account model, all payments are made directly through this Reserve Bank system which is simpler to regulate and, importantly, safer.
And because all transactions — both within and between banks — happen directly within the Reserve Bank payments system, banks can no longer create new money. The simple double-entry bookkeeping procedure that underpins current bank money-creation is no longer available to them.
From a customer’s point of view, nothing changes as their bank or payment service provider is still the point of access to their money. But with their deposits in Reserve Bank Transaction Accounts, they are now completely protected in the event of a bank failure.
However, Transaction Accounts earn no interest. To earn interest, customers open an Investment Account with their commercial bank. These deposits are subject to minimum terms or notice periods, like term deposits today. It’s these funds that are available to banks for lending. While they earn interest, they are also subject to risk in the event of bank failure.
Lending then happens in the way most people and textbooks expect it to — through banks acting as pure intermediaries, taking in deposits and lending them out with an interest margin. It’s the same way that non-bank lenders, such as cooperatives, finance companies, and building societies operate today.
The open banking revolution — Unbundling of banking has begun in New Zealand
Commercial banks are being pushed to open up customer data and payment systems to competitors, such as non-bank payment service providers. This move to ‘unbundle’ banking functions is called ‘Open Banking.’
An API (application programming interface) gives one computer restricted access to another. For example, APIs allow apps to access certain data from Facebook user accounts.
It’s also the way that commercial banks would access customer data held in Transaction Accounts at the Reserve Bank. In this respect, Sovereign Money implementation would mirror the way Open Banking works but with an important caveat.
The digital payments infrastructure should be publicly owned
Payments NZ is an industry-led consortium. In our view, control of New Zealand’s money and payment system is too important to be split among numerous private banks and left to an industry consortium to manage. This system — a legacy of the paper-based world — worked in the past but at present increases risk and regulatory complexity.
We recommend that New Zealand follow the lead taken by some other central banks (including the Bank of England) and move to centralise control of the payment system.
Tighter control of money and customer data will serve New Zealand much better as new entrants from fintech start-ups to powerful tech conglomerates (such as Facebook, Google, Amazon, and Apple) seek access.
The threat of a private global digital currency
As Facebook has shown with its Libra currency initiative, the potential now exists for new private currencies to undermine national currencies. Such threats are real and just around the corner.
Libra’s design (and probably its intention) will allow it to serve as an alternative currency, not just for foreign transactions but for purchases between parties within the same country. It’s likely it will also expand its services to lending.
The reach of Facebook and its partners makes it conceivable that the share of Libra transactions inside New Zealand’s domestic economy could make it a systemic threat and complicate economic management — as it would be effectively competing with the NZ dollar on its home turf.
How Sovereign Money can lower risk while encouraging financial innovation
We know that the public’s demand for new financial products and convenient digital access to their money will only increase, driven further and faster by the Open Banking movement.
The New Zealand Government must take steps to satisfy this demand while increasing the security, control, and value of our national currency.
Sovereign Money can provide the foundation that we need.
- Its design is digital from the ground up, unlike the current system which retrofits a paper-based legacy system
- At its core, it includes a central bank digital currency
- It can support financial innovation through initiatives such as Open Banking while improving security and control
- Its regulatory system is designed to improve government control over New Zealand’s currency — a prudent move as new threats and opportunities rapidly emerge
- It secures cash deposits at a time of higher risk from rapid technology change and competition
As we face far-reaching, technology-driven change, our response must begin with a ʻfirst principles’ re-examination of money itself. Today’s fiat money is a social construct, not a commodity. It’s defined by rules and backed solely by trust in its issuer. We make those rules and create that trust.
Now is the time to examine our money system’s very foundations. Perhaps that will mean some new rules or features that will work better to protect our dollar’s status as the trusted unit of account, store of value, and means of payment.
For a time like now, we need to lead this reform from the driver’s seat, not from the passenger seat as a mere regulator or even worse — from the back seat as a powerless spectator.