Why can’t the Central Banks (in our case the Reserve Bank) issue digital currency bypassing the commercial banks?

Think of the unobvious, when the obvious does not look promising, especially in a crisis where currency is in short supply.

Commercial banks are intermediaries, in the business of profiting from a spread between interest rates they charge to debtors vis-à-vis the interest rates they pay on deposits kept by the depositors. They are the biggest middlemen in the business of money exchange and they do a great duty.

Investment banks, by the way is another matter.

But think of it, if every transaction could be done in digital currency directly from the money released from Central Banks, what role would we have for commercial banks to play in terms of intermediation? The Central Bank would be the sole agency to determine the flow and level of digital money in circulation so that some broader social and economic goals could be kept like inflation or output levels or unemployment reduction. Is this feasible, given the objectives of central banks versus the objectives of the monetary transmission? Could this be done efficiently?

This is almost equivalent of helicopter money, but in a digitized form, with some norms of access and control.

For a country where sophistication in digitization has progressed quite far, like Switzerland or Singapore, this could be a no-brainer to implement, at least as per this report. The usual problems of the poor devaluing their wealth in such a situation or an asymmetric demand-supply could be far better managed in a smaller economy that is also better on income equality.

For a country like India, it would raise concerns for inequity. It would benefit those with quick access to digital money against those with no access at all. It could also mean that in the entire supply chain of money for every value chain, there would be missing links and therefore the proposal would have multiple disruptions. It could cause hyper-inflation as the newly created money directly accessed by the poor would create immediate shocks in demand and supply.

But think of it, do we have a system that is based on equitable allocation in the first place? Does every citizen have similar and cogent access to non-digitized money as every other? Of course this is not the case. The access to non-digitized form of money depends on so many factors; economic ones are the most potent.

The bigger reason why such a proposal has seen road bumps is because the banks presumably are the stumbling block in more good ways than bad ways. They add value towards many transactions, the most talked about is that they connect constituencies in need of funds with those who have apparent access, they provide micro-financing to the needy and they have the fiduciary duty to protect a depositor as well as a lender within the applicable laws. Many of the loans that the banks dole out could not have seen the light of day had the banks not applied their strategic as well as economy-building duty while keeping their fiduciary responsibility intact. Many of these transactions, including cross border, are fueled through collaterals of all kind.

Of the plethora of instruments that the banks use, some of them quite frighteningly difficult to gauge is in the risk management area, many have been off-shelved to the shadow banking system. The basic commercial banking job still is to facilitate borrowing and lending.

In short the economies could be coming to a grinding halt if any attempt is made to bypass the work done by commercial banks in disbursing funds to the needy while allowing those with excess to be safely parked.

But Singapore is already toying with the idea of removing intermediaries between banks or making an attempt where the Central bank could be the direct conduit to citizens bypassing the banks. The commercial activities of the banks could still continue but a substantial part of the retail transactions could be done directly without their interventions. Bank to bank transactions could also happen without any intermediary.

In fact we have seen monetary transmission being weak at all points of the interest rate cycles, they are weak when the rates are too high or too low or when they are in the middle range. The Commercial banks have failed to make the transmission smooth, which means whatever be the Fed Fund rate or the PLR there exists a widening gap with the actual interest rates in vogue in the retail transactions as the business cycles progress.

India is far out in the woods for such an experiment, but India has surprised almost everyone with the demonetization move, another innovative step like this one in due course may not be a bigger one.

The fact remains that banks as intermediaries must play a valuable role in transmission of money supply. They have to see how best to make this transmission smooth. At least for now in India they have no other duty than this figuratively or even otherwise.

The Reserve Bank must look at unprecedented and far bigger innovative moves to make currency move to the populace. Unconventional thinking is the need of the hour and we have not seen much in that area.

By declaring an unprecedented 100% incremental CRR, we have on the contrary a regressive step, no matter how clinically correct it might be for the balancing of collaterals. Now we need to see far greater innovation than just the logistics business we have seen so far.

The logistics of money, like the logistics of goods, moves better with innovation.