Could digital currencies put banks out of business? | The Economist

Banks are one of the engines of the modern economy, but the way they function is under threat. Tech payments giants and

digital

currencies

are revolutionizing the way people use money and this

could

have dramatic consequences far beyond banking; It

could

affect consumer privacy, government power, and the stability of the entire financial system. It's hard to overstate how radically different that world could be from the one we live in now. So what would a world without

banks

be like? What if you would even miss them? The fundamental principles of banking have been the same. for centuries and revolves around the biggest magic trick of all, how to create money, it's called fractional reserve banking, that's how it started hundreds of years ago,

banks

were storing gold for investors, but they realized it was little Everyone was likely to claim their gold at the same time so they started lending some of these gold deposits to other people, this generated money for the bank through interest and helped boost the economy by allowing idle deposits to drive new

business

. and commerce.

As time went on, banks began issuing banknotes or bills instead of physically issuing them. spread gold and these ious began to be traded in the economy, this meant that the amount of money in circulation was much greater than the value of gold in the hands of the banks, so bank loans in effect created new money today Most money is

digital

when the bank makes a loan, creates a new asset on its balance sheet, and credits the borrower's account with new funds, creating a new deposit. The fundamental principle is the same every time the bank makes a new loan, it creates new money, in fact, ninety percent of the money. in the world are digital deposits that have been created by banks in this way.

This is of great importance for the economy. What it means is that banks can respond to the demands for money in an economy and that means that their supply of money in the economy is very elastic, there is no fixed amount of money in circulation, so if the economy is boom and more goods are created, thanks to fractional reserve banking, the money supply should also increase as people take out loans and make new investments. How banks can create money is largely controlled by central banks, such as the Federal Reserve, which sets interest rates, if interest rates are high.

Banks pass those costs on to borrowers, making it more expensive for them to borrow money to buy things, so banks create less new money. Banks also supply money for use in the economy, printing the physical paper cash that people carry with them, so banks and central banks balance the need to create money between them. That kind of balance means that you know that money can easily grow with demand, but also that the central bank has a kind of direct presence in payments and transactions, but this delicate balance is threatened thanks to a revolution in the way it people use money to start.

An increasing number of companies no longer depend on banks for loans. This is because historically companies used to do it. create concrete assets, such as machinery, that banks would be happy to lend against, they could always reclaim the assets if the borrower defaulted, you know you are trustworthy, but intangible assets, such as software, cannot be easily published as collateral for a bank loan, the world has changed. in a way that makes it difficult for banks to finance the most innovative parts of the economy. If you want to raise funding as a Silicon Valley startup, you'll generally need to go to people who are equity investors to make a decision. part of their

business

in exchange for some money and it is not just innovative start-ups that look elsewhere for funding.

Since the 1950s, the share of bank loans as a percentage of GDP has remained relatively stable at the same time as Non-bank loans and securities have risen. Clearly, this means that the role banks play in financing major businesses is receding and that is not the way people move and spend their money. It's also changing thanks in part to a new breed of mega apps from China, one of the most popular being Chinese tech Alipay. giant ant group has more than 1 billion users and handles 16 trillion dollars in payments in 2019. I'm Alipay. I have a dream to create a world where mobile payments replace cash payments instead of using bank cards to make payments.

Alipay customers transact by loading money into digital wallets, they can do anything from buying lunch to investing in stocks and shares, all without leaving the app and instead of paying expensive international transaction fees to their bank. Alipay users can also use the app abroad. even in the United States, you know Walgreens in the states, except alipay, these kinds of new digital payments. The ecosystem completely ignores nation states and national borders. It's not just Alipay. Facebook is developing its own digital currency and Amazon is also working on financial services. Some are concerned about this. could concentrate too much power in the hands of a few technology companies, but for central bankers the problem is even more serious: they fear that these events could completely cut the cord between the central bank and the economy.

The super apps in China that now started like they make payments and now they provide loans, they provide investment services, they provide insurance, you know, they do all the things that banks do. Central bankers feel that their ability to oversee and conduct monetary policy and supervision is, you know, fundamentally declining. far away, so some central banks have taken radical steps by creating their own digital

currencies

to rival the payment systems of the tech giants in the hope that this will ensure their control of the economy. Central bankers' level of discomfort is potentially prompting them to act to change this. learn about the economic system, the monetary system that has underpinned modern economies for 250 years, China is one of the largest economies leading the way in testing a digital system.

You may have heard of bitcoin or other digital money that is supposed to disrupt finances, but it is digital. Currency issued by governments in this way could be even more radical. Is that how it works. Most central bank money is held by commercial banks as reserves against customer deposits. Only a small amount of this government-created money can be accessed through physical bills and coins. Physical cash is issued by the central bank in the United Kingdom. The banknotes are even signed by the chief cashier of the Bank of England. Central bank digital currency or CBDC is a bit like digital cash in that it gives the consumer a direct relationship with the central bank.

So in theory, instead of keeping your money in a commercial bank, you could keep all your money in the federal reserve or the Bank of England. CBDCs are only being used or tested in a handful of countries around the world, but they are growing rapidly, 80 percent by central banks. Banks are considering issuing them in the future The Bank for International Settlements, which is a club of central bankers, says that within three years a fifth of the world will live in countries that have this central bank digital money, this could change everything if everyone puts their money into a cbdc then fractional reserve banks could be put out of business, this could affect economic growth as they would not be able to rely on consumer deposits to fund their loans and this would be particularly pronounced in the world in development, where the majority of loans still come from banks, but that is just the beginning, there are also concerns about the possibility of cyber war because if the servers supporting the central bank's digital wallet system can be disabled, then an entire economy could be shut down.

Digital currencies could also increase the potential for state intervention in everyday life. transactions, it becomes much easier for governments to completely block your ability to pay for something. It's very easy to imagine that you know that maybe you could program, you know, money in China so that it couldn't be used to pay for foreign books or newspapers. Sellers who support CBDC say they could lead to a world where more people have access to financial services and it is cheaper and easier to move money across borders, but innovations like this could also upset the financial balance and give governments much greater control over their citizens' money and live like that, although for the first time in modern history it is possible to imagine a world without banks, you may find that you would miss them if they disappeared.

I'm Alice Forward, The Economist's Wall Street correspondent, if you'd like to read more. About the future of banking. I have written a special report on the topic which you can find by clicking the link. Thanks for watching.