How are Central banks in GCC responding to Digital Currencies?

07/05/2023 | by Marmore MENA Intelligence

Central Bank Digital Currencies (CBDCs) are digital currencies issued by a Central Bank that is pegged to the national unit of account and functions as the institution’s liability. It can be roughly categorised into Retail CBDC (also known as general purpose CBDC) and wholesale CBDC. Retail CBDC helps to facilitate transactions between individuals and businesses whereas wholesale CBDC helps to facilitate transactions only between financial institutions. So far, only 11 countries [[1]] have successfully launched CBDC including Bahamas’s Sand Dollar, Nigeria’s eNaira, Jamaica’s JAM-DEX and DCash of Eastern Caribbean Currency Union (comprising 8 member countries). Other central banks around the world are in different stages of research and development of both retail CBDCs and wholesale CBDCs. For instance, the UK initiated Project Rosalind to create prototype for their retail CBDC while Canada along with the UK and Singapore completed four phases of their wholesale CBDC Project Jasper.

The adoption of digital modes of payments have risen post-COVID-19 in the GCC, which is evident from the spike in the ratio between Point-of-Sale transactions to ATM Withdrawals. As users are now more confident about digital payments and find this form of transaction convenient, there is a high likelihood that the adoption of CBDCs could also be much quicker.  
How are Central banks in GCC responding to Digital Currencies? chart

Source: Saudi Central Bank Authority, Central Bank of Kuwait, Central Bank of Bahrain

Past 5-year data shows that the ratio of point-of-sale transaction to the ATM withdrawal has considerably increased suggesting that people’s reliance on cash for payments and transactions has decreased. Even before pandemic, Saudi Arabia saw a steep growth in card payments of over 70 percent [[2]] between February 2019 and January 2020. The declining cash usage has drawn the attention of the Central banks in GCC and to intervene in the payment systems, they have started experimenting CBDC use cases by conducting pilot projects domestically as well as globally.

Motivations behind issuing CBDC:

Retail CBDCs have the potential to boost financial inclusion. It lays a foundation for new and potentially cheaper financial services as well as access to a digital payment method to the unbanked and underbanked population. In GCC, around 22 percent [[3]] of the population is still unbanked. Individuals who do not have bank account or have limited access can access CBDC using a mobile phone or a digital wallet. Smartphone penetration in GCC stands at 96 percent [[4]] which further quickens the adoption of CBDC. The central bank broadens the usage of a digital currency by supplying a medium with a direct claim on it through the issuance of a CBDC. It would also imply a diversity of payment options, increasing choice and competitiveness in the payments sector. Access to CBDC would extend the security of central bank money to a wider range of payment applications, improving system stability overall unlike cryptocurrencies such as bitcoin. Furthermore, it will increase the payment transparency for the central bank thereby preventing money laundering and the financing of terrorism. Wholesale CBDCs can increase the efficiency of cross-border payments, making them faster, cheaper and more convenient. Users, especially expats, can make instant transaction without the need for intermediaries such as commercial banks. Once when the infrastructure is completely set-up, the cost of producing CBDCs would be lower than the physical currencies, thereby increasing seigniorage revenue for central banks.

Status of CBDC in GCC:

In November 2020, the Saudi Arabian Monetary Authority (SAMA) announced that it had completed a pilot project for a wholesale CBDC, called "Aber" (acronym for “crossing” in Arabic) in collaboration with the Central Bank of United Arab Emirates (CBUAE) [[5]]. The main objective of Project Aber was to assess the feasibility and potential benefits of using a CBDC for cross-border payments and to identify any challenges or risks associated with the implementation of a digital currency system. The results of the pilot project were positive, and the two central banks concluded that a CBDC could offer several advantages over traditional cross-border payment methods, including faster transaction times, lower costs, and increased transparency and security.

In May 2021, Central Bank of Bahrain announced digital currency settlement collaboration with Bank ABC and J. P. Morgan [[6]]. The first test was successfully completed with Onyx by J.P. Morgan’s JPM Coin System in January 2022. The test enabled Bank ABC to initiate real-time payments for Aluminium Bahrain (ALBA) to benefit ALBA's counterparties in the United States.

In October 2022, as part of Project mBridge, the Central Bank of the UAE (CBUAE) successfully completed the first and largest scale central bank digital currency pilot, in collaboration with the Hong Kong Monetary Authority, the Bank of Thailand, the Digital Currency Institute of the People's Bank of China, and the Bank for International Settlements (BIS). Twenty commercial banks used the pilot to conduct over 160 payments and foreign exchange transactions totalling over AED 80 million [[7]] (USD 22 million) over a six-week period. The project mBridge demonstrated quicker, more affordable, and secure cross-border monetary settlements utilizing central bank money, which was recognized as a G20 economic priority. Recently, CBUAE has inked a MoU with Reserve Bank of India for promoting various emerging areas of fintech, especially CBDC cross-border transactions. [[8]]

In March 2023 [[9]], as part of the implementation of domestic CBDC covering wholesale and retail segment, the Central Bank of the UAE (CBUAE) has signed an agreement with Abu Dhabi’s G42 Cloud (AI and Cloud Computing Company) and R3 (digital finance services provider) to be the infrastructure and technology providers respectively.

Difficulties and Challenges associated with CBDC:

The implementation of CBDC involves several steps, including the design of the CBDC, the development of the underlying technology and the establishment of the necessary infrastructure for its issuance and use. CBDCs need a sophisticated technological infrastructure, including secure and reliable payment systems, cutting-edge encryption, and mechanisms for digital identity verification. Privacy and anonymity of cash will not reflect in CBDC transactions as central banks have complete access. Central Banks will also be sitting on volumes of data and even a tiny data breach will have grave consequences. One of the main potential difficulties with issuing a CBDC is the legal and regulatory element. While central banks in GCC have the legal authority to issue a CBDC but the legislation must be changed to address several legal concerns.

If households substitute banknotes with retail CBDC or if only commercial banks distribute retail CBDC, then central bank and commercial bank have no issues. However, if households withdraw commercial bank deposits to recharge their CBDC wallets, then this would imply a funding loss, reduction in credit growth and impact on lending rate for commercial banks and could lead to disintermediation of the banking sector. Increasing payment digitalisation does not necessarily mean increasing financial literacy and hence awareness programmes must be conducted by the central banks to not leave out any segment of the population.

Central Banks have been actively experimenting CBDCs, both retail and wholesale, with majority focus on the latter. As part of the Vision 2030, Saudi Arabia has committed to increase the share of cashless operations to 70% of total transactions [[10]] by 2025 thereby developing digital infrastructure. Furthermore, the first phase of CBUAE’s CBDC strategy, being one of the nine initiatives of the CBUAE’s Financial Infrastructure Transformation (FIT) programme, is expected to be completed over the next 12 to 15 months [[11]] and mainly comprises three major pillars, the soft launch of mBridge, proof-of-concept work for bilateral CBDC bridges with India and proof-of-concept work for Digital Dirham. While KSA and UAE have already conducted pilot projects, Central Bank of Kuwait led Kuwait National Payment System (KNPS) whose objectives include issuance of CBDC. Other central banks have a long way to go as they are still in the foundation stage in CBDC issuance. Nevertheless, while technological and regulatory aspects of CBDCs are improved, it is likely that CBDCs will be a part of the payment systems in GCC as well. The pace of implementation may widely vary between the nations depending on the central banks’ efforts.

[1] Central Bank Digital Currency Tracker, Atlantic Council

[2] McKinsey & Co. report,” The future of payments in the Middle East”

[3] PwC Report

[4] Statista

[5] Project Aber Report by Saudi Arabian Monetary Authority

[6] Central Bank of Bahrain

[7] BIS Innovation Hub

[8] Financial Express

[9] Central Bank of UAE

[10] KSA Vision 2030

[11] Central Bank of UAE