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The Future Of Banking: China's Digital Renminbi Could Hit Payment Platforms

China is the first G-20 country to trial a digital currency. S&P Global Ratings believes any success or failures will offer lessons to other aspiring nations. While the trial started small, it has large implications for the future of banking.

The People's Bank of China (PBOC) conducted the trial in October 2020, by distributing Chinese renminbi 10 million (about US$1.5 million) in tokens of Digital Currency Electronic Payment (DCEP, or digital renminbi for simplicity purposes) to users in the city of Shenzhen. Users were able to make purchases at selected stores via a designated approved software application (app). After a transaction, the ownership title of the digital renminbi changes hands from the customer to the merchant and this is registered with the PBOC.

Should this trial lead to broader adoption, we expect digital renminbi would predominately be a payment tool rather than a storage of wealth. Given that DCEP will not bear interest, at this time, it will not likely replace bank deposits for savings. However, it may provide a cheaper and more convenient way of paying for retail items, and in this sphere will compete with payment services provided by payment companies and commercial banks.

Key Questions

How is digital renminbi different from cash or other types of electronic payments?

In our view, the direct link maintained between the central bank and the token digital renminbi (attached with the owner's information) is the key differentiator from paper and e-money (electronic forms of money such as bank deposits and surplus balances in payment companies).

It differs from paper because digital renminbi has the owner's "name" on it. It's different from e-money due to the direct link with the PBOC rather than via a commercial banking intermediary or payment agency. Importantly, because ownership of the digital renminbi never transfers to the commercial bank, digital currencies are not deposits in our view and do not sit on balance sheets of the commercial banks. DCEP remains a direct liability to the PBOC, same as cash and coins.

Could digital renminbi take off, and if so, what does this mean for commercial banks and payments business?

A digital renminbi could be popular for payments, given it reduces transaction costs for users. Because both the sender and recipient of the tokens benefit from the common link with PBOC, settlement and clearing is more efficient and the process cuts out some intermediary services, in our view. The concept is similar to "pay cash, pay less," so broad use of such alternatives could lead to lower fee revenue of payment service intermediaries. This includes payment processors such as Unionpay and online payment platforms such as Alipay and WeChat Pay.

We believe the payments sector would still compete for digital renminbi business to meet customer needs and ultimately derive income from providing holistic customer experiences. The size of investment costs is also another consideration to be taken into account for latecomers to the e-wallet game. Relative to banks that are already offering popular e-wallet services, the latecomers could find the cost to benefit of offering digital renminbi a difficult formula to square.

For digital renminbi to be widely adopted, it would have to offer additional utility or convenience over e-money. One benefit is that, like cash, DCEP transactions do not require networks like credit cards or e-wallet apps. It has offline transaction capabilities, which can be enabled by instant Near Field Communication (NFC) verification; though some steps, such as balance updates, will require internet. While there are clear benefits, an established token recovery process (for lost mobile devices and other mishaps) would likely be needed for digital renminbi to become a mainstream storage of wealth. There could also be additional security risk associated with offline capabilities that may necessitate more control.

We expect customer service functions to be performed by commercial entities, while backstage tech enhancements will be a collaborative effort between the commercial banks and the central monetary authority. Commercial banks and payment companies are set to act as agents in the payment business, developing or enhancing their e-wallets to cater for this additional digital renminbi payment option. We believe the current rules on account-opening background checks and operational limits also apply to digital renminbi e-wallet functions.

In China, retail e-payments is dominated by Alipay and WeChat Pay, which are in turn associated with two of China's biggest tech groups, Alibaba Group Holding Ltd. and Tencent Holdings Ltd. Given their links to leading e-commerce and social media companies, we expect user stickiness to help the platforms maintain a clear lead over commercial bank hopefuls.

Chart 1


We anticipate the competitive dynamics between Chinese commercial banks and tech-backed payment companies will persist following the rollout of digital renminbi. Chinese commercial banks dominate the payment share market for big ticket and wholesale transactions because of their large corporate customer networks (see chart 1). In addition, large transactions may require the accompanying of substantial working capital facilities, a balance sheet business familiar to banks. We do not expect tech-backed lending services to move into large ticket loans because of lower margins and their lack of capital. While it is possible that digital renminbi could be used for wholesale transactions, the current focus is for retail usage. Wholesale transactions could come later.

How do digital renminbi loans, deposits and interest rates work?

Like with notes and coins (M0), interest is neither paid nor charged on digital renminbi, at least for now. To earn interest, customers can convert their digital renminbi for traditional deposits using the bank's e-wallet or other customer-facing services. In doing so, the customer now holds traditional e-money deposits and in exchange the bank now has ownership title over the digital renminbi (see next section).

Similarly, loans to customers and corresponding journal entries to their current account remain in e-money form and are only converted to digital renminbi at client requests. Following this conversion, the digital renminbi exits the bank's balance sheet and enters the customer's stash of digital renminbi tokens. This stash is being stored in the designated app during the trial, and we believe going forward this is likely to be linked to e-wallets provided by commercial banks and other payment service companies such as Alipay and WeChat Pay.

How would a digital renminbi affect government policies?

Live data feeds on digital renminbi transactions would benefit the PBOC's visibility on economic developments, especially as China transitions into a more consumption-led economy. Authorities could also leverage available information to implement more targeted fiscal policies, such as more precise household transfers and benefits allocations.

We do not expect interest rates would be applied to digital renminbi at an early stage, because in its current form, DCEP is more like a substitution of physical bank notes to provide an additional settlement channel.

While some countries are looking at central bank digital currencies (CBDC) in structures that would allow for negative interest-rate CBDC, this objective, in our view, is not a priority to China. In addition, if a country wanted to make negative interest rates on digital currency an effective policy tool, the central bank would need to eliminate bank notes and coins as an alternative to CBDC. Otherwise, people could simply switch their CBDC to bank notes.

We expect digital renminbi to be a supplement, instead of a replacement of bank notes and coins at an early stage of development, in part due to concerns that major switch to digital forms would lower financial-inclusion. Cost savings generated from the reduction of bank notes usage could offer an extra benefit for banks and the PBOC, but is unlikely to be significant.

If digital renminbi were introduced broadly, we expect most of the conversion to be with bank deposits (predominately cash management balances) rather than cash. This is because the Chinese e-payments system is mainly linked with existing deposit accounts and credit cards, where cash usage has largely decreased in recent years, especially in more affluent regions. In this instance, if a large amount of e-money is swapped into digital renminbi it could reduce the money supply (M2). This is because bank deposits are under the fractional reserve framework whereas digital renminbi, notes, and coins are not. We expect the PBOC to ensure financial stability from any unintended disruptions as digital renminbi is rolled out.

Payment convenience and potentially more cost-efficient transactions could be attractive to users, while more detailed transaction-level data for macro policy-setting could appeal to authorities. The collected information could also help strengthen anti-money laundering and anti-terrorist financing measures. On the other hand, personal privacy issues may slow market adoption as it seems the central monetary authority obtains information on senders, recipients, and transaction amounts.

Lastly, while the development of digital renminbi is currently focused on domestic use, it is possible to further develop and extend payment connection with other jurisdictions. Substantial collaboration would be needed, including potential fresh international payment and transfers rules to govern this new digital currency payment and conversion process. Such a development could help further renminbi internationalization.

Would China's digital renminbi trial speed up introduction of similar structures globally?

Many governments are discussing key digital currency principles; however the pace could be slower than China due to different political and social considerations, especially in Europe. Further, China has the scale and volume to justify the research and development to make digital renminbi more cost effective.

What, if any, are the environmental considerations?

While very small in the grand scheme of China's production-driven carbon footprint, a wide adoption of digital renminbi could help. Reducing the amount of paper money in circulation and phasing out ATMs could contribute to this.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Harry Hu, CFA, Hong Kong (852) 2533-3571;
Secondary Contacts:Ryan Tsang, CFA, Hong Kong (852) 2533-3532;
Xi Cheng, Hong Kong (852) 2533-3582;
Mohamed Damak, Dubai (971) 4-372-7153;
Markus W Schmaus, Frankfurt (49) 69-33-999-155;
Robert Xu, Hong Kong (852) 2532-8093;
Research Assistant:Winnie Wang, Taipei

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