Hong Kong seeks financial inclusion through digital currency

Source/Financial Services Development Council of Hong Kong

Compilation/Ning

Central bank digital currencies (CBDCs) are a global vision — and China has one of the most advanced projects in the world. With more than 20 million individual and 3.5 million corporate “wallets” open, China’s central bank digital currency transactions have exceeded RMB 34.5 billion. Hong Kong, a leading international financial center and a major gateway to the Chinese economy, is evaluating the feasibility of developing its own CBDC asset.

The People's Bank of China (PBoC) noted that the digital yuan, also known as e-CNY, is being gradually introduced as China transitions to a digital economy and reduces the use of cash. Although paper money is unlikely to disappear completely in the next decade, societies are increasingly turning to digital payments as technology penetration, financial inclusion, and data protection develop widely.

With 80% of the world's central banks currently working on some kind of CBDC project, China has completed the design and functional development of e-CNY and will further expand the scope of trials and use. "Digital legal tender is a new thing," the People's Bank of China said in a recent report. "Its impact on the economy and the financial services sector can be evaluated through pilot testing and practice."

China has said it is seeking to exploit the advantages of a digital currency while enforcing capital controls. The CBDC would be distributed through China’s operating institutional banks, shrinking digital payment systems used in e-commerce and other technology platforms, which a PBOC governor said last year posed “challenges and financial risks.”

China is one of the first countries to develop CBDC: a special research group on legal digital currency was established in 2014 to conduct research. The digital RMB is fully backed by the credit of the People's Bank of China and is a legal tender, redeemable at a 1:1 ratio with the RMB. The digital RMB will allow people without physical financial accounts to use it for small transactions, including the unbanked. In China, this will allow 200 million rural people to enter the financial system.

An executive at a blockchain software company told S&P Global that China’s CBDC is different from other central banks in the world because it is retail-focused. “Most central banks initially focused more on wholesale CBDCs and are now working on retail CBDCs,” he said.

There are different types of digital RMB e-wallets, depending on the type of holder, privacy level, and whether it is software or hardware. The dual-layer operation of the e-wallet design and encryption technology achieves 'managed anonymity', which can balance the requirements of privacy protection and risk control. CBDC transactions have been piloted in multiple regions including Shenzhen, Suzhou, Xiongan New Area in Hebei, and Chengdu, as well as the site of next year's Winter Olympics.

CBDC preserves anonymity while enabling transaction traceability, which will greatly help combat illegal activities such as money laundering. Based on a traceable series of transactions, policymakers will be able to strengthen the implementation of monetary policy and the enforceability of other laws and regulations.

In Hong Kong, the Financial Services Development Council, which works with the government and the private sector to promote the further development of financial services and set strategic directions, is closely following the development of CBDC and its impact on Hong Kong.

"Thanks to the high liquidity of the Hong Kong dollar, Hong Kong has been actively participating in the trial of cross-border CBDC," said Laurence Li, chairman of the FSDC. "CBDC will become the mainstream of the future non-monetary economy, and given the government support of CBDC, funds are expected to be reallocated from other digital assets to CBDC."

The Hong Kong Monetary Authority (HKMA) - the banking regulator of the special administrative region - is conducting a joint feasibility study with the Bank for International Settlements Innovation Center in Hong Kong to develop a digital Hong Kong dollar (e-HKD) similar to the digital RMB as a CBDC for retail transactions. The e-HKD will be an electronic version of the banknote, and the issuance mechanism of the digital currency will be the same as that of physical banknotes under the US dollar currency peg system.

The People’s Bank of China has signed a memorandum of understanding with the HKMA and has also joined a global central bank digital currency initiative called the Multilateral Central Bank Digital Currency Bridge (m-CBDC Bridge), led by the Bank for International Settlements (BIS) in Basel, the so-called “central bank of central banks.” The Bank of Thailand and the Central Bank of the United Arab Emirates have also signed on to the project.

"Our goal is to build a brand new cooperative environment for central banks and the private sector through this m-CBDC bridge, and to further explore the potential of DLT to improve the efficiency of settlement and liquidity management of cross-border payments," Howard Lee, deputy chief executive of the Hong Kong Monetary Authority, said at the BIS Innovation Summit.

"We are grateful for the involvement of the private sector, including two stock exchanges, banks and multinational corporations in the project," he added. "This collaboration gives us greater confidence that the ideas and solutions generated through the project will take into account the needs of a variety of market players in different markets."

CBDCs are not a gimmick or a passing trend—they can have real-world impacts beyond monetary policy. For example, a digital yuan could help China achieve some important long-term goals beyond payments. In one pilot, Chengdu encouraged individuals to apply for free e-yuan coupons to ride public transportation to support carbon neutrality goals.

Overall, CBDCs will be more environmentally friendly than traditional fiat currencies, as the paper used in traditional fiat currency production uses polymers to combat counterfeiting and is difficult to recycle. They also have clear advantages over cryptocurrencies such as Bitcoin.

"Given their lack of intrinsic value, sharp price fluctuations, low transaction efficiency and huge energy consumption, virtual currencies are unlikely to serve as currencies used in daily economic activities," the People's Bank of China said in a recent report.

As the FSDC notes, “The financial services industry appears to still be in a learning phase when it comes to adopting technology and the sustainability implications. But as awareness gradually increases, this could clear the way for CBDCs to dominate the virtual currency space, as they are not expected to pose as significant environmental challenges as their potential counterparts.”