New IMF report lays down the risks of e-money becoming more popular than physical cash

As e-money rises in popularity, a new International Monetary Fund (IMF) report has looked into the rise of cryptocurrencies, e-money and i-money like Facebook’s Libra and what the associated risks to the economy are.

Kicking off The Rise of Digital Money report, the IMF researchers noted that different types of electronic and digital currencies are growing in popularity.

For instance, the researchers point out that the digital currency M-Pesa is used by 90 per cent of people over the age of 14 in Kenya. Moreover, both WeChat Pay and Alipay are popular in China. “All, and many others, are increasingly in our wallets as consumers and on our minds as policymakers,” the researchers added.

In fact, they stated that there is even a chance that these different solutions may overtake physical money and banknotes in usage. They warned that the increasing adaptation of digital currency solutions comes with some challenges.

“E-money may be more convenient as a means of payment, but questions arise on the stability of its value,” the authors wrote. “It is, after all, economically similar to a private investment fund guaranteeing redemptions at face value. If 10 euros go in, 10 euros must come out. The issuer must be in a position to honour this pledge.”

To bring that point home, they mention that e-money shared many similarities with constant net asset value (CNAV) funds. The researchers then reminded the reader that one of the reasons behind the 2008 recession was because CNAV funds failed to live up to the promise of returning “a dollar for each dollar invested”.

The IMF report points to four different risks associated with e-money: liquidity, default, market and foreign exchange risks. These could “all potentially undermine the guarantee of redeemability at face value.”

Nevertheless, the researchers said financial stakeholders should prepare for the digital currencies becoming even more popular.

“Banks will feel pressure from e-money, but should be able to respond by offering more attractive services or similar products,” they wrote. “Nevertheless, policymakers should be prepared for some disruption in the banking landscape. Today’s new entrants in the payment arena may one day become banks themselves and offer targeted credit based on the information they have acquired. The banking model as such is thus unlikely to disappear.”

One solution provided by the researchers to tackle the risks associated with e-money is if central banks could offer settlement services to e-money providers much in the same way that they already do for fractional banks.

Indeed, some central banks like the Hong Kong Monetary Authority, the Reserve Bank of India and the Swiss national bank “already offer special purpose licenses that allow non-bank FinTech firms to hold reserve balances”, reducing the risks mentioned earlier.

The researchers concluded: “Much lies in the hands of central bankers, regulators, and entrepreneurs, and much remains to be seen. But one thing is certain: innovation and change are likely to transform the landscape of banking and money as we know it.”

Copyright © FinTech Global 2019

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