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EAC eyes digital money to level cross-border transactions

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East African Community member states will explore the potential of a central bank digital currency. FILE | FOTOSEARCH

East African Community member states will explore the potential of a central bank digital currency (CBDC) for their shared payment system to end reluctance by member countries to trade in each other’s currency.

The bloc’s secretariat said advances in technology and innovation have created a potential for new forms of cross-border payments even as it moved to upgrade the struggling East African Payment System (EAPS), which was launched in May 2014.

“Review recent advances in technology and innovations that have created the potential for new payment infrastructures and arrangements that could be applied to cross-border payments,” the secretariat said in a consultancy call for a feasibility study on the planned upgrade of the EAPS.

“The consultant will, therefore, conduct an exploratory scoping review of such developments, as well as emerging technologies and their adoption, including but not limited to technologies involving the use of Central Bank Digital Currencies,” it added.

Single currency

The adaption of a CBDC could provide an option for the EAC partner states, which target to attain a single currency for the region by 2024 in line with the bloc’s Monetary Union Protocol.

A CBDC uses an electronic record or digital token to represent the virtual form of a fiat currency of a particular nation or region. These digital currencies are centralised and are issued and regulated by the competent monetary authority of the country.

The CBDC acts as a digital representation of a country’s fiat currency and would be backed by a suitable amount of monetary reserves like gold or foreign currency reserves. Central bank money is deemed safe because it allows users to exchange central bank liabilities without concern about liquidity and credit risk.

The CBDC is, however, different from the many cryptocurrencies that have been created by different individual organisations based on some assets.

“No one has a choice but to change with the times. Blockchain is becoming big and everyone must join the bandwagon or risk being rendered irrelevant by technology. The EAC can benefit from this and boost efficiency in its cross-border payments” Bitange Ndemo, a professor of entrepreneurship at the University of Nairobi School of Business told the Business Daily.

The present EAC payments system has been dogged by difficulties in funding arrangements of the regional currencies from regional commercial banks.

“The original funding model where participants sourced for funding of other EAC currencies from the market is proving expensive due to unavailability of partner States’ currencies in the local market,” the secretariat said.

Automated mechanism

The performance of the current EAPS has also been constrained by the fact that lacks an automated mechanism to confirm if messages sent by the local commercial banks have been received and settled in the respective central banks. This leads to a delay in receiving feedback on the settlement of transactions from the regional counterparts.

“A lack of centralised user support means that resolution of any problems with the usage of the system takes a long time, which impacts negatively on the operations of the system.

“The fact the system does not operate on a single platform also means that centralised liquidity and collateral management is not possible” the EAC secretariat also noted.

Currently, Kenya dominates transactions in the EAPS, which allows citizens of member countries to make and receive payments in regional currencies — the Kenya shilling, Uganda shilling, Tanzania shilling, Rwanda franc, and Burundi franc.

At the time EAPS went live in 2014, only three partner states — Kenya, Tanzania, and Uganda — had implemented a national real-time gross settlements (RTGS) system.

Fund transfers

The three countries, therefore, initiated cross-border fund transfers in their respective national currencies using the existing RTGS infrastructure as the settlement systems for cross-border payments.

Rwanda then joined the EAPS in December 2015 after completing the implementation of its RTGS in 2014. Burundi, which recently completed the implementation of its RTGS, is expected to join the EAPS while South Sudan will do so once it implements an RTGS system.

The focus by EAC on digital money adds to a global trend in which more nations are betting on such innovations to improve efficiency in international trade.

Many of the world's central banks are currently looking into the possibility of creating CBDC, but the only one already in existence is China's digital yuan, which is currently undergoing public testing.

The Bank of England and the UK Treasury announced in April that they are setting up a task force to explore the possibility of a central bank digital currency.

“A CBDC would be a new form of digital money issued by the Bank of England and for use by households and businesses. It would exist alongside cash and bank deposits, rather than replacing them,” the Bank of England said in a statement on April 19, 2021, but pointed out that no decision had been made yet on whether to introduce a CBDC in the UK.

The US Federal Reserve governor Lael Brainard last week also pushed the case for a digital dollar to boost efficiency and cross-border payments, or transactions between people in different countries.

“One expected benefit is that a CBDC would reduce or even eliminate operational and financial inefficiencies, or other frictions, in payments, clearing, and settlement,” she said in a speech at the consensus by CoinDesk 2021 Conference in Washington on May 24, 2021.

She said multidisciplinary teams at the Federal Reserve are investigating the technological and policy issues associated with digital innovations in payments, clearing, and settlement, including the benefits and risks associated with a potential US CBDC.

“For example, the TechLab group at the Federal Reserve Board is performing hands-on research and experimentation on potential future states of money, payments, and digital currencies. A second group, the Digital Innovations Policy programme, is considering a broad range of policy issues associated with the rise of digital payments, including the potential benefits and risks associated with CBDC,” said Ms Brainardshe.

The Covid-19 pandemic has hastened the shift to digital payments as cautious buyers and sellers avoided hard cash for fear of contracting the disease.

Even before the pandemic, some countries, like Sweden, were seeing a pronounced migration from cash to digital payments.

Central Bank of Kenya governor Patrick Njoroge last October disclosed that the country had started talks with international central banks to explore the possibility of entering the CBDCs space.

It was not immediately possible to get an update from Dr Njoroge on the status of the talks and whether Kenya is still keen on exploring the use of CBDCs for cross-border payment transactions.