Dear roundtable participants

I'm most grateful to OMFIF for having organised this roundtable discussion on the role of central banks in supporting adoption of new currencies. In my introductory remarks, I shall outline why the role of central banks is critical for the adoption of smaller currencies and why central banks need to assume a proactive role to drive greater currency diversification. While this is relevant for the adoption of central bank digital currencies (CBDC), it shall hold also as a general case.

The role of national currencies in cross-border payments had been central to the purpose of the International Monetary Fund (IMF). As we commemorate this year the 80-year anniversary of the Bretton Woods Conference where the IMF was founded, it is fitting to assess how the objectives at the time were met. One of the main purposes of the IMF and critical motivation for the conference was the establishment of a multilateral payment system. It was meant to be understood that every country should be able to use its currency to conduct exports and imports. This objective has not been met.

The international monetary system, how international liquidity is being managed, rests on a narrow set of currencies to conduct cross-border payments and manage international liquidity. Many observers would agree that while it brings advantages of using few currencies, it may create unwanted dependencies. More currencies mean more of a level playing field and more sources of international liquidity to meet current and financial transactions. It would establish a more balanced system.

International liquidity can be approximated by the foreign exchange market. The foreign exchange market is the largest financial market with a daily average turnover of about US$7.5 trillion. It is a highly concentrated market. At end 2022, in 90 percent of foreign exchange transactions, the dollar represents either the bought or sold currency. Most exchange rates are only quoted against the dollar. It means an entity needs dollars to transact in the foreign exchange market. This poses high barriers of entry and makes it difficult for smaller currencies to gain traction.

Emerging markets currencies remain marginalised in foreign exchange transactions. While East and South Asian currencies have seen some adoption, at end-2022, they represented one currency leg in 18 percent of foreign exchange transactions; Latin American currencies were making up only 3 percent.

Currencies need to be liquid to be used in international payments. Bringing new currencies on stream is complicated. It requires market makers being willing to quote and hold currencies. If currencies are illiquid, market makers will not find it attractive to trade them.

Central banks through interventions in the foreign exchange market accumulate foreign exchange reserves and are important marginal liquidity providers for currencies. Foreign exchange reserves are substantial at US$12 trillion (12 percent of world GDP). The composition of central banks’ foreign exchange reserves is indicative of the currencies being used in international transactions. 4 currencies make up about 90 percent of central banks’ foreign exchange reserve holdings out of 125 currencies in circulation. While there has been some diversification in foreign exchange reserve holdings, progress has been limited.

The risk of holding smaller currencies is typically shunned by central banks to protect their balance sheets. The incipient rise of East and South Asian currencies has been accompanied by increasing holdings by central banks of East and South Asian currencies. The Latin American currencies had found no such support.

Central banks can play an important role in facilitating adoption of smaller currencies. They can act as buyer and seller of last resort and give comfort to commercial banks that they can trade smaller currencies and unwind unwanted foreign exchange positions. It would materialize in more diversified foreign exchange reserve holdings with the accumulation of smaller currencies.

The IMF could play a role in supporting orderly adoption of smaller currencies. It could set up a special facility where the IMF would absorb some of the foreign exchange risk. Central banks may be able to off-load selectively their foreign currency exposure to the IMF facility in exchange of a claim on the IMF. It may give support to central banks not willing or able to assume large foreign exchange losses.

New approaches to foreign exchange settlement using CBDCs could be important drivers for change. CBDCs promise efficient settlement without requiring the liquidity and large network effects of conventional settlement arrangements. They may benefit disproportionately smaller currencies.

The BIS Innovation Hub-led project mBridge is one of the most advanced CBDC projects for cross-border payments using smaller currencies. It provides for the use of CBDCs—issued by the participating central banks of China, Hong Kong (SAR), Thailand, UAE and now also Saudi Arabia—by commercial banks for the settlement of cross-border claims on the basis of an outright exchange of CBDCs between resident and non-resident institutions (from the point of view of the issuing central bank). However, I believe its success will be largely contingent on participant central banks holding foreign currency CBDCs to support liquidity.

The attractiveness of a currency is naturally a function of financial entities holding them including in particular foreign central banks. Hence, the challenge is about getting towards the new equilibrium where smaller currencies are more attractive. Central banks are believed to be critical catalysts to achieve that. 80 years on, this could lay the foundation towards installing a multilateral payment system.

I very much look forward to the discussion.