As central banks around the world contemplate the risks and benefits of issuing central bank digital currencies (CBDCs), Beijing is likely to leverage frustrations with the inefficiencies of existing cross-border payments channels to strengthen support for its vision of lower-cost alternatives built upon CBDCs. If realized, such arrangements could allow Chinese firms and their trading partners to reduce usage of the U.S. dollar for cross-border transactions and circumvent payments channels that the U.S. government can shut off to entities it sanctions for national security reasons.
China’s state-sponsored digital currency, the digital renminbi (or e-CNY), is already being designed to achieve these ends. The country’s central bank, the People’s Bank of China, stated in a July 2021 white paper that the digital renminbi is “ready for cross-border use.” Yet for Beijing’s grandest ambitions for its state-sponsored digital currency to be realized, the digital renminbi must be interoperable with the CBDCs of other countries. Hence, the People’s Bank of China is supporting the development of global CBDC standards and working with other monetary authorities to launch a multi-CBDC arrangement.
Any such arrangement would likely face governance obstacles, but if successful, a multi-CBDC arrangement could help Beijing reduce the power of U.S. sanctions and the use of the U.S. dollar in cross-border business transactions. This outcome is particularly possible in emerging markets, where U.S. dollars—and thus U.S.-regulated payments systems—are highly used in international trade but existing cross-border payments channels are increasingly difficult to access. Washington needs to do more to reduce the risk that increasing global interest in CBDCs ultimately could result in the growth of cross-border payments arrangements that undermine U.S. economic and national security interests.
Accordingly, efforts aimed at reducing the costs of existing payments channels for large-value cross-border transactions denominated in U.S. dollars should be accelerated, and Washington should support public- and private-sector efforts aimed at leveraging new technologies to improve the efficiency of large-value cross-border payments. Without more robust policy responses to growing global interest in CBDCs and the inefficiencies of the existing channels that most cross-border payments flow through, the United States risks losing its leading influence over global payments infrastructure.
Why the Status Quo for Cross-Border Payments Bothers Beijing
In its July 2021 white paper, the People’s Bank of China listed “explor[ing] ways to improve cross-border payments” as one of its objectives for the digital renminbi. Cross-border payments are predominantly large-value transactions—not the small-value consumer-to-consumer or consumer-to-business payments for which the digital renminbi is now mostly used. Indeed, estimates indicate that over 95 percent of global cross-border transactions are business-to-business, and these types of payments are projected to reach over $150 trillion annually by 2022. Recent statements by the president of one of China’s largest state-owned banks and the director of a state-backed think tank indicate that the digital renminbi will increasingly be used for cross-border business-to-business payments and will ultimately be leveraged to help try to transform China’s currency into Asia’s dominant regional currency.
Currently, however, the vast majority of such business-to-business transactions involving China and nearby emerging markets are carried out using the U.S. dollar. In fact, data suggest that about 80 percent of Central, East, and Southeast Asian exports are invoiced in U.S. dollars, and just 20 percent of China’s exports and imports are reportedly settled in renminbi (much of the rest are settled in U.S. dollars). Globally, estimates suggest that U.S. dollar–invoiced transactions account for around 40 percent of global exports, even though the United States only accounts for about 10 percent of exports. By comparison, about 45 percent of exports are invoiced using the euro, but this figure is on par with eurozone countries’ roughly 40 percent share of global exports.
These statistics bother many officials in Beijing, who view the U.S. dollar’s dominance as a threat to international financial stability and to what these officials term as China’s financial security (jinrong anquan). Leading Chinese bureaucrats have said as much, including Guo Shuqing—chairman of the China Banking and Insurance Regulatory Commission and a member of the Chinese Communist Party (CCP) Central Committee. In April 2020, he wrote in Qiushi (the CCP’s leading political journal) that, because of the U.S. dollar’s dominance, “the unprecedented unlimited quantitative easing policy of the United States . . . erodes the foundation of global financial stability and will have unimaginable negative effects,” particularly in emerging markets. Importantly, high use of the U.S. dollar as a trade-invoicing currency reinforces its status as the dominant currency of global finance and vice versa. Accordingly, efforts to reduce the U.S. dollar’s usage in cross-border commerce could, as a senior economist at one of China’s large state-owned banks recently suggested, help Beijing address its broader perceived risks related to the dollar’s dominance in global finance.
Guo also emphasized the importance of CCP General Secretary Xi Jinping’s call for “financial security,” which former senior Chinese officials (including a current member of the Chinese People’s Political Consultative Conference) and prominent academics close to the People’s Bank of China believe is threatened by the widespread use of the U.S. dollar as a currency for cross-border payments. As they note, Washington could shut off Chinese financial institutions from the global payments infrastructure if these organizations facilitate transactions involving U.S.-sanctioned businesses or persons.
How the Existing Business-to-Business Payments System Works
To understand why this is the case and how CBDCs fit into Beijing’s policy goal of diminishing the U.S. dollar’s use as a payments currency for global trade, it is first important to understand the existing channels through which most business-to-business payments generally flow.
Historically, 90 percent of U.S. dollar–denominated, cross-border fund transfers have reportedly been facilitated by the Clearing House Interbank Payments System (CHIPS), which is U.S.-based and federally regulated. CHIPS settles payments between participating institutions by using digitized U.S. central bank liabilities held with the Federal Reserve System. CHIPS participants are U.S. banks or large foreign banks with a U.S. presence (including some of China’s largest banks). Most U.S. dollar–denominated, cross-border business-to-business transactions generally flow through these entities, which regularly serve as correspondent banks—meaning institutions that offer banking services to other banks, particularly banks with no international branches. Ultimately, a cross-border payment from one non-U.S. business to another often needs to pass through intermediary banks in both the seller’s and the buyer’s countries, which in turn route payments through CHIPS-participating institutions.
These payments channels have been criticized for being expensive and inefficient for businesses in emerging markets. Time zone differences and multilayered correspondent banking linkages (made longer by uncommon currency pairs) can cause payment settlement to take several days. This means that banks often maintain prefunded accounts at correspondent banks for carrying out customer payments, thus trapping liquidity and driving up costs. What is more, large global banks’ concerns about the profitability of relationships with emerging market banks, driven in part by worries that these relatively smaller institutions may not adequately comply with U.S. sanctions and rules to combat money laundering, are contributing to a decline in the number of correspondent banking channels that businesses in emerging markets can use.
Yet as the central banks of Canada, Singapore, and the UK recently observed, despite all of these issues, “correspondent banking remains the only ubiquitous cross-border payment solution.” And even when a transaction is not invoiced in U.S. dollars, U.S.-regulated intermediaries and U.S.-influenced systems are often involved. Correspondent banks that facilitate transactions not denominated in U.S. dollars often concurrently serve as correspondent banks for U.S. dollar–denominated transactions; Washington can thus effectively shut them off from U.S. dollars for serving businesses sanctioned by the United States for national security reasons. Additionally, the messaging system used to transmit most correspondent bank payments is the Belgium-based Society for Worldwide Interbank Financial Telecommunication (SWIFT) service, which Washington can effectively block sanctioned entities from using.
Obstacles to China’s Alternative Cross-Border Payments Channels
Many in Beijing are concerned about China’s high dependence on SWIFT and CHIPS for facilitating large-value cross-border payments. But if Beijing seeks to reduce its reliance on these systems and decrease U.S. dollar usage in the cross-border business transactions of Chinese companies with trading partners in nearby emerging markets (some of which invoice nearly all exports in U.S. dollars), then it needs a reliable, cheaper alternative to existing payments channels. China has taken steps to create such alternatives, but many obstacles to circumventing the U.S.-dominated payments architecture exist.
In 2015, Beijing launched the Cross-Border Interbank Payment System (CIPS) to facilitate renminbi-denominated transactions with Russia, India, and other neighbors. Recently, use of the service has grown. Beijing is also increasing cross-border trade conducted in renminbi via a global web of affiliates of large state-owned banks able to facilitate renminbi-denominated transactions outside of China—many of these entities were launched across Central and Southeast Asia over the last few years (including in Thailand in 2015 and in the Philippines in 2021). Yet CIPS and China’s large state-owned banks all still largely rely on SWIFT. Also, China’s large state-owned banks need access to U.S. dollars to function in international financial markets. This provides U.S. authorities with the policy option of effectively shutting off these institutions from the dominant channels of global finance if transactions they facilitate jeopardize U.S. national security.
Additionally, data indicate that invoicing transactions in U.S. dollars and then converting funds into local currencies is still cheaper than using the renminbi instead. The U.S. dollar is on one side of almost 90 percent of foreign exchange transactions, which helps make its currency exchange transaction costs significantly less expensive than those of other currency alternatives. The costs of using the renminbi as an invoicing currency could in theory be lowered relative to the U.S. dollar if CIPS and renminbi-denominated payments channels were dramatically more efficient than those built upon SWIFT and CHIPS, but this is not currently the case. Costs could also be lowered if the renminbi was more freely tradable, but there are major political obstacles to the large-scale internationalization of the renminbi. For example, weak state-owned enterprises could be harmed by liberalized financial flows. Accordingly, in the years ahead, the pace of renminbi internationalization will be “steady and prudent” as the CCP’s recent five-year plan states.
How Beijing Could Use CBDCs to Erode the U.S. Dollar’s Dominance
These dynamics help explain why some in Beijing are hopeful that the global proliferation of CBDCs could give Chinese policymakers what they perceive as the best of both worlds: the opportunity to maintain a slow and steady pace of renminbi internationalization, while decreasing the use of U.S. dollars, SWIFT, and CHIPS for transactions between Chinese firms and businesses in emerging markets.
Notably, a recent survey of sixty-five central banks found that over 60 percent are experimenting with CBDCs and that central banks in emerging markets are “more likely to have advanced to a pilot or implementation phase” given a stronger perceived need for CBDCs. Because China is a first mover in CBDCs, its central bank—as recently observed by one senior official from the Bank for International Settlements (BIS), a global organization owned by sixty-three central banks—is well-positioned to teach other monetary authorities that are in the developmental stages of adopting CBDCs.
Greater global deployment of CBDCs across various countries could give rise to a multi-CBDC arrangement, whereby the CBDC payment system in one country could communicate with that in another country. The People’s Bank of China is already working with the BIS and the monetary authorities of Hong Kong, Thailand, and the United Arab Emirates (UAE) to launch a multi-CBDC arrangement—an effort initially called Project Inthanon-LionRock but recently renamed mBridge. Highlighted in the Chinese central bank’s July 2021 white paper on the digital renminbi, the project is explicitly designed to decrease reliance on correspondent banking channels. Notably, its technology subcommittee is headed by the People’s Bank of China.
If successful, this multi-CBDC arrangement would facilitate cross-border payments between businesses in China, Thailand, and the UAE through a corridor mutually governed by the participating jurisdictions’ monetary authorities. Such an arrangement theoretically would be operable twenty-four hours a day, seven days a week, unlike CHIPS and CIPS. Participating jurisdictions’ CBDCs would be interoperable, and the most recent mBridge prototype entails nearly instantaneous cross-border CBDC transactions being recorded on the same ledger. In theory, this could allow for payments from a Chinese importer’s digital renminbi account to be swiftly converted through the corridor into Thai CBDC credited to a Thai exporter’s account, with central banks capable of monitoring transactions continuously. Indeed, the People’s Bank of China could precisely control the levels of offshore digital renminbi held by entities outside of China. Smart contracts could be used to enforce such restrictions, increase the speed of payments, and reduce foreign exchange costs. A late September report on mBridge published by participating monetary authorities and the BIS estimates that the initiative could reduce cross-border payment costs by as much as 50 percent and cut payment times from a few days to a few seconds.
Achieving these outcomes is easier said than done, however, and huge operational hurdles remain. As BIS research notes, a major challenge posed by such an arrangement is that monetary authorities must share the management of rules and governance. But Beijing is also undoubtedly eying the establishment of simpler multi-CBDC arrangements, which could emerge from the streamlining of technical standards for CBDCs globally so that these instruments can more easily be used by existing systems such as CIPS to facilitate large-value transactions. This helps explain why the head of the People’s Bank of China Digital Currency Research Institute, Mu Changchun, endorsed global CBDC interoperability earlier this year. Notably, Xi himself has called upon China to play a role in standard setting for digital currencies.
Greater CBDC use in cross-border commerce also aligns with Beijing’s desire to slowly and steadily internationalize the renminbi on its terms. As the mBridge example suggests, the programmable nature of CBDCs could make it easier to enforce capital controls that restrict overseas currency usage. A recent survey of central banks suggests that the global proliferation of CBDCs would lead to more countries adopting capital controls.
Ultimately, some People’s Bank of China officials believe that the digital renminbi will make foreign exchange transactions involving the renminbi less expensive and more efficient, thus aiding in the internationalization of the renminbi and supporting its use as a cross-border payments currency. Such an outcome aligns with an April 2021 statement by the People’s Bank of China’s then deputy governor Li Bo (now deputy managing director of the International Monetary Fund) that the goal of the digital renminbi is not to displace the dollar as the world’s dominant currency, but instead to allow the market to choose what currencies are used in international trade and investment. In other words, Beijing seeks to help bring about a competitive alternative to U.S. dollar channels for processing large-value cross-border payments. Notably, the director of the People’s Bank of China’s Institute of Research, Zhou Chengjun, believes that, as the vision for market-driven overseas renminbi usage is realized, the currencies of countries affiliated with Beijing’s push to make capital-intensive investments overseas through the Belt and Road Initiative will ultimately become effectively pegged to the renminbi. In other words, the renminbi could evolve into a regional currency.
U.S. Policy Options
How, then, should the United States respond? To begin with, Washington must do more to prepare for the risk that China successfully stands up a multi-CBDC arrangement that does not align with U.S. interests but offers a low-cost alternative to existing cross-border payments channels built upon U.S.-regulated intermediaries. Recent bipartisan U.S. legislation introduced to require that the executive branch study the national security implications of China’s CBDC is a positive step in this direction. U.S. policymakers should also examine the potential economic and national security implications of the successful launch of multi-CBDC arrangements overseas. Additionally, it is important for Washington to engage collaboratively with U.S. allies to ensure that multi-CBDC arrangements are not set up in ways that harm U.S. interests, and U.S. policymakers should seek to better understand how U.S. companies are involved in the development of multi-CBDC arrangements abroad.
Efforts to reduce the inefficiencies of existing large-value cross-border payments channels must also be accelerated. Certain 2020 recommendations from the Financial Stability Board (FSB) on enhancing cross-border payments such as uniform payments standards can—once adopted—improve the speed and lower the cost of large-value cross-border transactions. Yet the projected implementation dates for many recommendations are years away, and the FSB does not anticipate that the time required for a sizable majority of global large-value cross-border payments will fall to one hour or less until at least 2027. One important reason for delays in existing cross-border payments channels is that many systems used to process large-value payments close for parts of weekdays and for most of the weekends. To address this issue, Washington could devote more resources to help shift CHIPS and FedWire (a real-time payments system run by the Federal Reserve System that is important to the functionality of CHIPS) to operating twenty-four hours a day, seven days a week.
To further respond to China’s CBDC efforts, U.S. policymakers should consider regulatory changes that could allow for greater innovation in the private sector aimed at improving cross-border payments channels for U.S. dollar–denominated transactions involving emerging markets. One policy option is to expand U.S. non-bank access to digitized U.S. central bank liabilities in a way that allows for the growth of affordable and high-speed U.S. dollar payments solutions in markets underserved by correspondent banks while guarding against potential financial stability concerns. Additionally, as the United States explores the possible risks and benefits of issuing its own CBDC, policymakers should also examine what steps need to be taken to enable low-cost, efficient exchanges between the U.S. dollar and CBDCs designed for business-to-business payments that are launched abroad.
Regardless of whether the United States launches a CBDC, responding to China’s CBDC ambitions in the near term necessitates that the U.S. private and public sectors get more involved in research and innovation aimed at decreasing large-value cross-border payments costs, particularly in emerging markets.