The Bank of Japan has published the minutes of the fourth meeting of the Liaison Council for Central Bank Digital Currencies, which took place on Thursday, November 24, 2022. Following opening remarks by Director Uchida, and a secretariat discussion of its CBDC initiative, demonstration experiments, and study of privacy-protecting technologies, as well as retail payment system trends in various countries, members of the Liaison Council were providing their comments. Given the limited time allocated to each speaker, these comments are notable for the emphasis the various player chose to make.

As a reminder of the current state of the BOJ experiments (as discussed in our Japan FinTech Outlook 2023 [on Medium or YouTube]), Phase 2 of the Proof-of-Concept will be executed until March 2023, covering specific technical functions. While the official chart above, dated July 2022, left the further phases, such as a pilot program, open, the BOJ used the schedule of the Liaison Council to communicate its intention to formally enter into a two-year pilot program with participation from the three mega banks. Thus, the Liaison Council members’ comments address various aspects of such pilot, and the broader testing.

In the following, we have extracted some key comments from the Liaison Council members, with regards to cost, pilot participation, technology and the financial intermediary function, and added our comments.

Cost

Most Liaison Council members appear to be concerned with the cost and resource requirements of participating in the pilots, and running additional infrastructure once implemented. Such positioning is somewhat curious, as at least the major banks previously had their own stablecoin initiatives (MUFG Coin, J-Coin), and are now active participants in private stablecoin consortia (DeCurret, ProgMat). Many regional banks have implemented wallets, and some are also participating in regional or municipal coin initiatives. Overall, the Fintech Association of Japan is spot on when stating that the long-term benefits, in particular when allowing private sector innovation based on public sector rails, will by far outweigh any short-term costs.

[Japanese Bankers Association] We would like to discuss how to cover the resources and costs of participation, which will be a reasonable burden for the operators participating in the pilot experiment. We have stated that the design of CBDC should be considered based on its public nature, and we believe it is appropriate that the cost burden associated with participation in the pilot experiment should also be considered based on this concept.

[Second Association of Regional Banks] We believe that providing a basic means of settlement in the form of CBDC means providing infrastructure to the public at large, and that there is a certain rationality in limiting the burden on private financial institutions through the public burden of the costs associated with such infrastructure.

[Fintech Association of Japan] In the medium to long term, system investment could lead to significant efficiency gains. If the basic infrastructure can be prepared to facilitate the private sector to build services, the efficiency of private sector investment above that layer could be improved, leading to improved competitiveness and services.

Pilot Participation

Liaison Council members appear to be generally concerned about being at an information disadvantage if not participating in the pilot program. We interpret this as a critique of the initial announcement that seemed to include the three mega banks in the pilot, thus creating an unequal playing field.

[Regional Banks Association of Japan] We would like you to disclose the details of the experiment and the results of the verification in a timely and appropriate manner so that there will be as little disparity as possible in the information on the status of CBDC studies depending on whether or not individual institutions have participated.

[International Bankers Association] The Liaison Council is made up of a wide variety of businesses with different characteristics, and we would like to see the Liaison Council take into account the opinions and realities of each of these businesses. If you proceed with the pilot experiment, we would like you to share information and provide feedback to us in a timely manner so that there will be no advantage or disadvantage depending on the type of business.

[Fintech Association of Japan] It is extremely important to ensure fairness between those who participate and those who do not.

Technology

The International Bankers Association and the Fintech Association of Japan are advocating for a modern technology stack, or at the very least for an open discussion around the merits of leaving legacy technologies behind. This is supported by the Bank of Japan, which is active in international central bank working groups. Domestic groups are more hesitant, and especially on the regional banking side, where often the technology is not owned, but completely outsourced to system integrators, there are concerns about the leap required.

[Center for Financial Information Systems] Proven, well-known technologies should be used for socially important systems that require high reliability and safety. For example, while some argue that the adoption of open technology and cloud computing is a kind of proposition that transcends discussions of risk and cost, the fact that megabanks are maintaining the use of mainframes in the core of their banking systems is also a judgment based on the same insight.

[International Bankers Association] Since we will be working with new technology, we would like you to make efforts to avoid dragging the negative legacy of the past as much as possible. For example, it would be possible to consider how to avoid vendor lock-in. At present, there are cases where remittances to Japanese financial institutions cannot be made unless the name of the payee or remitter is in katakana. If CBDC is to be used for cross-border payments, for example, it may be possible to use something like the IBAN code, which is used mainly in Europe.

[Fintech Association of Japan] Since CBDC will be a critical infrastructure, the probability of utilizing stable technologies is extremely high. However, since this is currently an experiment, it will be important to try a wide range of technologies, including those in the experimental stage, to gain suggestions. Therefore, although there are resource constraints, we would like to request that new technologies be verified through experiments, and then we would like to have a thorough discussion on whether or not to use them.

[Regional Banks Association of Japan] In conducting the pilot experiment, we would like you to publicize the details and confirm the wishes of financial institutions and IT vendors.

[Bank of Japan] The Bank of Japan participates in a joint CBDC research group consisting of seven major central banks. Since its establishment in 2020, this group has continued to study the institutional design and advanced technologies for CBDC. There is some overlap with today’s discussion, but since technology is constantly evolving, there is an argument that even if the latest technology is adopted for CBDC, if it is not a technology that will be widely used in the future, it may instead hinder the maintenance of the system in the long run. In addition, there is an argument that, in order to avoid rework in system construction, it would be better to study the CBDC design layer by layer and, when discussions toward publication are complete, to finalize the overall system design while incorporating more future technologies, instead of finalizing the CBDC design based on the current technology. There is also an argument that it would be better to solidify the design of the system as a whole while incorporating more future technologies when the discussion toward issuance is complete. We will continue to work on the specific institutional design of the CBDC system together with the parties concerned, but we would like to continue to introduce trends at overseas central banks and discussions at major central bank groups as technology continues to develop, in order to serve as a reference for them.

Financial Intermediation Function

The Japanese Bankers Association is rightfully concerned about leakage of deposits into digital wallets. However, this concerns is generally addressed at the global level by introducing limits on CBDC holdings, for example in line with AML reporting (USD 10,000 or JPY 1,000,000).

[Japanese Bankers Association] We would like to emphasize the importance of maintaining the financial intermediary function. As we have said in the past, the introduction of CBDC will result in a certain amount of outflow of funds from deposits to CBDC. If this exceeds a certain level, we cannot deny the possibility that the credit creation function will decline. You explained the function of setting limits on the amount of CBDC holdings and transactions in consideration of this point, and we would like to ask you again to take this possibility into account while ensuring that there is no negative impact on the local economy.