Does the Digital Yuan Mark the End of Commercial Banks, Established Players?

By Denis Chen, Jinn Guo, Jay Ward, and Swathi Mantripregada, all MBA ’23

Overview

China’s launch of its new digital currency, the e-yuan, has several implications. Unlike the model of the stable coin, the e-yuan is a digital version of China’s fiat currency and will adopt “a centralized management model and a two-tier operational model.” Since the e-yuan is a direct liability of the central bank, one could argue that banks won’t have to compete for deposits from consumers and businesses. With the introduction of the e-yuan, CBDCs are believed to impact large fintech players such as Alipay and WeChat Pay. On the other hand, the e-yuan and its wallets will face the same issues that any application faces when trying to grow its user base: What are the incentives for users is to switch from their current solutions? In a way, the e-yuan will challenge established banks and act as a catalyst for innovation in the financial industry at the same time.

Impacts and implications of the e-yuan launch

For decades, Visa, the largest bank card payment system in the United States, has been the exclusive electronic payment provider for the Olympic Games, the world’s biggest sporting event. But at this year’s Beijing Winter Olympics, Visa found itself having to share the pie with China’s new digital currency, the digital yuan.

With the rollout of the digital yuan, also referred to as e-yuan or e-CNY, it is worth asking about the impact of digital currencies, and specifically Central Bank Digital Currencies (CBDCs), on the current financial landscape and its major players. It’s certainly not the ambition or goal of the People’s Bank of China to compete with existing commercial banks, in which the state has significant ownership as well. In the rollout of the e-yuan, the People’s Bank of China has been trying to limit its role in the issuance and administration of the currency while leaving other services and obligations to the existing financial infrastructure. For example, at the moment, the distribution and management of wallets will be managed by four commercial banks and three telecommunication companies.

Limiting the impact and risks of the e-yuan is embedded into its design. An important characteristic is that the e-yuan is mainly a substitute for cash in circulation—often referred to as M0—that will coexist with the physical yuan issued by the Central Bank. This has several implications.

First, unlike the model of the stable coin, the e-yuan is not pegged on the yuan; it is a digital version of China’s fiat currency. The amount released is in parallel with the yuan and takes into consideration the total amount of money issued. Second, the e-yuan will adopt “a centralized management model and a two-tier operational model.” The e-yuan will be issued by the state to commercial banks that will manage it through the whole life cycle. Third, as an M0, the e-yuan will not carry any interest and won’t charge any transaction fees between different parties.

Origins and properties of the e-yuan

Another clarification that is worth discussing is that the e-yuan is different from regular digital cash that commercial banks issue today through their loans. As a CBDC money unit, each e-yuan has a unique digital identity and is a direct liability of the central bank, instead of the commercial bank that issues it. This difference in the nature of the e-yuan will have an impact on the entire banking system. The white paper, “Progress of Research & Development of E-CNY in China,” which set the foundation for the creation of the e-yuan in July 2021, also discussed these impacts and risks.

Deposit disintermediation is the main impact discussed in that paper. Traditional banks make a profit primarily from the interest difference between what they pay to depositors and what they receive from commercial or investment loans. Retail deposits are an important source of funding for retail and commercial banks. With the e-yuan, a significant flow of deposits could remain in people’s wallets instead of being deposited in banks, resulting in a loss of funding for banks. This could deprive banks of a low-cost source of funding required for their normal business models. Should banks rely on other funding sources that cost more, then product offerings such as personal loans and mortgages rates could go up as well.

From another angle, one could argue that banks won’t have to compete for deposits from consumers and businesses. Since the e-yuan is a direct liability of the central bank, commercial banks could borrow most of their deposits from the central bank to finance their lending activities. Competition will shift to a focus on efficiency, as customers shop for attractive loan rates and value-added services. In a way, the e-yuan will accelerate the challenge to established banks the way fintech companies have.

Potential impacts on major fintech players

China’s e-yuan will also have an impact on large fintech players such as Alibaba’s Ant Financial, which operates Alipay and Tencent’s WeBank for Wechat payments. The seamless transfer of the e-yuan between these digital wallets is very much like the solution that fintech companies offer to their users. From the government’s perspective, this reduces a reliance on Alipay and Wechat, which accounts for roughly 94 percent of all online payments. Both organizations control oceans of data that are essential for most of their business offerings, but that also create risks for society and the government.

Chinese tech giants are known for implementing protective measures to compete with their rivals and prevent user leakage (for example, sharing Tiktok’s link with users on WeChat is cumbersome). Therefore, at first glance it might seem surprising that the same companies have been quick to show their support for the new e-yuan system. Earlier this year, Tencent, owner of WeChat and its pay functions, announced that its messaging app would integrate support for the e-yuan.

Although the e-yuan has the backing of the government, it will face the same issues that any application faces when trying to grow its user base. The current players are well-established, and the question should be how to incentivize users to switch apps.

The e-yuan as a catalyst for innovation

The bottom line is that the e-yuan will act as a catalyst for innovation in the financial industry. Banks will have to switch their business model and change their competitive advantage to compete. As Chinese banks continue their expansion overseas, they will have a first-mover advantage in competing internationally. Fintech companies (such as Alipay, Wechat Pay) and established payment solutions (such as VISA and Mastercard) will have to continue to innovate to remain relevant and avoid losing market share to government-backed currencies.

About the Authors

Denis Chen is a class of 2023 student in the Johnson Cornell Tech MBA program at the Samuel Curtis Johnson Graduate School of Management at Cornell University. Prior to Johnson, he spent five years in Montreal, where he held a range of positions in business development, supply chain management, and enterprise digitalization. Chen earned a bachelor’s of engineering from McGill University in Montreal.

Jinn Guo is a class of 2023 student in the Johnson Cornell Tech MBA program at Johnson. Prior to Johnson, Guo spent five years in entrepreneurship and product management roles.

Swathi Mantripregada is a class of 2023 student in the Johnson Cornell Tech MBA program at Johnson. Prior to Johnson, she worked in technology and business innovation.

 Jay Ward is a class of 2023 student in the Johnson Cornell Tech MBA program at Johnson. He enjoys Pokémon Go! and playing jazz on his alto saxophone.