On Thursday, February 10, 2022, the Central Bank of Kenya (CBK) announced the issuance of a Discussion Paper on Central Bank Digital Currency (CBDC) for public comments.
The Discussion Paper invited comments from the public to be considered when assessing the potential use case for CBDC in Kenya.
CBDC is a digital currency issued by the central bank and intended to serve as legal tender. It serves the same purpose as e-money, cryptocurrency and stable coins.
E-money is an electronic store of monetary value on a technical device, such as a mobile phone device, that may be widely used for making payments to entities other than the e-money issuer. The device acts as a prepaid bearer instrument that does not necessarily involve bank accounts in transactions.
On the other hand, a stable coin is a crypto asset that aims to maintain a stable value relative to a specified asset, or a pool of assets.
“A digital currency is a means of payment that exists purely in electronic form and can be exchanged for a pre-determined amount equivalent to the local fiat currency. A CBDC, therefore, is a digital currency issued by the central bank and intended to serve as legal tender. It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency, only that it is in electronic form. As opposed to the other forms of electronic money issued by central banks, that is central bank reserves, CBDC designed for retail payments would be universally available,” said CBK in the papers.
Central banks exploring CBDC issuance cite different objectives, including mitigating systemic risks, financial stability and payments resilience, enhanced cross border payments, customer protection, promoting innovation and financial inclusion.
Conversely, there are significant potential risks with CBDC issuance. These include financial exclusion, technology risks, competing with bank deposits and undermining bank intermediation, hampering monetary policy transmission, Anti-Money Laundering and Combating the Financing of Terrorism (AML/CFT) and data privacy balance and infrastructure costs.
Early use of currency in Kenya as a means of payment commenced with the Arab influence who were among the first to use currency as we know it. Penetration of coins and notes accelerated when construction of the railway commenced in Mombasa in 1896 to reach Port Florence – present day Kisumu – in 1901.
After the World War I in 1919, the East African Currency Board (EACB) was introduced in the East African region with the responsibility of providing currency. As the East African territories became independent in sequence from 1962, the EACB ceased to issue notes. With the establishment of individual Central Banks for the East African countries, Kenya began printing and minting its own currency in 1966, under the mandate given to the Central Bank of Kenya in the Central Bank of Kenya Act.
The initial issue of Kenya shilling notes were in the denominations of 5, 10, 20, 50 and 100 shillings. Later came the introduction of bank notes and coins in the current denominations. These notes and coins are issued by the CBK and used as a means of payment by the public. The entrance of indigenous banks in 1968, popularised bank deposits as a store of money. Later, bank to bank transfers would now be used as a means of digital payments.
The emergence of banks also came with the introduction of payment cards (debit, credit and prepaid cards) as a payment channel. Mobile money emerged in 2007, through M-Pesa. Its rapid acceptance rate depicted a receptive attitude by Kenyans towards innovative payment channels. This led to the emergence of other private mobile money providers.
Today, the reliance on cash and mobile money remains the most significant in Kenya’s payment ecosystem especially in retail payments.
Kenya ranks third after Mongolia and China in financial inclusion out of 52 countries within emerging markets and developing economies. The digital financial inclusion index (financial inclusion through fintech) is higher than the traditional financial inclusion index (financial inclusion through financial institutions such as banks).
In 2021, the financial inclusion was 83 percent from 26 percent in 2006. Mobile money has been credited for the growth in financial inclusion. In 2020, the mobile penetration in Kenya was 129.1 percent14.
As of May 2021, there were 67.77 million registered mobile money accounts. 79 percent of adults have a mobile money account compared to 40 percent of adults who have a bank account.
CBK joins other Central Banks exploring the use of CBDC as the legal tender for digital payments.
The Bank of England’s (BOE) is exploring the concept of CBDC given that the use of banknotes is falling in England while the use of privately issued money and alternative payment methods is rising. BOE aims to provide an alternative to the privately issued digital money, that is safer and most trusted form of money to households, businesses and the financial system. BOE, through its CBDC discussion paper in June 2021, invited feedback and ideas from the public to facilitate the assessment of CBDC for future deployment.
Other countries mooting digital currency projects include Bahamas, Canada, Singapore, Sweden, China and Turkey.
There are no universally applicable best practices or prescribed rules that will guarantee the ultimate success of CBDC issuance.
Before issuing CBDC, CBK would need to carefully review the legal and institutional preconditions. These would include infrastructure, regulatory and supervisory framework, governance and risk management, central bank resources, and central bank legislation.
Developing the needed infrastructure to support CBDC issuance would include ensuring a high level of availability and resilience of the general infrastructure such as electricity grids, mobile network and internet coverage.
Ultimately, CBDC issuance is best considered in the broader context of national payment systems development, and driven by needs, objectives, and capacity rather than technology.