The Bank of Israel released a preliminary Digital Shekel design for public comment – a real opportunity for competition and innovation?

Last week, the Bank of Israel published a preliminary design of the central bank’s Digital Shekel system. In a detailed document, holding more than 100 pages, the Bank of Israel presents guiding principles and a work plan for further advancing this ambitious project.

At inception – a decision as to whether the central bank should issue a local digital currency in Israel has not yet been made, and it appears that it will take a few more years before such a decision is reached. Nevertheless, the document currently published presents the structure of the Digital Shekel system to those stakeholders and key players who would be participants as users or as service-providers. The document also includes a description of the next stages in the project which, upon completion, will enable a decision to be made as to whether to recommend to the Governor of the Bank of Israel to issue Digital Shekels and to initiate a legislative process, which will, of course, require cooperation from the government and the Knesset.

In recent years, central banks around the world (including the Bank of Israel) have been exploring the possibility of issuing a Central Bank Digital Currency (CBDC) as legal tender in addition to physical cash. The digital currency will be a universal means of payment with characteristics similar to that of cash, including a serial number and a controlled quantity, however the currency will be digitally represented. The Digital Shekel will be convertible at a 1:1 ratio into ILS in cash or money in bank accounts. The public will hold Digital Shekel in digital wallets and will be able to pay or receive payment from anyone in Digital Shekl, thereby enjoying the convenience of digital means of payment.

CBDCs offer numerous advantages: improving the payments market and increasing competition; promoting innovation in the financial system; combating the “black economy”, money laundering and terrorism financing; allowing for interoperability among international systems; and increasing disadvantaged populations’ access to advanced payment services. On the other hand, the issuance of a CBDC also entails high costs and potential risks, particularly in terms of information security, privacy protection, and maintaining the banking system’s liquidity and the supply of credit to the public.

According to the Bank of Israel’s outline, the Digital Shekel will be available to the general public (including minors and foreigners) and to all types of businesses (including public institutions and financial institutions). Payments in Digital Shekel will be immediate and final, and the Digital Shekel system will be available 24/7/365. The system will enable payments at both very small and very large amounts, and will also support offline payments in emergencies or in the absence of network connectivity, so that payment transactions can be completed seamlessly. Furthermore, as with cash, the public will be able to make anonymous payments using Digital Shekel at limited amounts. For the first time, the Bank of Israel is announcing that the Digital Shekel system will enable the payment of interest on retained balances of Digital Shekel, with the goal of increasing competition in the deposits market. 

To hedge risks to the banking system’s liquidity and adverse impacts on the supply and price of credit, limits might be imposed on end-users’ retained balances of Digital Shekel and, in the event of a financial crisis, also Digital Shekel funding limits. According to the Bank of Israel’s assessment of preliminary simulations, activities requiring exceptionally high amounts will require a holding limit regime but will not constitute an effective restriction on the public’s routine activities in the Digital Shekel system.

The Bank of Israel plays a central role in the Digital Shekel system: it will be the issuer of Digital Shekel, will set the rules of the Digital Shekel system, and will serve as the system’s administrator, operator and supervisor. The Bank of Israel will also set rules and licensing processes for each type of participant in the Digital Shekel system – payment service-providers (PSPs), funding institutions (FIs), and additional service- providers (ASPs). Anyone wanting to use Digital Shekel will have to engage with a PSP and hold a digital wallet through it. FIs managing the accounts will support the loading and use of Digital Shekel wallets against the account being managed by them or against cash. ASPs will offer various advanced applications.

The possibility that a wide variety of participants in the Digital Shekel system will be offering services to the public of Digital Shekel-users, opens a door to increased competition in the financial market, particularly in relation to the banking and payments sectors, and to technological innovation. However, the operation of the Digital Shekel system may impose a regulatory burden on entities such as banks, credit card companies and existing PSPs, which will be obligated to participate in the Digital Shekel system in order to ensure its universal operation.

Furthermore, the Digital Shekel system also raises material concerns that will need to be clarified at a later stage, for example: in relation to aspects of the finality of the payment and the inability to deny a transaction, concerns about information and data leakage, and about violations of users’ privacy.

As stated in the heading to this article, the Bank of Israel is enabling the public and relevant stakeholders to express their opinions about the initial design of the Digital Shekel system and to take part in the project by answering questions in a designated online form, which is accessible at:

https://forms.gle/4oe8nzKVjhqPLZTT6.

***