Digital shekel may be coming as Bank of Israel preps an ‘action plan’

The Bank of Israel said Tuesday it was preparing an “action plan” for the issuance of a digital shekel, if conditions develop in the future that lead the central bank to believe that the benefits of such a currency outweigh the costs and potential risks.

As digitalization in the global financial system develops rapidly, the Bank of Israel is beginning preparations for an eventual launch of the currency, with a plan ready to be put into action, if the right conditions arise, the report said. The central bank emphasized that in line with many other central banks, “the Bank of Israel has not yet decided whether it intends to issue a digital currency.”

The central bank also emphasized that it will continue issuing cash in the form of banknotes and coins, “as long as there is a demand for such on the part of the public, and as long as the Bank believes that it is necessary” to support the payment system in Israel.

For the purpose of preparing the ground, a steering committee appointed by the central bank’ s governor, Amir Yaron, has set out, in general terms only, a draft model for a potential Bank of Israel digital currency.

This model will now be the basis for a discussion by players in the payments, finance and technology sectors, in academia and in relevant government agencies and organizations, the central bank said in a statement.

Governor of the Bank of Israel Amir Yaron speaks at the Eli Horowitz Conference for Economy and Society, held by the Israel Institute of Democracy, in Jerusalem, on December 17, 2019 (Hadas Parush/Flash90)

A document published by the central bank on Tuesday outlines the draft model of a Bank of Israel digital currency. Called “A Bank of Israel Digital Shekel – Potential Benefits, Draft Model, and Issues to Examine,” the draft model is accompanied by a public call for responses to its contents.

Amid a digital revolution that is enveloping the financial system, central banks around the world are wondering whether in the near or distant future they will have to provide the public with another form of currency — digital money — and if it will be possible to keep, or even improve, the qualities of existing money in its digital form.

As of now, the public uses two main types of money: cash, which is a physical liability of the central bank toward the public, and bank money, which is a liability of the commercial banks toward account holders.

Digital money already exists, in a way: the money the public holds in banks, which it pays from via bank transfers, payment cards and payment apps is in fact digital money. It exists in in the computer systems of the financial institutions that provide it, and it does not exist in the physical dimension.

The retail central bank digital currency (CBDC), or the general purpose CBDC that is being considered now, would give households and businesses access to use the central bank’s digital money in addition to physical cash. This would constitute a liability of the central bank toward the holder of the currency, as opposed to a liability of a commercial bank toward the user of the currency as is the case with payments today.

3D rendering of a bank vault with gold bars inside (tifonimages; iStock by Getty Images)

While cryptocurrencies do not belong to any specific country and some have no central authority to manage them, a CBDC will be issued by the country’s central bank, and it is the central bank that would determine its quantity, its manner of use, and the regulations that will apply to it.

The new model formulated by the Bank of Israel’s steering committee, headed by deputy governor Andrew Abir, envisages a two-tier approach in which a partnership is set up for the creation of the CBDC between the Bank of Israel and the private sector (banks, credit card companies, and technology and/or finance companies from Israel and abroad). With this partnership, the central bank will provide its digital currency not directly to the public but rather via the private-sector institutions. It will be up to these institutions to develop the apps to allow this form of payment, based on the basic infrastructure provided by the Bank of Israel.

In terms of the technology to be adopted, the model does not at this stage determine whether the system will be based on distributed ledger technologies (DLT) or on a central registry technology.

Full and immediate conversion will be enabled between a digital shekel and existing means of payment, and the system will support conversions to and from foreign currency, the model says.

Illustrative photo of the new 200 New Israeli Shekel bill. February 7, 2016. (Nati Shohat/Flash90)

Payment will be enabled not only through cellphones, but also through a variety of means, including simple devices, and offline payments, via digital codes for example, will also be enabled in a limited form.

In terms of privacy, the digital shekel will be designed in keeping with anti-money-laundering (AML) rules, and in a way that will not interfere with the government’s efforts to collect taxes. As such, absolute privacy will not be possible. However, various levels of privacy vis-à-vis payment providers and commercial entities will be possible, the model says.

In terms of the economic characteristics, according to the draft model, the digital shekel will carry a zero-interest rate, but it will remain technologically possible to change this in the future. The infrastructure should also allow for the authorities to be able to define restrictions on the volume of holdings and use of the digital shekel. The cost of making a payment should be very low or near zero, and its use will also be made possible for those who do not have a bank account in Israel, e.g., children and tourists.

“This draft does not represent any Bank of Israel decision regarding the characteristics of a digital shekel should any be issued,” the central bank said in a statement. “The draft model is the basis for a discussion and for examination of alternatives by the work teams involved in the matter at the Bank of Israel.”

The Bank of Israel has been examining the issue of central bank digital currencies since 2017, the statement said.

“The Bank of Israel has not yet decided whether it intends to issue a digital shekel, but in view of the rapid developments in the digital economy and in payments, and in view of the major central banks’ work on the issue, the Bank of Israel is accelerating its research and preparation for the potential issuance of a digital shekel,” the statement said.

Federal Reserve Chairman Jerome Powell speaks during a news conference following a two-day Federal Open Market Committee meeting in Washington, July 31, 2019. (AP Photo/Manuel Balce Ceneta, File)

While no central bank in an advanced economy has yet announced a decision to initiate a project that would lead to the central bank issuing a digital currency, there has recently been a change in global sentiment on the matter. In 2020, China became the first major economy to pilot a digital currency in various provinces, and a total of a few million dollars’ worth of digital currencies has been distributed.

According to a press report on May 10 by state-backed China Securities Journal, MYBank, an online privately owned bank in which Alibaba’s Ant Group has a stake is allowing some users to link their accounts with China’s digital currency app.

Bahamas in October 2020 became the first country to issued retail CBDC to the general public. And in the US, the Federal Reserve is conducting an in-depth examination of the implications of digital currencies for the financial system and the payment system.

In March, Fed chairman Jerome Powell joined international peers saying the launch of a central bank-backed digital currency would be a momentous step for the financial system that needs careful preparation and shouldn’t be rushed, according to a Bloomberg report.

The Bank of International Settlement (BIS) published a joint report with seven leading central banks in October 2020. These banks, including the Bank of England, the Federal Reserve and the European Central Bank, are actively examining the potential of issuing CBDCs as a means of payment for use by the general public. They detailed the principles they agreed upon and their intention to continue cooperation in researching the matter.

In view of these developments, the Bank of Israel has decided to accelerate its learning, research, and preparation leading to the potential issuance of a Bank of Israel digital currency in the future, the statement said.

The steering committee set up by governor Yaron in November 2020 has created a number of working groups from among professionals in various fields within the bank, through which it has mapped out the potential advantages, various issues, and risks involved in a potential issuance of a digital shekel.

Among the key questions studied by the committee are what benefits the Israeli economy would derive from the existence of a digital shekel and what needs it would meet.

Considerations that would tip the balance in favor of a digital currency would be whether it will help fight the shadow economy by reducing the use of cash; offer an efficient, advanced and secure alternative to the existing means of payment; better ensure the functioning of payment systems during emergencies or breakdowns; create an efficient and inexpensive infrastructure for cross border payments; and allow the public to use the currency while ensuring a certain level of privacy.

An illustrative image of digital payments and digital currency (sefa ozel; iStock by Getty Images)

The issuance of a CBDC may also involve risks, however. A large part of the steering committee’s work is focused on researching these risks as well.

“A Bank of Israel digital currency, if one is issued, will have to win public trust to the same extent that cash has, so the system will have to be designed and built to meet the highest business and technological standards,” the authors of the report said. “The preparations for issuing a CBDC are expected to take some time. In contrast, as stated, the world of payments and digitization is developing rapidly. Therefore, the Bank of Israel is already beginning its preparations.”