I am very grateful for the invitation to deliver remarks at this conference here in the beautiful pink city of Jaipur. Let me begin by expressing my sincere gratitude and appreciation to Mr Patra, Deputy Governor of the Reserve Bank of India and Chairman of the Deposit Insurance and Credit Guarantee Corporation (DICGC), and the staff of the DICGC for organising this conference here in Jaipur.

The theme of today’s conference is very relevant and timely. I am sure that today and tomorrow we will explore many interesting facets of financial innovation and its implications for deposit insurance systems.

In my remarks today, I would like to

• First, I will discuss how technological advances such as distributed ledgers and tokenisation are changing money and deposit-taking.
• I will then touch on some of the potential challenges and risks, and
• Finally, I will outline some implications for the regulatory environment and deposit insurance systems that may govern the transition.

Money, deposits and technological innovation

Money is a social convention.  People use money with the confidence that others will accept it. Trust in money is essential for the monetary system to function effectively. The methods society has used to store and transfer value have changed over time. In ancient times, stamped coins circulated here in Jaipur. Rulers had the right to mint their own coins since medieval times and retained it until the Indian rupee was introduced.  It was a symbol of their authority and control over the economy. The quality and consistency of these coins played an important role in maintaining the confidence of traders and the public. Rulers who vouched for the integrity of their coins by ensuring their weight, purity and value were more likely to foster confidence and facilitate trade within their empire. 

Much of the money in use today is already in digital form (e.g. bank deposits and e-money). However, technological advances such as distributed ledgers and tokenisation are forcing policymakers and financial service providers to fundamentally rethink money.

The development of programmable platforms for commercial applications, including those based on Distributed Ledger Technologies (DLT), is creating demand for ‘cash equivalents’ that act as liquid means of payment and stores of value in a DLT environment.

The search is on for a money that is better suited to an increasingly digitalised economy and meets the changing expectations of users. In order for DLT platforms to be used for financial transactions, the assets and forms of money to be exchanged need to be represented in digital form on the platforms, i.e. they need to be tokenised. Tokenisation involves the representation of real-world assets on a DLT platform, including but not limited to commercial bank deposits. It changes the way ownership of assets is recorded and enables far-reaching new functions.

Two forms of digital money are currently under close scrutiny:

• tokenised deposits, and
• Central Bank Digital Currencies (CBDCs).

Tokenised deposits are economic equivalents of existing traditional deposits issued by a licensed deposit taker, but recorded in a novel form. They represent a deposit claim against the depositor’s commercial bank, just like a regular deposit, but on a DLT platform. They can be used to pay for or settle transactions between digital assets and act as a store of value and a means of exchange on DLT platforms. They can take different forms: they can be ‘native’, reflecting the value recorded directly on the DLT platform as the primary record, or ‘non-native’, where the DLT simply mirrors an off-chain record.

Tokenised deposits offer a range of new functionalities and can enhance a variety of uses of commercial bank money. They can be exchanged for other digital assets almost instantaneously (‘atomically’), removing the risk of parts of a transaction not being settled because a counterparty fails or is unable to deliver. Whereas the traditional model for transferring funds relies on information and value being separated and intermediated by banks, so that the communication of information and the movement of funds occur sequentially, tokenised deposits embody the information contained in the payment instructions. This enables direct peer-to-peer transfers of funds. Another new feature is programmability, the ability to hardwire into the ledger future transfers of value that automatically self-execute based on the occurrence of future conditions at the smart contract level (i.e. programmes on a DLT platform that run when a set of pre-determined conditions are met). Tokenisation also provides greater transparency into the status of transactions and facilitates the application of customer due diligence rules by creating reliable transaction records and audit trails. It provides efficiencies in risk management and offers 24/7 transfer availability.

Central bank digital currencies (CBDCs) are digital forms of national currencies issued by central banks. They are forms of central bank money. A survey by the Bank for International Settlements in 2024 found that at the end of 2023, 94% of the (86) responding central banks were involved in CBDC work. An important distinction between different CBDC designs is to whom the central bank issues the currency. Wholesale CBDCs are issued only to financial institutions, while retail CBDCs are closer to digital cash issued to individuals and businesses. Around 30% of central banks focus only on retail CBDCs and 2% only on wholesale CBDCs. More than half of respondents (54%) are experimenting with proofs of concept, and one in three (31%) are running a pilot. By 2023, both retail and wholesale CBDC work had progressed to more advanced stages.

Challenges and risks

As with most things, there are challenges and risks. In a system based on trust, resilience is critical. The global CrowdStrike outage last month was a stark reminder of the fragility of the interconnected IT systems we rely on. If one component fails, it can set off a chain reaction that affects other parts of the system. Ensuring operational resilience is therefore critical. Automation, for example through the use of smart contracts, can increase efficiency and reduce the risk of human error. At the same time, reducing direct human involvement also increases the risk of undetected errors, such as software bugs. Automation through smart contracts must therefore be monitored and audited and be subject to robust technology risk management standards.

Atomic settlement enabled by DLT applications has the potential to further increase the speed and intensity of execution. Programmability may make it possible for customers to automatically withdraw funds following negative news about a bank. This could exacerbate runs, even if the triggers are dispersed. But tokenisation could also mitigate risk. It may allow banks to respond immediately and automatically to liquidity stress by moving liquidity to where it is needed.

For their benefits to be realised, tokenised deposits must be secure. Trust and confidence in them will be fundamental to financial stability. Tokenised deposits, like traditional deposits, derive their stable value from confidence in the creditworthiness of the issuing bank, the regulatory environment and the availability of deposit insurance. If users cannot redeem their digital money for cash or transact with it at its stated value, trust is lost. Just as medieval rulers were responsible for minting reliable coins, policymakers today must ensure the operational resilience, security, integrity and stability of a digital asset system to foster user confidence.

Regulators and institutions must identify and address these unique risks through tailored frameworks and measures that ensure the stability and protection of depositors and the financial system.

The importance of robust regulation and risk mitigation

At the BIS Innovation Summit 2024 in Basel earlier this year, Agustín Carstens, General Manager of the BIS, spoke about developing a financial system fit for the future. He stressed that robust governance and regulatory arrangements are needed to create a truly coherent vision of the future financial system.

The FSB has promulgated the principles of “same activity, same risk, same regulation” in the context of crypto-asset regulation. This means that entities engaged in similar activities should be subject to similar regulatory requirements, on a functional basis and proportionate to the financial stability risk posed by the specific activities. When applied to deposit taking, this principle suggests that institutions accepting traditional deposits and those accepting tokenised deposits should be subject to equivalent regulatory and supervisory standards, as long as tokenisation does not change the underlying economics and fundamental nature of a depositor’s claim.

Tokenised deposits must therefore be issued by institutions licensed as banks and subject to strict minimum liquidity, capital and risk management requirements. As an extension of traditional deposits, tokenised deposits are not backed by specific assets (unlike stablecoins), but by the fractional reserves that a bank typically holds to support its liquidity needs. The issuing bank and the regulatory environment in which it operates play an important role in ensuring the value stability of tokenised deposits, as is the case with any other commercial bank money today.

However, the unique characteristics and risks associated with tokenised deposits may require the development of alternative or additional risk mitigation mechanisms. It is important for supervisors to assess the specific risks involved and determine appropriate measures to protect depositors’ interests in the context of tokenisation:

• Deposit tokens may have different behavioural characteristics from traditional deposits, as they bring new features and may be adopted by a slightly different user base. Existing liquidity, capital and risk management frameworks already require banks to assess redemption behaviour and stress conditions and to maintain prudentially safe levels of funding.
• The technical features, such as programmability and instant settlement, are likely to increase velocity (i.e. a measure of how quickly money changes hands) relative to traditional deposits, which may affect liquidity needs. It will be important to implement controls to interact with DLT platforms and prevent technology risks that may arise from the use of these platforms.
• The underlying technology must ensure the integrity, immutability and confidentiality of transactions, similar to the trust placed in traditional banking systems. Tokenised deposits should be built on secure and reliable DLT platforms, and depositors should be able to easily convert their tokenised deposits into cash, and the deposits should be readily usable for transactions or investments. Strong cyber defences are essential to maintain trust by protecting the security and privacy of tokenised deposits.

What about deposit insurance?

Deposit insurance systems are designed to protect traditional bank deposits, providing a level of insurance to depositors in the event of a bank failure. In doing so, they create positive externalities. They reduce the risk of bank runs and minimise the need for public funds to deal with a systemic financial crisis. For them to continue to do so, they must be applied to all forms of deposit money, whether tokenised or in some other technological or legal incarnation. Deposits must remain deposits, regardless of the technology used, in so far as they perform the same economic functions and the fundamental nature of a depositor’s claim does not change.

Tokenised deposits need to be treated in a similar way to traditional deposits. If banks wish to accept tokenised deposits from retail customers, this would need to be done in a way that meets the rules for eligibility for depositor protection. It also means that tokenised bank deposits must operate within a regulatory framework that provides the same protections and safeguards as traditional bank deposits. This includes prudential regulation of banks, including capital, liquidity and customer due diligence requirements, as well as resolution and deposit insurance frameworks.

If the jurisdiction recognises tokenised deposits as equivalent to traditional bank deposits, and if they are subject to the same prudential, supervisory and resolution frameworks as traditional deposits, then tokenised deposits should also be covered by deposit insurance schemes that provide the same level of protection as traditional bank deposits, up to the same amount and subject to the same eligibility criteria.

The International Association of Deposit Insurers (IADI) is currently reviewing the Core Principles for Effective Deposit Insurance Systems, the international standard for deposit insurance systems. IADI’s Executive Council, which mandated the review, called for the review to ensure that the Core Principles remain relevant and effective in the evolving financial environment and adaptable to the ongoing and rapid changes in financial systems due to technology and other emerging trends. In particular, the IADI Executive Council emphasised that the Core Principles must remain technology-neutral. Thus, whether deposits are traditional or tokenised should not be a factor in the application of the Core Principles.

Conclusion

We should certainly be humble when it comes to predicting what the future financial system will look like. Structural changes such as climate change and demographics have a direct impact on bank balance sheets, as does geopolitical instability more generally. Generative artificial intelligence will have a transformative impact on society, the economy and the financial system. If the financial system is to serve society well, it must certainly be open to competition from new entrants and evolve as the forces of innovation unfold. However, these developments may pose risks, or at least challenges, for public authorities, in particular deposit insurers.

In an ever-changing future, our priority should be to build and maintain safe, secure and resilient financial systems. As Mahatma Gandhi wisely said, “The future depends on what you do in the present,” and this message applies to deposit insurers and policymakers alike. As banks and digital natives around the world continue to explore the potential of blockchain and distributed ledger technologies, the importance of forward thinking by policymakers becomes increasingly clear. It is imperative that deposit insurance systems keep pace with technological advances. I am confident that today’s and tomorrow’s conference will provide valuable insights and stimulate thoughtful discussions.

References

Technological innovation: small steps and giant leaps, Speech by Mr Agustín Carstens, General Manager of the BIS, at the BIS Innovation Summit 2024, Basel, 6 May 2024.

The Future of Payments Is Not Stablecoins – Liberty Street Economics, Federal Reserve Bank of New York, by Rod Garratt, Michael Lee, Antoine Martin, and Joseph Torregrossa, 7 February 2022

Financial Stability Board Global Regulatory Framework for Crypto-asset Activities, 17 July 2023

Embracing diversity, advancing together – results of the 2023 BIS survey on central bank digital currencies and crypto, by Alberto Di Iorio, Anneke Kosse and Ilaria Mattei, 14 June 2024

The tokenisation continuum, BIS Bulletin  |  No 72  |  by Iñaki Aldasoro, Sebastian Doerr, Leonardo Gambacorta, Rodney Garratt and Priscilla Koo Wilkens, 11 April 2023