Widespread use of digital assets may undermine the effectiveness of BNM policies

KUALA LUMPUR (March 30): While digital assets could revolutionize several aspects of financial services, Bank Negara Malaysia (BNM) said the widespread use of these assets could undermine the effectiveness of central bank policies.

“The widespread use of digital assets for payments may lead to currency substitution, akin to “digital dollarization”. In the event that digital assets become widely used as a means of payment instead of ringgit, it could harm the effectiveness of the bank’s monetary policy.

“Therefore, this could impact the bank’s ability to manage inflation and implement effective countercyclical policies to foster sustainable economic growth,” it said in its 2021 annual report released on Wednesday. March 30.

BNM added that digital assets could also lead to macro-financial risks, affecting both the financial system and the economy, as if the public finds it more attractive to keep their savings in digital assets such as stablecoins – a type of digital asset that aims to maintain a stable value – this could lead to large shifts of deposits away from banks.

He said such changes could increase banks’ reliance on more expensive and less stable sources of funding such as wholesale deposits, which could in turn increase the cost of funding for borrowers and increase vulnerabilities to panics. banking.

“The stabilization mechanisms during times of systemic stress – such as deposit insurance, countercyclical capital and liquidity measures and liquidity support schemes – that support bank intermediation activities would also be rendered less effective. “, said the central bank.

Furthermore, he said digital assets could also be exploited to circumvent exchange rate policy measures, which could destabilize capital flows and complicate the management of exchange rate volatility.

Financial institutions’ exposure to digital assets could also lead to increased liquidity, market, credit and operational risks for these entities, the bank added.

He also raised concerns about money laundering and terrorist financing due to the lack or absence of customer identification; consumer protection issues given vulnerability to cyberattacks; and volatility in the value of digital assets that could put investors’ wealth at risk.

New sources of risk are also emerging from stablecoins and decentralized finance (DeFi), he said, noting that stablecoins can experience runs if investors doubt the value of the underlying assets used to back them. stable coins.

“Large-scale redemptions of stablecoins can trigger a fire sale of the underlying assets. This could create disruptions in the financial institutions and markets (eg, short-term funding markets) in which these assets are invested.

“If DeFi becomes mainstream, its vulnerabilities and growing interconnectedness with the financial system could undermine financial stability. These vulnerabilities include high leverage, liquidity mismatches and limited buffers such as banks that can provide liquidity during times of stress,” he said.

However, at its current size, BNM said digital assets are not likely to pose systemic risks to the financial system, although that may not be the case if rapid growth continues.

“Given this, we are pursuing a cautious and pragmatic approach to promoting responsible innovation, while ensuring that the risks arising from it are properly managed,” he said.

BNM said this would allow it to harness the benefits while mitigating the associated risks, adding that it will continue to support public-private partnerships and international collaborative efforts to advance the principles of responsible innovation in the space. digital assets.

Read more stories from the BNM Annual Report 2021 here.