Thinking Big on Fed Accounts, Digital Dollars and Financial Inclusion

Chris Brummer is a Georgetown law professor and host of the Fintech Beat podcast, produced by CQ Roll Call.

In the fintech community, financial inclusion isn’t usually a question about whether it’s needed, but is instead about which one of a growing number of technologies is best suited to achieve it — or will be first out the gate with a practicable solution. And even where technologies are identified and named, it doesn’t take long to discover that any particular tool can in fact comprise a suite of similar but conceptually distinct paths and options.

Take, for example, the conversation on digital dollars driving policy conversations on the Hill and beyond. Almost universally, it’s understood as a solution to address financial inclusion and the difficulties the federal government has faced in moving dollars to those who need it. But in many regards the term digitization is just a catchphrase: the dollar is already digitized — in the form of digital facilities throughout the financial system, from credit and debit cards to online bank accounts.

I tend to think about digitization as an ongoing policy exploration concerning just how far, and widespread, digitization should go. And I use the word exploration intentionally: I don’t think there’s yet a high pitched debate per se between advocates, or firm positions driving people into belligerent camps, even where there may be initial skepticism towards preferred options. Which makes for wonky and pretty liberating policymaking.

What tech for a digital dollar?

I get the sense that most financial experts and economists support the release of a digital dollar, at least of some sort, that would comprise a liability of the Federal Reserve carrying the full faith and credit of the U.S. government. The disagreements appear to lie in what kind of technology should support it. For some of the more high profile voices in this space, like Chris Giancarlo and Dan Gorfine, a digital dollar would be tokenized. That means digital dollars would operate as bearer instruments that could be transferred instantaneously and would provide advantages over account-based forms of electronic money that use reconciliation-intensive, message-based approaches to adjust entries in a ledger. Notably, the conversation from this particular camp tends to highlight the efficiency that would be introduced to payments, and how such efficiency could improve the plight of small businesses as well as preserve the global preeminence of the U.S. dollar. Inclusion is a goal, but often packaged more subtly within larger operational and national security themes.

Meanwhile other voices support an account-based path for digitization that would comprise just one component of a larger, explicit strategy of enabling financial inclusion through the buildout of digital individual accounts at the Fed. Under this approach, described by Vanderbilt law professor Morgan Ricks as Fed Accounts, the Fed would offer all the functionality of ordinary bank accounts with the exception of overdraft coverage. The accounts would also have all the special features that banks currently enjoy on their central bank accounts, as well as some additional, complementary features. Among them, as University of California Irvine law professor Mehrsa Baradaran observes, the U.S. Postal Service could serve as branches so that households can be brought into mainstream banking.

Make no mistake, the upsides of digital Fed Accounts are truly compelling. Payments between Fed Accounts would clear in real time, just like interbank payments processed by the Fed. There would be no possibility of default on balances of any size. Deposit insurance would presumably be superfluous. Plus, finally, the unbanked could access high quality banking services.

I do have questions, though. Central bank account proposals face the difficult question, posed most recently by the Philadelphia Fed, of how commercial banks are supposed to lend money if their deposits are uprooted as people move their transactions to Fed Accounts. And, of course, there’s the even deeper question as to whether or not capital flight could make commercial banks even more fragile. But what has me especially worried is the repeated emphasis on tackling the “cash-digital divide” by focusing on providing more digital-dollar backed ATMs in rural and urban neighborhoods when cash, and commonly touched surfaces like dial pads, are potential vectors for COVID-19 transmission.

Might as well go big

Sitting back and thus looking at the conversation as it plays out, I wonder if we’re thinking ambitiously enough. I’ve been volunteering a bit of my time sitting on the advisory board of the digital dollar project — led by Mr. Giancarlo and Gorfine, where I’ve found the idea of tokenization really interesting. And I’ve been impressed by the work central banks are doing to upgrade their financial ecosystems.

There is, of course, a political economy behind maneuvers, as different countries seek to entrench or increase the popularity of their own currencies by improving the customer experience of holding and using them. And this is something the digital dollar project has highlighted time again.

But what I really find to be the most compelling case for tokenized systems is the prospect of our payment rails acting as base layer infrastructures for other game-changing applications.

Indeed, the potential advantages of a tokenized dollar from the standpoint of financial inclusion are impossible to ignore. If the tech could be developed supporting a platform model for money (emphasis on if), I see no reason why policymakers should limit a digital dollar’s ecosystem to payments. The supporting rails for a digital dollar could be opened up to other kinds of applications that could help contribute holistically to a transformation of the very model of financial inclusion.

It may sound a little sci-fi, but it’s not hard to imagine a tokenized dollar of the kind embraced by the payment gurus, but one constructed with some of the immediate policy goals and priorities of the postal-banking advocates. Under this model, government agencies, as well as authorized nonprofits and market participants, could try to build out applications for the underbanked on top of the platform on which it is run. I could even imagine a digital dollar ecosystem offering services like government sanctioned digital IDs, alternative credit scoring tools, and savings programs. Situated on top of layer one infrastructure could be even robo-advising and financial education services for low-income people.

This kind of thinking would take at least rhetorically a slightly different turn from some of the highest profile ideas batted around. But at times like ours, with wealth disparities growing as fast as civil unrest, it’s time to think big. And I think it’s worth adding to the discussion forward-looking proposals that tackle financial inclusion for what it really is — a challenge for which no one magic bullet will provide all the answers, but where instead a suite of mutually reinforcing forms of assistance will be necessary.