Central Bank Money

Central bank money is money that is a direct claim on, and a liability of, a country's central bank. It takes two forms: physical cash (banknotes and, depending on the country, coins) held by the public, and electronic balances that commercial banks and certain other institutions hold in their reserve accounts at the central bank. Together these make up what economists call the monetary base.

Because the issuer is the authority that creates the currency, central bank money carries no credit or liquidity risk in its own currency. That makes it the safest settlement asset available and the anchor for the rest of the monetary system.

Most money that households and companies use is not central bank money but commercial bank money: deposits, which are a private bank's promise to pay. A deposit of 100 at a commercial bank is a claim on that bank, and its value depends on the bank's soundness, supported by deposit insurance and regulation. A banknote of 100 is a claim on the central bank itself.

The two circulate at par because commercial bank money is convertible into central bank money on demand: depositors can withdraw cash, and banks settle payments between themselves using reserves. This one-for-one convertibility, sometimes called the singleness of money, is what lets people treat deposits at different banks as the same currency. If confidence in a bank fails, depositors try to convert into central bank money all at once, which is the mechanism of a bank run and the reason central banks act as lender of last resort.

When a customer of Bank A pays a customer of Bank B, the customers exchange commercial bank money, but the two banks must settle the obligation between themselves. In most countries the final step is a transfer of reserves across the central bank's books, typically through a real-time gross settlement (RTGS) system such as Fedwire in the United States or the system behind CHAPS in the United Kingdom. Once reserves move, payment finality is achieved and no bank is exposed to the failure of another for that payment.

International standards reflect this. The Principles for Financial Market Infrastructures, issued in 2012 by the Committee on Payments and Market Infrastructures (CPMI) and IOSCO, state that financial market infrastructures should conduct money settlements in central bank money where practical and available, because doing so removes settlement risk arising from the failure of a settlement bank.

Access to central bank money is not equal. Anyone can hold cash, but only eligible institutions can hold reserve accounts. Traditionally these are licensed banks, sometimes joined by central counterparties and other infrastructure operators. Payment and e-money firms that lack direct access must hold their funds as commercial bank money and settle through a bank, adding cost and dependency. Several central banks, including the Bank of England, have opened settlement accounts to non-bank payment providers, and access policy remains an active policy debate.

Central bank money is created when the central bank buys assets or lends to banks, and destroyed when those operations reverse. Its quantity is shaped by monetary policy, demand for cash and any reserve requirement. It is a small fraction of the broad money supply, most of which is deposits created by commercial bank lending.

Falling cash use in some countries has prompted concern that the public could lose direct access to central bank money. A retail central bank digital currency (CBDC) would give the public an electronic claim on the central bank, while wholesale CBDC and tokenized reserves are being explored for settling tokenized assets between institutions. Private alternatives such as stablecoins and tokenized deposits are, by contrast, claims on private issuers. The Bank for International Settlements (BIS) has argued that settlement in central bank money should remain the foundation of any tokenized system.