Insurance industry in the age of digital

Description

The decrease in loan disbursements resulting from CBDC implementation may directly impact the insurance industry, particularly in terms of reduced credit insurance premiums.       

The rapid advancement of the digital world has driven the adoption of technology in various sectors, including in the use of crypto assets and other digital currencies that aim to replicate traditional fiat money. As a result, central banks around the world, including in Indonesia, have introduced the concept of a central bank digital currency (CBDC) as a centralized digital currency, accommodating the evolving behavior of society.

Bank Indonesia (BI) says that the digitalization of the economy has shifted people's preferences toward financial services that are faster, easier, cheaper, more secure and more reliable. With internet penetration reaching 74 percent, 98 percent of transactions being conducted digitally and 59 percent of the population utilizing digital financing, there is already a solid foundation for developing the CBDC framework.

Under the Garuda Initiative, BI is actively exploring the design of the Indonesian CBDC, known as the Digital Rupiah. This project complements BI’s various initiatives in promoting the national digital transformation agenda, specifically the integration of the digital economy and finance in an end-to-end manner. These efforts are currently being advanced through the 2025 Indonesian Payment System Blueprint (BSPI 2025) and the 2025 Money Market Development Blueprint.

In a multilateral setting, BI is also engaged in initiatives during Indonesia’s ASEAN chairmanship in 2023 and in the Group of 20 presidency in 2022 to promote CBDCs in response to the widespread adoption of private digital currencies. This has prompted BI to reformulate its 2020-2025 Vision, aiming to become the leading digital central bank, to make a tangible contribution to the national economy and to set the benchmark among emerging market countries.

The implementation of CBDCs will have an impact on the monetary sector and the economy as a whole. According to BI (2022), CBDCs complement physical currencies by enabling faster circulation and contributing to the funding needs of development. The ability to create and change monetary policy will be accelerated, allowing policy actions to have a more significant impact.

However, the hypothetical influence of this policy on the financial sector, particularly the insurance industry, may not always be positive. It will need to go through several stages in the transmission mechanism.

Firstly, BI will need to determine whether CBDCs will have an interest rate or not. Despite their lack of official recognition as a means of payment, the high returns and rapid development of cryptocurrencies such as Bitcoin and Ethereum have been remarkable.

According to Bloomberg data, the price of Bitcoin increased from only US$3.40 per coin in mid-2011 to $25,848 per coin as of June 12 (after experiencing a decline from its peak of $62,941 in October 2021). Similarly, Ethereum's price rose from 90 US cents per coin in March 2016 to $1,738 per coin on June 12.

Furthermore, when compared with other assets like stocks or gold, certain crypto assets have demonstrated higher year-to-date (YTD) returns. For instance, Ethereum has recorded a YTD return of 45.43 percent, Bitcoin has reached 56.56 percent and Solana has surged to 58.33 percent as of June. In contrast, traditional assets like the S&P 500 have achieved a YTD return of 12.81 percent, while gold has yielded a return of 7.67 percent. This may prompt the central bank to consider issuing an interest-bearing CBDC to ensure market acceptance, given the assumption that CBDCs and private cryptocurrencies can serve as substitutes.

Secondly, as explained in a Bank for International Settlements (BIS) study in 2021, the issuance of CBDCs has the potential to alter the structure of commercial banks' T-accounts. Before implementing a CBDC, the banking balance sheet should comprise high-quality liquid assets (HQLAs) such as cash, loans and other assets, while liabilities should include deposits, wholesale funding and capital. However, the introduction of a CBDC could lead to a decrease in the amount of HQLAs due to the liquidity coverage ratio associated with the CBDC.

Furthermore, the adoption of CBDCs could prompt commercial banks to raise deposit rates in order to prevent people from being more inclined to place their money in CBDCs. Consequently, to balance finances and increase assets, banks might increase lending rates, allowing the banking sector to provide higher deposit returns to customers.

Several studies have examined this issue. A study conducted by Keister and Sanches suggests that higher interest rates on deposits may potentially lead to a decrease in loans, as financing becomes feasible only for projects with a higher return on investment. Agur et al and Mancini-Griffoli et al have found that larger banks with a stronger bargaining position may prefer to raise lending rates, thereby reducing the amount of available credit needed to offset the increase in deposit rates. Consequently, Piazzesi and Schneider conclude that the implementation of a CBDC could result in a more expensive credit channel within the monetary policy-transmission mechanism.

Thirdly, let us examine the anticipated impact on the insurance industry. The decrease in loan disbursements resulting from CBDC implementation may directly impact the insurance industry, particularly in terms of reduced credit insurance premiums.

In Indonesia, as studied by IFG Progress, credit insurance is the third-largest contributor to general insurance premiums, following motor vehicles and property. Indonesia ranks first in terms of credit insurance penetration, calculated at 0.067 percent, based on insurance premiums as a percentage of GDP, followed by Germany (0.053 percent) and Japan (0.004 percent).

Moreover, the proportion of credit insurance to general insurance in Indonesia was significantly higher than in other countries in 2020. In Indonesia, credit insurance accounts for 15 percent of the total general insurance, while in countries like the United States, Germany, France, Japan, China and Singapore, it accounts for about 5 percent.

The insurance industry should anticipate that the introduction of a CBDC might change the landscape of the credit channeled by commercial banking and therefore impact the credit insurance premium.  

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Ibrahim Kholilul Rohman is a senior research associate at the state-owned Indonesia Financial Group (IFG). Afif Luviyanto is a research associate at IFG Progress research. The views expressed are their own.

This article was published in thejakartapost.com with the title "". Click to read: https://www.thejakartapost.com/paper/2023/07/03/insurance-industry-in-the-age-of-digital-currency.html.