50.5 Legacy central-bank transition

The existing State central bank should be wound down separately from the introduction of the VoTa monetary system. Its responsibilities cannot disappear immediately because legacy currency, contracts, banks, payment systems, and public financial obligations may remain important for many years. This subchapter describes how its influence can decline with the monetary system it serves.

Allow the legacy central bank to decline in importance

The existing State central bank should not be confused with the constitutional Central Bank that operates Central Bank currency and the Central Bank Payment System. The two institutions may coexist for a long transition, but they operate different currencies under different rules. The legacy central bank continues to administer the legacy monetary system; it does not become the issuer, owner, guarantor, or monetary-policy authority for Central Bank currency.

There need not be an abrupt date on which the legacy central bank is abolished. Its importance can decline with the importance of the system it serves. As households and businesses increasingly hold Central Bank currency, quote prices and wages in it, use it for payments, and borrow and invest in it, a progressively smaller share of economic activity depends on legacy currency, commercial-bank deposits denominated in that currency, or settlement through legacy central-bank reserves. The old institution may initially remain large and active, then become a smaller administrator of a contracting monetary domain, and ultimately become a limited wind-down institution.

This is a consequence of voluntary migration rather than a compulsory exchange. Legacy notes, deposits, debts, and contracts do not cease to exist merely because Central Bank currency has been introduced. Existing obligations can continue under their original terms, and parties remain free to use the legacy currency. The decline occurs as old contracts mature, users choose the new currency for new transactions, and commercial banks reduce their dependence on legacy demand deposits. The pace should therefore respond to observable adoption and financial-system capacity, not just to a political deadline.

Phase out legacy interest-rate policy through declining reach

A legacy central bank normally gives effect to monetary policy by setting or closely influencing a short-term policy interest rate. It can pay interest on reserve balances, lend reserves at stated rates, and buy or sell assets so that the rate for overnight funds remains near its target. Because commercial banks use those reserves to settle with one another, the policy rate influences their funding costs and can pass through, imperfectly and with delays, to deposit rates, mortgage and business-loan rates, bond yields, asset prices, and the exchange rate.

That transmission mechanism remains relevant while much of the economy uses the legacy currency. It should not be switched off while large stocks of variable-rate mortgages, business loans, bank deposits, and payment obligations still depend on it. A sudden withdrawal could disrupt funding markets and payment settlement, produce sharp movements in borrowing costs, or leave existing contracts without the monetary arrangements on which they were written.

Its reach nevertheless narrows naturally during adoption. A policy rate for legacy reserves can strongly affect a loan denominated and funded in legacy currency, but it cannot set the interest rate on a private loan of Central Bank currency. The latter rate is negotiated in the market between savers, investors, intermediaries, and borrowers. Nor can the legacy central bank change the quantity of Central Bank currency, pay interest on Central Bank accounts, or defend a fixed exchange rate between the two currencies.

Consequently, a change in the legacy policy rate affects a diminishing proportion of credit and spending as new lending, refinancing, payrolls, prices, and savings migrate to Central Bank currency. The effect is not determined solely by the proportion of payments made in each currency: it also depends on the denomination and funding of debts, the currency in which prices are set, and the financial links between the two systems. These exposures should be measured and published so that the reduction in policy activity follows the actual loss of monetary-policy reach.

During coexistence, exchange-rate movements can still carry some legacy policy effects into the new currency economy. For example, a change in legacy interest rates may alter demand for legacy assets and therefore the floating exchange rate. That indirect influence is not authority over Central Bank currency and should generally weaken as legacy assets and contracts become less economically important. The constitutional Central Bank does not respond by creating currency, targeting an interest rate, or trading assets to offset the movement.

Do not reproduce a separate reserve tier

In the legacy system, commercial banks hold accounts at the legacy central bank so that obligations between them can be cleared and settled in central-bank reserves. Those reserve balances form a special settlement asset used by eligible financial institutions. They are useful for settling legacy commercial-bank money, but they do not clear or back Central Bank currency in the VoTa system.

A commercial bank instead holds Central Bank currency in its own account with the constitutional Central Bank, just as any other account holder does. When one bank pays another in Central Bank currency, the payment is an ordinary transfer of existing units from the payer's account to the recipient's account. Settlement is complete when the common ledger records that transfer. The banks do not exchange a second kind of money behind it, and they do not need privileged reserve accounts available only to financial institutions.

In this sense, commercial banks are not special. Their Central Bank accounts operate under the same rules as other accounts, and transfers to or from them conserve currency in exactly the same way as any other transfer. Being a bank grants no privileged access to currency creation, overdrafts, Central Bank credit, settlement guarantees, or a distinct asset available only to banks. A bank's role as lender, intermediary, custodian, or payment-service provider arises from voluntary contracts with its customers, not from a special position inside the monetary system.

This also means that there is no separate reserve currency backing Central Bank currency. Central Bank currency is itself the final asset recorded in Central Bank accounts. A bank cannot obtain it by having the Central Bank create reserves, borrowing it from the Central Bank, or converting a private deposit into it by an accounting entry. It must receive existing units from customers, savers, investors, loan repayments, asset sales, or other willing counterparties before it can transfer or lend them.

Banks may still create private clearing arrangements for their own liabilities and may net a series of obligations before making a final payment. If final settlement is promised in Central Bank currency, however, the net amount must ultimately be transferred through their ordinary Central Bank accounts. Any privately issued balance remains a claim against its issuer; it does not become Central Bank currency merely because banks use it among themselves.

Reduce the legacy settlement and protection functions together

The legacy central bank may also issue notes, maintain reserve accounts, operate or support wholesale settlement, provide liquidity to banks, hold foreign reserves, act as banker to the government, and perform financial-stability or regulatory functions. Some of these functions may be located in separate agencies in a particular country, but their transitions remain connected. They cannot be assumed to disappear merely because a new retail payment system exists.

As legacy bank deposits and interbank payments contract, banks require less legacy reserve settlement and the old payment infrastructure carries less traffic. As deposit guarantees and lender-of-last- resort support are phased out, depositors and creditors bear more of the risk they voluntarily accept, while bank-specific prudential regulation can be reduced in parallel. These changes should be coordinated: removing oversight while leaving an expectation of rescue preserves moral hazard, while removing liquidity and settlement support before banks and customers can migrate could create an avoidable crisis.

No timetable can guarantee that migration will always be smooth. Confidence in legacy banks may occasionally fall faster than planned, especially once customers have a safe alternative payment account. The transition should therefore publish milestones, exposures, and contingency procedures; require clear disclosure of which liabilities are privately guaranteed; and ensure that the Central Bank Payment System can accommodate increasing use. A contingency may slow a scheduled withdrawal of legacy support, but it must not authorise creation of Central Bank currency to rescue legacy banks or promise conversion of their liabilities at par.

Run off the legacy central bank transparently

Declining monetary influence does not eliminate the legacy central bank's balance sheet. It may still hold government securities, loans to banks, foreign reserves, buildings, and other assets, while owing reserve balances, notes, government deposits, and contractual obligations. These items must be inventoried and dealt with explicitly. They should not be silently transferred to the constitutional Central Bank, whose inability to borrow, lend, or own money is fundamental to its design.

Assets and liabilities can be allowed to mature, sold or settled in legacy currency, or assigned to a separately funded legacy-resolution body under published rules. Government debt and government accounts require coordination with the tax and political transitions. Foreign reserves and sale proceeds remain public legacy assets and should be disposed of through a transparent, legally defined process rather than used to manipulate the floating exchange rate of Central Bank currency. Losses on legacy assets must remain visible legacy obligations; they must not be covered by creating Central Bank currency.

Over time the institution should cease making new long-dated commitments, narrow discretionary monetary operations, consolidate little-used facilities, and retain only the staff and powers needed to settle remaining obligations safely. This gradual contraction preserves continuity and allows experienced staff to complete projects, transfer technical knowledge, or retire normally. Final closure becomes practical only when remaining functions can end or be performed without special State monetary privilege. Until then, the objective is not to pretend that the legacy central bank has vanished, but to make its shrinking role explicit, measurable, and incapable of compromising the constitutional rules governing Central Bank currency.