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Central bank digital currencies: a solution in search of a problem? Contents

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Chapter 2: Households and businesses

Consumers and innovation

20.Under the Bank of England’s proposed CBDC model, the Bank would not provide direct CBDC accounts to customers. Instead, it would operate the core digital infrastructure to enable CBDC payments while commercial banks and other financial services providers would connect to this infrastructure to provide CBDC wallets and related services. The Bank’s March 2020 Discussion Paper said this model could encourage innovation and enable “the private sector to create services that support greater choice” for consumers.23

21.Most witnesses were sceptical that a UK CBDC payments system would provide significant advantages to consumers over the existing payments system. Patrick Honohan, a former Governor of the Bank of Ireland, said that the benefit of a CBDC to UK consumers, “at present [would be] absolutely nothing.” Because the UK already has a “reasonably efficient payment system … just having a CBDC does not give you an advantage.”24

22.Professor Eswar Prasad, Senior Professor of Trade Policy and Professor of Economics at Cornell University, New York, agreed that the UK has an effective payments system and said there was not a strong consumer case for introducing a CBDC: “One could still make the user case in terms of the CBDC catalysing additional innovation and being a backstop for financial instability, but in terms of access and efficient low-cost payments the case is perhaps much weaker in the UK than it is even in the US.”25 Georges Elhedery, Group Executive and Co-CEO of Global Banking & Markets at HSBC, made a similar point: “some of the benefits immediately available to a consumer were marginal” but HSBC was considering whether additional innovation spurred by CBDCs could “leapfrog” existing payment services.26

23.Currently, when customers pay for goods or services with a card, the merchant pays a fee which can be as much as 2–3% of the transaction, depending on several factors including the size of the merchant’s business and the type of card used to pay. Debit card payments, which would likely resemble a CBDC payment most, have fees that are typically much lower than credit card fees. Andrew Cregan, Head of Finance Policy at the British Retail Consortium, said a widely used CBDC has the potential to increase competition in the retail payments sector, which could reduce the fees charged by the existing payment operators.27

24.Other witnesses agreed on the potential for a CBDC to foster private-sector innovation. David Birch, an adviser and commentator on digital financial services, said this was the best single reason for introducing a CBDC28 and the Atlantic Council said a CBDC could help level the playing field for new market entrants.29 Innovate Finance thought CBDC would help the UK to develop world leading expertise.30 We also heard that a CBDC could help increase the overall resilience of the payments system, which was another potential advantage set out by the Bank of England.31 David Birch said a CBDC should be “constructed as a parallel system” to the existing payments system so that overall resilience increased.32

25.That said, we heard there is already significant innovation taking place in payments. For example, the growing use of payment apps is increasing competition with the major payments networks as they can link directly to bank accounts rather than physical cards. Charlotte Hogg, CEO of Visa Europe, told us that the UK is one of the most competitive payments markets globally, and that this trend had accelerated in recent years.33 Georges Elhedery said a great deal of work had been done by the public and private sectors to improve the domestic payments systems but nevertheless a CBDC could provide a step change.34 In its March 2020 Discussion Paper, the Bank of England set out several initiatives that are ongoing to improve payments, including:

• Open Banking and PSD2,35 which require banks and other payment service providers to share customer financial transactional data with authorised third parties, with customer consent. This is designed to increase competition in the banking sector and to enable third parties to innovate and create new financial products.
• Pay.UK’s New Payments Architecture, which will replace the existing interbank retail payment systems with infrastructure that supports instant settlement with a view to ending multiple-day clearing cycles. It should provide new capabilities that payment service providers can use to benefit customers.
• Real-Time Gross Settlement (RTGS) renewal, which will see the Bank of England, as operator of the Sterling RTGS service, promote innovation in payments by renewing the existing RTGS and expand access to settlement in central bank money. In 2017 the Bank announced that Electronic Money Issuers and payment institutions authorised by the Financial Conduct Authority could start applying for RTGS settlement accounts.36

26.John Glen MP, the Economic Secretary to the Treasury, told us that the Government recognised that the UK payments system was already effective but wished to assess the additional benefits a CBDC might provide.37

27.Sir Jon Cunliffe, Deputy Governor for Financial Stability at the Bank of England, said the use case for consumers and merchants should be taken together. As it becomes more difficult for merchants to refuse digital payments—accepting cash only—“the question is whether they should have an alternative that anchors the cost floor.”38 Andrew Bailey, Governor of the Bank of England, told us that increasing the competitiveness of the payments infrastructure is a longstanding challenge that requires further work but his view was that issuing a CBDC was a disproportionate response to that issue.39

28.A CBDC system has potential to spur innovation and greater competition in payments, in addition to those that are already taking place, which may reduce card fees paid by merchants. However, we heard few other significant advantages for UK consumers. We recommend that the Joint Taskforce include a greater number of representative consumer groups on its engagement forum to help it to identify whether a CBDC would provide any benefits to individuals and households. We heard the UK’s existing domestic payments system is secure and efficient, and it continues to foster innovation and the expansion of services.

Decline in cash use

29.Many central banks are concerned by the decline in the use of central bank money (i.e. physical banknotes) by the public. The Bank of England said banknotes provide an “anchor of confidence” in the banking system, as households and businesses know they can convert bank deposits to central bank money and that this provides financial stability.40

30.The Bank is exploring whether CBDCs could improve the availability of central bank money and address the consequences of declining cash use. While the number of notes in circulation has continued to rise in the UK, most payments that were made in cash are now made in commercial bank money, including via debit and credit cards, as set out in Figure 1. The trend is likely to have accelerated in 2020 because of the COVID-19 pandemic, when cash use fell by 35% compared with the previous year.41

Figure 1: Payment volumes (millions) 2010 to 2020

Source: UK Finance, UK payment markets summary 2021: https://www.ukfinance.org.uk/sites/default/files/uploads/SUMMARY-UK-Payment-Markets-2021-FINAL.pdf [accessed 15 December 2021]

31.Richard Brown, Chief Technology Officer of R3, an enterprise technology company, said that policymakers had an obligation to decide whether a digital form of cash should be introduced if cash use declined to nothing, as cash provides people with the ability to transact with one another without recourse to any other authority and with high levels of privacy.42

32.Some witnesses were sceptical that CBDCs would satisfy the demand for cash. Andrew Cregan, Head of Finance Policy at the British Retail Consortium, did not think a CBDC was “in any way” a substitute for cash: “I do not envisage that individuals who have been so reticent over using card payments over the years … will jump on the CBDC bandwagon and abandon cash. People use cash either for budgetary purposes or for concerns around security or fraud. They use cash for other reasons that will not be affected by the creation of a CBDC.”43

33.Other witnesses said CBDCs could not provide the same level of privacy as cash. Stephen Bonner, Executive Director, Regulatory Futures and Innovation at the Information Commissioner’s Office, said a CBDC would not be like cash and that “proportionate” rules on privacy and data protection would be needed.44 We explore the implications of a CBDC for privacy in the next chapter.

34.UK Finance said further analysis was needed to determine the benefit of a CBDC as the public already has access to risk free money in the form of cash and guaranteed commercial bank money through the Financial Services Compensation Scheme, and National Savings and Investment (NS&I) provides consumers with access to HM Treasury backed savings products.45

35.The Bank of England has recognised that a CBDC would be an imperfect substitute for cash. Its March 2020 Discussion Paper said, “for those in society who value the physical nature of cash, the introduction of CBDC is unlikely to affect their payment behaviour, and so we consider that CBDC would likely act as a complement to cash rather than a substitute.”46

36.Sir Jon Cunliffe said that, from a central bank perspective, cash plays an important role in anchoring confidence in the monetary system as people can convert commercial bank money into central back money on demand.47 John Glen MP told us the Government had committed to legislate for the continued issuance of cash.48

37.Cash continues to be widely accepted in the UK. If this were to change it is not obvious that the properties of CBDCs would satisfy any residual demand for cash, which is often valued for its physical properties and the privacy that it can provide. We note that the Bank of England has said that it will continue to issue cash on demand and that the public need for money without default risk is covered for most savers by the availability of cash and deposit protection. We also note that a core aim of prudential regulation is to ensure we have a stable banking system: this, together with the deposit guarantee scheme, should ensure that confidence in the monetary system is anchored.

Financial inclusion

38.The Bank of England said that cash provides an important role in financial inclusion, particularly for groups in society without bank accounts. The Bank’s March 2020 Discussion Paper said that if cash use continued to decline, “there is no guarantee that the current private sector provision of the retail payment systems may meet the needs of all users, leaving underbanked groups of society particularly at risk.”49 It said, “a well-designed CBDC may also help to boost financial inclusion … by being accessible to a broader range of people, potentially in different formats, than private sector solutions.”50

39.According to figures cited by the Government in its latest financial inclusion report, the number of ‘unbanked’ adults in the UK declined steadily from 2.85 million in 2005–06 to just below 1 million in 2018–19. The number of adults living in households without access to a relevant account fell to a record low of just under half a million.51 The legal requirement for large banks to offer customers a ‘basic bank account’ has probably played a role in this reduction.

40.EY, a consultancy, told us that people in G20 countries are most likely to be excluded from the financial system because they are unable to meet the identification requirements for bank accounts. It said that digital challenger banks in the UK and the EU had been successful “not because they are blockchain based, but because … they enable more efficient customer onboarding and better customer experience.”52

41.Natasha de Teran, member of the Financial Services Consumer Panel, said many of the non-bank alternatives to bank accounts, such as prepaid debit cards, were comparatively expensive. She thought a CBDC could lay a framework through which the provision of simple, affordable, non-bank alternatives could be provided to households and individuals without bank accounts. She said that, while a CBDC is not a prerequisite for such services, it is likely that this functionality would be a feature of any CBDC that the Bank of England designed.53

42.David Birch said increasing financial inclusion is an important goal, as people trapped in the cash economy paid the highest prices for certain services and were vulnerable to theft. However, he thought it was not clear that CBDC was the answer to these particular problems.54 Barry Eichengreen agreed that people without bank accounts paid the most for utilities and other services, but said the argument that CBDC would solve this problem was “specious”. He explained that the unbanked paid more because credit providers saw possession of a bank account as a signal of financial stability and reliability but a CBDC “available to everyone unconditionally would not signal anything”.55

43.We heard that the digital nature of any CBDC would likely prove to be a barrier for some people who are excluded from the financial system. Natasha de Teran told us that the increasingly digital nature of the economy meant that people are not digitally literate need a simple means of making payments and it was not clear whether CBDCs would fulfil that role.56 We also heard that reliance on comparatively expensive digital devices could be exclusionary. Professor Darrell Duffie, Adams Distinguished Professor of Management and Professor of Finance at Stanford University thought it was possible that CBDCs could be obtained through physical payment cards, which might mitigate the necessity to use digital devices to access accounts. However, he said realising the potential for financial inclusion from CBDC was not guaranteed.57

44.In March 2017, the House of Lords Select Committee on Financial Exclusion set out ways that the Government could increase access to financial services. It concluded that an increasing emphasis on technology in banking might exacerbate financial exclusion: “digital exclusion is likely to have a particularly significant impact on those who are already most at risk of financial exclusion.”58 In April 2021, the House of Lords Liaison Committee followed up this work and found that certain groups continued to be financially excluded because of increasing digitalisation and reliance on mobile banking services.59

45.Should cash acceptance decline significantly, a CBDC could be a way to ensure greater financial inclusion in that it would provide access to digital payment services that are like bank accounts However, for some, not having a bank account is a choice and for others, the technological requirements for CBDC transactions may exclude them from accessing it. It is likely that there are more straightforward and targeted ways to support access to financial services than to launch a CBDC.

Cross-border payments

46.Cross-border payments are expected to total $250 trillion by 2027. In addition to high-value international wholesale markets, cross-border payments are increasingly important to small businesses and individuals. In 2020, remittance flows to low and middle-income countries reached $540 billion.60 The Bank of England’s March 2020 Discussion Paper said that for many users, “cross-border payments are expensive, slow, and opaque” and that CBDCs may offer a more efficient way to provide cross-border payments if national CBDC systems could be connected.61

47.Jana Mackintosh, Managing Director for payments and innovation at UK Finance, told us that CBDCs could make cross-border payments cheaper and faster, and could provide data that would make transactions more secure.62 Andrew Cregan said, “there is significant scope for the reduction in friction of cross-border payments through new digital money and central bank digital currencies”.63

48.Other witnesses said improvements to cross-border transactions represented the best use case for CBDCs. Prof Duffie thought improving cross-border payments is the “greatest promise” offered by CBDCs. Patrick Honohan said the ability to make cross-border payments more quickly and cheaply would be an advantage.64

49.We heard technological innovation was already improving cross-border payment systems. Charlotte Hogg, CEO of Visa Europe, said competition was driving cost reductions and that new forms of digital remittances were increasing efficiency and savings.65 Prof Duffie told us that some banks in the US were working with fintech companies to use new technologies to improve cross-border payments. On 22 November 2021, Victoria Cleland, Executive Director for Banking, Payments and Innovation at the Bank of England, delivered a speech on progress made at the G20 level on making cross-border payments more efficient. The targets included increasing the speed of transactions so that 75% of payments are to be settled within an hour and ensuring the global average cost of retail payments is no more than 1% and the global average cost of sending a $200 remittance no more than 3%.66

50.Barry Eichengreen told us the barriers to making national CBDCs interoperable were “formidable”:

“The two central banks would have to agree on an architecture for their corridor. They will have to jointly govern its operation. They will have to license and regulate dealers holding inventories of currencies and depository receipts to ensure that the exchange rate inside the corridor doesn’t diverge significantly from that outside. They will have to agree on who provides emergency liquidity, against what collateral, in the event of a serious order imbalance.”

51.He said in a world where there could be several CBDCs circulating at once, arrangements of this type “would require scores of bilateral agreements … considerably more elaborate than those of the World Trade Organization or the [International Monetary Fund].”67 Simon Gleeson expressed doubt that central banks would allow their own CBDC to circulate widely in the international system in the short- to medium-term:

“I find it impossible to imagine the Bank of England encouraging widespread circulation of it outside the UK simply because the risk of … fairly wild swings in demand externally would create a degree of monetary instability that would pose a severe threat … If your CBDC itself starts being used internationally, that presents a problem for you.”68

52.John Glen MP, the Economic Secretary to the Treasury, agreed that bilateral arrangements to enable cross-border CBDCs would be “incredibly complicated.” He added, “I imagine that it would be very difficult to establish a global system very easily, given the different ways that central bank digital currencies may evolve in different jurisdictions.”69

53.The Bank of England has been working to improve cross-border payments and Sir Jon Cunliffe told us that the Committee on Payments and Market Infrastructures (CPMI) is leading work on interoperability in CBDCs.70 The CPMI is currently exploring what standards and alignments might be necessary to ease the different types of interoperability which might improve cross-border payments.71 However, some jurisdictions “might not want to make it completely frictionless to move out of one currency and into another” due to the risk of capital flight or financial instability.72

54.Cross-border payments can be expensive and slow. CBDC systems could, in theory, bypass some of the existing frictions in the international payments systems, with lower costs. Nevertheless, a CBDC system would still have to comply with oversight frameworks, national laws and international technical standards which are a long way from being agreed. Cross-border payments are already improving as a result of innovation and competition in the fintech sector. A lot of international collaboration is under way both in the private and public sectors (including at the G7 and G20 levels) to further improve cross-border payments, which will make them more efficient, with or without CBDCs.

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