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

Summary of conclusions and recommendations

Central bank digital currencies

1.Digitalisation is transforming payments systems and governments must consider what responses are necessary. Any UK central bank digital currency would have far-reaching consequences for households, businesses and the monetary system for decades to come. Parliamentary scrutiny should be an essential part of assessing the case for a CBDC and if the Government decides to proceed, Parliament should have the opportunity to vote on any final decision, along with the governance arrangements for any such system, during the passage of primary legislation. The Government should set out the costs of introducing and operating any design that is proposed. (Paragraph 15)

2.The Bank of England has consulted on seven different ways in which a CBDC could support the Bank’s objectives to maintain monetary and financial stability. However, a CBDC cannot be designed to support all seven objectives equally well and there are likely to be alternative solutions for enhancing the payments system with fewer risks. When the Joint Taskforce publishes the use case for a possible CBDC in 2022, it should set out the most significant long-term problem to which it believes a CBDC may be the answer. Its assessment should compare CBDCs against alternative means of achieving the same aims. (Paragraph 16)

Households and businesses

3.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. (Paragraph 28)

4.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. (Paragraph 37)

5.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. (Paragraph 45)

6.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. (Paragraph 54)

CBDCs and the monetary system

7.We heard that some central banks are concerned that big tech companies will combine crypto asset technology and their vast network of users to launch a digital currency capable of rapid adoption by large numbers of people. While we agree this is a risk, the introduction of a CBDC may not be a necessary or complete response. Private entities of a size that can compete with the existing payments systems can and should be regulated. The Joint Taskforce should set out answers to the following questions:

We welcome the work of governments and financial watchdogs in recent months to start identifying ways to regulate issuers of crypto assets. (Paragraph 66)

8.While it is yet to be established whether any future UK CBDC would bear interest, over the last decade many central banks have become accustomed to unconventional monetary policies. A CBDC would provide them with new options for responding to crises. (Paragraph 74)

9.However, the application of monetary policy should not be a motivation for introducing a CBDC. Such measures would likely increase the Bank’s role and influence in the economy substantially. Scrutiny of any changes to the Bank of England’s monetary policy toolkit is essential. We recommend that the Joint Taskforce publishes its assessment of the potential for monetary policy via a CBDC in its 2022 consultation. This will assist such scrutiny. (Paragraph 75)

10.Introducing a CBDC will lead inevitably to some disintermediation of the banking sector, although how much is uncertain and will depend on how a CBDC is designed. Higher levels of disintermediation would likely lead to more expensive credit and tighter lending criteria. Without safeguards, CBDCs could exacerbate financial instability during periods of economic stress as people would likely seek to replace bank deposits with CBDC. (Paragraph 86)

11.There are two main options for reducing the negative effects of disintermediation. The first is to limit the amount of CBDC that can be held or spent. The second is to disincentivise use by paying uncompetitive (or prohibitive) rates of interest on CBDC above a certain level of holdings. Either of these options, or a combination of both, would likely reduce the attractiveness of a CBDC to users, depending on their stringency. This could undermine other possible objectives such as increasing financial inclusion or crowding out privately issued stablecoins. We recommend that the Bank of England conduct further studies to assess what would be the effect on the banking system if more than 20% of deposits converted to CBDC. (Paragraph 87)

12.Widespread adoption of any CBDC would depend on a high level of public trust. While there are design options that would provide some privacy safeguards, technical specifications alone may be insufficient to counter public concern that a government might use a CBDC as an instrument for state surveillance. The Bank risks being drawn into controversial debates on privacy, which could undermine its reputation for independence from the Government. (Paragraph 94)

13.The Bank of England has indicated that it favours a private sector led approach for managing ‘Know Your Customer’ checks. However, there is significant public concern over control of consumer data, particularly by big tech. The requirement to provide ‘Know Your Customer’ checks may reduce the incentives for new companies to provide CBDC payment services, particularly if the checks are onerous or expensive to complete. While conducting such checks will be necessary, their cost may undermine the objective of using CBDC to spur private-sector innovation, or limit involvement to the largest companies or those which have existed the longest. (Paragraph 95)

14.We heard that a digital identification system may be an effective component of any CBDC payment system to ensure compliance with legal requirements. However, the Bank of England’s March 2020 Discussion Paper mentions the possibility of digital ID only in passing, and the Department for Digital, Culture, Media and Sport’s January 2021 consultation on digital ID does not mention CBDCs at all. The Joint Taskforce should set out whether the Government’s work on digital ID now relates to its work on CBDCs. (Paragraph 96)

International implications

15.In the short term, barriers to creating interoperable cross-border CBDCs are formidable. While a growing number of central banks are investigating this possibility, complex agreements on standards, design and governance would have to be agreed by all countries concerned. However, agreements between small groups of countries could be negotiated more quickly and it is clear there is political will in certain countries, including China, to create alternatives to the established international payments system, including through interoperable, cross-border CBDCs. (Paragraph 104)

16.While this may be a distant prospect, if such payments architecture is implemented effectively, the pressure on the US dollar as a payment currency will increase. This trend could erode the US dollar’s sanctions leverage, helping countries seeking to evade economic sanctions to bypass US dollar-dominated systems such as SWIFT. We recommend that HM Treasury’s Office of Financial Sanctions Implementation assesses whether similar risks exist for sterling and the euro. It should also assess the development of CBDCs by countries which are a threat to UK security and any implications for the effectiveness of economic sanctions. (Paragraph 105)

17.There are two clear security risks for a CBDC system. The first is that individual accounts, managed by the private sector, could be compromised as a result of cyber security weaknesses. The second is that a CBDC system, as a piece of critical national infrastructure, would be a target for attack from nation state or criminal actors. Such attacks would risk the exposure of sensitive payments data and the loss of national wealth. No design will guarantee absolute security. Any CBDC would need to be designed so that it was adaptable and could be updated rapidly in response to technological change and emerging security threats. (Paragraph 111)

18.While other countries are developing and testing CBDC technology faster than the UK, the Government should prioritise opportunities to collaborate with its international partners in order to shape the emerging CBDC systems. The UK would derive most long-term benefit by ensuring global standards and rules on governance, privacy, security and interoperability are compatible with the national interests and values of the UK and its allies. (Paragraph 116)

19.A wholesale CBDC would be less disruptive than a retail CBDC, with fewer economic and political risks. Although the wholesale operations of the monetary system are already highly efficient, a CBDC may help to further enhance efficiency in securities trading and settlement. Further exploration and experimentation are necessary. HM Treasury and the Bank of England should assess whether the work on wholesale CBDCs being undertaken by some of the UK’s economic competitors poses risks to UK competitiveness. We recommend the Joint Taskforce consults on the use case for a wholesale CBDC alongside its 2022 retail CBDC consultation. (Paragraph 125)

Conclusion

20.We have yet to hear a convincing case for why the UK needs a retail CBDC. While a CBDC may provide some advantages on speed of settlement and cheaper and faster cross-border payments, it would present significant challenges for financial stability and the protection of privacy. Furthermore, a lot of work remains to find workable solutions which do not entail difficult design trade-offs which may make a CBDC unattractive. Earlier in this report, we put several questions to the Joint Taskforce which need to be answered. Crucially, it should set out the most significant long-term problem (or problems) to which it believes a CBDC may be the answer; and its assessment should compare CBDCs against alternative means of achieving the same aims. There are several other questions that should also be answered before deciding on whether to issue a CBDC:

21.While there appear to be no significant advantages for the UK in being an early adopter of CBDCs, we recognise that consumer payment preferences, technological developments and the choices of other countries may enhance the case for a UK CBDC in the future. The long lead times involved in scoping and developing a CBDC mean the Joint Taskforce should continue to assess the rationale and technology in preparation for such a measure possibly being needed in future. The Government and the Bank of England should continue to work with international partners on principles and standards while learning lessons on technical design and usage from the experiences of countries that introduce a CDBC soon. (Paragraph 127)





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