The UK’s second parliamentary chamber, the House of Lords, has reviewed the work of the Bank of England and Her Majesty’s Treasury Taskforce that is working on the potential for introducing a retail Central Bank Digital Currency (CBDC) in the UK. With the report title ‘CBDCs: a solution in search of a problem?’ 1, it would be fair to say the report was unconvinced about the needs for a CBDC. It lays out a series of searching questions which apply equally to any central bank working in this area.
The paper starts by stating the two reasons for introducing a retail CBDC are to manage the excessive market power of ‘Big Tech’ companies should they enter payments with stablecoins and the decline in the use of cash. It then puts forward three key areas of risk, privacy, financial stability in a crisis and a centralised point of failure, the CBDC ledger as, a target for criminals and hostile foreign states.
The Taskforce will set out an assessment of the case for introducing a retail CBDC in 2022 and go out to consultation about it. The Lord’s want the assessment to answer the following questions;
What problem does a CBDC solve?
What is exactly is the ‘Big Tech’ threat and how does a CBDC address that threat? What about regulations?
How can a CBDC be a competitive payment option in the light of how it may disintermediate banks affecting credit allocation and financial stability?
What are the additional monetary policy options offered by a CBDC and would these be proportionate to the Bank’s current mandate for monetary and financial stability?
How would a CBDC offer privacy and meet financial compliance rules? Who would have access to the data and why? What would the data be used for?
What are the domestic and international risks and how would they be managed? Is it possible to balance security and useability?
In the March 2020 Bank of England consultation, it laid out seven different ways CBDCs would support the Bank’s objective to maintain monetary and financial stability. The Lord’s concluded that a CBDC cannot support all seven objectives equally. It is probable that there are alternative solutions for enhancing the payment system which have fewer risks. The consultation should, therefore, lay out the most significant long term problems to which a CBDC would contribute and it should compare a CBDC with the alternative solutions.
1. Risk of private money creations.
Why isn’t regulation and appropriate way to address this?
2. Declining use of cash.
It is ‘not obvious that the properties of a CBDC would satisfy the demand for cash, which is often valued for its physical properties and the privacy it can produce.’ The report goes on to make the point that the ‘public need for money without default risk is covered for most savers by the availability of cash and deposit protection.’
3. Implications for the monetary system.
Disintermediation: While limits on CBDC holding and charges on large holdings can reduce the risks of disintermediation, account holders withdrawing deposits and converting them to CBDCs, particularly at a time of crisis, this may also reduce the attractiveness of CBDCs to consumers. The result may be that fewer of today’s financially excluded people open CBDC accounts. It may also result in privately issued stablecoins being crowded out. The Taskforce is asked to model the impact of 20% of today’s deposits being turned into CBDCs.
Monetary policy: Although today’s Governor has said that he does not intend to use CBDCs to implement monetary policy, the risk remains of possible options for unconventional forms of monetary policy. Such measures may increase the Bank’s role and influence in the economy, and this needs scrutiny now.
Privacy: The design and technology used for a CBDC may help privacy but may also be insufficient to counter public concerns. The result would be to involve the Bank in controversy.
Competition: The plan to use the private sector to implement requirements such as ‘Know Your Customer’ could reduce the incentive for new entrants to provide CBDC account services. This would undermine competition in the payment sector. The Taskforce needs to clarify on the digital identity requirements for CBDC accounts.
4. Implications for households and businesses.
While CBDC may offer competition to existing payment solutions leading to reduced costs for merchants and, perhaps, eventually consumers, what other benefits do CBDCs offer? There appear to be few.
Cross border payments is one potential area although there is considerable work still to be done to put in place oversight frameworks, solutions that meet national laws and agreement on international technical standards. In the meantime, there is considerable work going on concerning non-CBDC solutions.
Financial inclusion is much talked about. The report points out that not having a bank account is a choice for some and for others the technical requirements may exclude them. It questions whether there are more straightforward ways to achieve this.
International implications: Some countries are motivated to use CBDCs to avoid US sanctions. While global solutions are a long way off, smaller scale country to country/groups of country solutions are possible to achieve more quickly.
Security risks: There will be cyber security risks to individual accounts and a centralised ledger will represent a high value target to criminals and hostile states. Creating a secure solution that can develop as new technology becomes available is a key requirement.
The report dips into the topic of wholesale CBDCs encouraging the Bank to accelerate its work in this area. While today’s Real Time Gross Settlement systems are highly efficient, a wholesale CBDC may enhance efficiency in securities trading and settlements. The ability to have conditionality of payments (programmability) would support automation and help mitigate risks. Given the position of the City of London, the UK needs to be at the forefront of work in this area.
If the 2022 consultation leads to a decision to proceed, the next step is development and testing with the earliest possible launch after 2025.
1 - House of Lords Economic Affairs Committee: Third Report of Session 2021-22.
