CBDC: Bank of England offers support for private sector it doesn’t trust

Working paper grapples with ambiguous necessity for sovereign cash

The Bank of England’s new paper on whether it will introduce a central bank digital currency is a sensible review of reasons to procrastinate for now, while laying the ground to move quickly later – maybe. ‘The case for introducing the digital pound depends to a significant degree on how the payments landscape evolves in coming years.’

The Bank seems principally driven by the potential damage to the domestic credibility of the pound, citing its aim as: ‘To sustain access to UK central bank money – ensuring its role as an anchor for confidence and safety in our monetary system, and to underpin monetary and financial stability and sovereignty.’

If state cash disappears, at a time of innovation in payments systems and methods, the Bank seems to think people and businesses may lose faith in sterling overall. It isn’t sufficient merely for the Bank to oversee and back-stop the provision of private money, which now represents 95% of payments. Trust in money seems to depend on the knowledge that a state payments system (cash) exists, even if it isn’t used.

The Bank also worries that innovation in payments will lead to fragmentation – a common theme in OMFIF’s Digital Monetary Institute sessions – and that private providers will spot ways to seek rents from trapping users in ‘walled gardens’. In other words, the Bank doesn’t believe it will be able to manage ‘uniformity’ and prevent cartel or monopolistic behaviour in payments with regulation alone.

Jon Cunliffe, deputy governor of the Bank, consistently refuses to defend bank business models as they stand. However, they are getting a degree of cover from these plans since the Bank, for the purposes of financial stability, would disbar material volumes of digital cash to pass directly between corporations, as it would citizens, with a limit of between £10,000 and £20,000, at least initially. The Bank assumes that a move of around 20% of deposits would cause bank lending rates to rise by around 20 basis points, although it acknowledges this is an uncertain estimate.

The Bank sets aside the idea that a CBDC would be used to increase the transmission of monetary policy (‘not a motive’), including negative interest rates to improve the effective lower bound, which it discounts as a possibility while physical cash still exists. The German popular press’s cries of state ‘enteignung’ (disappropriation) during the negative rate period before Covid-19 might be ringing in the Bank’s ears. A positive deposit rate would potentially harm financial stability, in the way unlimited CBDC accounts would.

The Bank’s other aim is to support innovation. As a benefit of creating a state-backed digital cash platform, it cites being able to target transaction charges paid by small- to medium-sized enterprises, where the smallest merchants pay four times the rate of their larger peers. The Bank is suggesting that it might assist private-sector disruptors in payments by laying the groundwork for them. Commercial banks and credit card companies, who work together to facilitate payments, are aware that their regulators are homing in on fees. In private DMI discussions, we have heard each side consider doing without the other to defend their own margins and/or reduce fees in the face of this pressure.

Financial inclusion is a commonly cited motive for CBDCs, though the Bank is somewhat circumspect about this. It makes the sensible point that the financially excluded are likely also to be digitally excluded, making the design of digital wallets to address that group difficult. It also implies that financial inclusion is the government’s job, not the Bank’s: ‘Over the last year, the government has continued to make significant progress on financial inclusion. The UK has a vibrant financial services sector and levels of financial inclusion are high compared to many of its international counterparts.’ As the DMI often hears, one of the most prominent attempts so far to use a CBDC as a tool for financial inclusion – the eNaira in Nigeria – has been described as a ‘massive failure’.

On technology, the Bank suggests a phone app or a physical card, though the latter seems to square badly with the Bank’s aim of creating an infrastructure for as yet unknown innovation. The app raises difficult questions around digital identity. The Bank’s paper pays a lot of attention to the issue of data privacy, though it can’t really hide the fact that, in absolute terms, a CBDC will represent a loss of data sovereignty for its users versus physical cash. This is because CBDCs, at least for anything above the smallest transactions, will not be anonymous.

However, CBDCs should represent an opportunity to recapture some control of data in digital payments. Broadly, the protection for CBDC transaction data will be similar to the rules for commercial bank or credit card payments: the Bank would not access personal data unless it really wanted to for law enforcement reasons.

That is already the case, but with CBDC the Bank has the opportunity to deploy the privacy enhancing techniques (including zero knowledge proofs, pseudonymisation and distributed data analysis) it discusses in the technology working paper published alongside the consultation paper.

The state’s ability to snoop on our transactions make retail populations queasy to varying degrees. But the fact is that digital payments are already an open book. A CBDC represents an opportunity to limit how much of the book can be read and by whom.

The Bank remains open-minded on stablecoins within its new payments ecosystem. ‘If appropriately designed, within a robust regulatory framework, stablecoins offering greater functionality than existing forms of electronic money could play an increasingly important role in retail payments, offering benefits such as convenient and cheaper payment services.’

One wonders why this mindset can’t hold true for other forms of private money, making retail CBDC unnecessary and leaving the Bank to focus on wholesale CBDC, the upgrading of real-time gross settlements and careful supervision of the financial companies plugged into it.

John Orchard is Chief Executive Officer of OMFIF.

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