HSBC – WRITTEN EVIDENCE (CDC0009)

 

CENTRAL BANK DIGITAL CURRENCIES INQUIRY

 

Introduction

  1. As the world’s largest trade bank, and one of the world’s largest foreign exchange dealers and payment banks, HSBC has been collaborating on studies and proofs of concept on Central Bank Digital Currencies (CBDCs) since 2018. Our CBDCs work has included collaboration with the central banks of Canada, China, France, Hong Kong, Thailand, Singapore, the UAE, and the UK. We have investigated both domestic and cross-border use cases.  HSBC has also recently been selected to be part of the Bank of England and HM Treasury Central Bank Digital Currency (CBDC) Engagement Forum.[1]

 

  1. We believe that our deep involvement with payments, Foreign Exchange and trade financing, and our global CBDCs experience means that we are very well placed to help central banks and governments to continue to explore these topics. 

 

  1. What are the main issues driving central banks to explore CBDCs?
  1. The motivations for considering CBDCs vary for each jurisdiction, and are often driven by specific local circumstances. There are, however, some common issues that we are seeing across many major economies.

 

  1. One common global issue is an exponential increase in digital payments, and associated decrease in the usage of cash. Since cash is central bank money, but digital payments tend to be commercial bank money, the question arises – do economies require direct public access to central bank money in a digital form? It is suggested by some that central bank money is required to ‘anchor’ the widespread use of commercial bank money. A CBDC is central bank money in a digital form.

 

  1. Another common reason to consider CBDCs is the emergence and growth of private digital currencies, such as stablecoins and cryptocurrencies. These private digital currencies are currently not subject to the same high regulatory standards as existing commercial bank money. If their public use reaches systemically significant proportions, they raise legitimate concerns related to monetary policy and financial stability, including the impact on the existing banking system.

 

  1. Central banks also have more positive motivations to consider regarding CBDCs. CBDCs could improve the efficiency of domestic payments. Internationally, they could enhance cross border payments and banking[2][3][4]. Depending on the design, CBDCs may also expand monetary policy options, for example via ‘programmable money’, improve financial inclusion, and reduce criminal activity.

 

  1. What are the main benefits and risks of a CBDC?
  1. If designed well, CBDCs offer the possibility of faster and lower cost payments for consumers and businesses. They could improve security while respecting privacy, and enable business growth and investment. CBDCs could reduce financial risks for consumers, and be a trusted alternative to cryptocurrencies and stablecoins. CBDCs would not incur the energy costs of some other digital currencies.

 

  1. The design of CBDCs and how the public access them as a form of ‘digital cash’ is very important when considering the main benefits and risks. There are potentially many different CBDC models, but the two main approaches are:

 

  1. A well designed indirect CBDC could provide effective public access to central bank money in a digital world. This could offer potential benefits to consumers of financial services, to financial service providers, and to the financial system as a whole, including:

 

 

  1.          However, it is vital that these benefits are weighed against the risks that a CBDC might create, such as:

 

 

  1. Could the proposed benefits of a CBDC be achieved through improvements to existing payment systems?
  1.          There are continuing global efforts, notably by the CPMI, to enhance existing cross border payments infrastructure. This multiyear global effort aims to tackle identified frictions in order to enhance cross-border payments. These frictions include: fragmented data standards or lack of interoperability; complexities in meeting compliance requirements, including for anti-money laundering and countering the financing of terrorism (AML/CFT), and data protection purposes; different operating hours across different time zones; and outdated legacy technology platforms. HSBC is closely involved in discussing these developments with policy makers, and we are working to improve the existing cross border payments regime.

 

  1.          Policy makers will need to define carefully the specific benefits that CBDCs can deliver compared with the benefits from improving existing transfer approaches. There is considerable ongoing work and investment by the industry and authorities to redesign and improve retail payments and the growth of Open Banking, as well as the Bank’s work on updating and improving the Real Time Gross Settlements system. The required investment and change across the industry to adopt retail CBDC will also need to be factored in.

 

  1.          However, we do believe that CBDCs may represent an important technological opportunity to resolve key issues in this area. The principal potential benefit is near instantaneous payment. Many financial transactions can be thought of as ‘delivery vs. payment’. Delivery is a transfer of ownership of the asset while payment goes in the opposite direction. Distributed Ledger Technology allows a secure, certain and near instant transfer of delivery, but this is of limited value unless you can also process the related payment in a similar manner. CBDCs would allow this.

 

  1.          Near instantaneous secure and certain payments and other transactions can reduce the number of intermediaries involved in payment chains, reduce settlement risk, resolve issues related to time zone differences and reduce transaction costs. These benefits could be passed along to consumers. Well-designed CBDCs could ensure that this is all done in a manner that corresponds with existing approaches to tackling financial crime.

 

  1. How should the Bank of England and HM Treasury address concerns over privacy and traceability of payments when exploring CBDC design?
  1.          There are important design considerations regarding transaction data access, personally identifiable information and Anti-Money Laundering/Customer Due Diligence requirements that are a primary focus of CBDCs research and testing.  The ability to meet consumer privacy expectations, as well as legal requirements around financial crime, will be critical to the success of any CBDC.

 

  1.          CBDCs would create data that could negate that anonymity. In considering these designs privacy needs and expectations must be balanced against other public policy priorities. Cash is fully anonymous once obtained through a transaction or withdrawn from an ATM, but full privacy and anonymity in digital payments could lead to a breakdown of the current Anti-Money Laundering regime.

 

  1.          Digital money should include data privacy and protection in designs to coexist with, and support, the wider legal and regulatory framework for the financial sector and the overall integrity of the financial system. Financial institutions must ensure that they comply with all laws related to privacy, and also that they respect their customer’s privacy expectations. If the loss of privacy is seen to outweigh the benefits to user, then confidence in these new forms of money will decrease, and usage will be negatively impacted.

 

 

  1.          There are some potential benefits from the use of data obtained, such as improved products and services. However, considerations around privacy need to be included throughout the design process. That includes the acknowledgement that under certain circumstances (e.g. anti-money laundering screening during onboarding), consent may not be possible or desirable. In other circumstances it must be clear that only specific actors have access to certain types of customer data (e.g. bank level transaction data). For CBDCs to be trusted widely and therefore used, end users need to have clear information as to what data is being held by commercial banks, central banks or other actors, and know how their privacy rights are being maintained.

 

  1.          This design balance is possible with technologies that are under test. There are options for developing new mitigations for privacy, as noted in the BIS paper “III: CBDCs: An Opportunity for the Monetary System”. In certain retail CBDC designs the payment authentication process can be built to conceal personal data from commercial parties and public authorities.[5]

 

  1.          There may also be value in allowing different levels of information to be shared through reporting mechanisms, for example, by making more data on macroeconomic level monetary flows available to the Central Bank.

 

  1. What effects might a CBDC have on the financial sector?
  1.          As mentioned in our answer to question 2, depending on the CBDC design, there are a number of potential effects to the financial sector to consider when developing a CBDC. Both benefits and risks need to be considered.

 

  1.          Without appropriate regulation and great consideration regarding the impact on the existing financial system, an improperly designed CBDC could undermine public confidence in money. The risks that CBDCs pose to liquidity credit and the money market could be serious and are, as of now, untested.

 

  1.          The introduction of a CBDC may improve the range of transaction services provided to the public, but depending on the design choices made they may also reduce the overall efficiency of credit provision in the economy. Any aggregate increase in the cost of credit as a result of a policy decision related to a CBDC could have significant economic and societal consequences, undermining trust and confidence in authorities and the financial system they oversee. This must be avoided.

 

  1.          An increase in the overall cost of credit could also see a commensurate reduction in the provision of credit by traditional lending institutions, such as banks. The Bank of England New Forms of Digital Money discussion paper[6] notes uncertainty around the capacity and effectiveness of non-bank intermediated credit that could mitigate the impact on bank credit from CBDCs. This aligns closely with the work on resiliency of non-bank finance shocks by the Financial Stability Board and the Financial Policy Committee. The March 2020 ‘dash for cash’ illustrated the need to take a holistic approach to bank and non-bank resiliency.

 

  1.          Any CBDC that is interest-bearing could have a significant impact on the creation of money in the economy. We think an interest-bearing CBDC should be avoided. It would likely reduce the amount of available funding for commercial banks, and some banks may choose to compete to protect deposits by offering higher interest rates in order to influence consumer behaviour. They may do this based on the economic trade-off between raising rates versus raising expensive and inherently riskier wholesale funding. Such a dynamic is undesirable for financial stability and credit provision.

 

  1. What effect might a CBDC have on competition and innovation in the payments and fintech sectors?
  1.          While competition and innovation should be encouraged and supported, authorities must also ensure the continued resilience and stability of the financial system, as well as the proper conduct of all market participants.

 

  1.          An indirect CBDC approach would ensure the continuation of division of labour between central banks and the market. This would see the private sector continue to perform customer-facing activities and operational tasks and enable the potential for greater innovation and competition. Assuming that central banks grant access to existing payment systems for appropriately regulated and licensed firms, these firms could compete to provide both CBDC wallets for consumers and/or a myriad of overlay services.

 

  1.          We think that an initial technology neutral approach to the development of CBDCs is essential. It is not yet clear which technical approaches (e.g. decentralised/centralised; Distributed Ledger Technology or traditional) may be most appropriate.

 

  1.          CBDCs must promise, credibly and consistently, to be fully interoperable with existing domestic and international payment systems and fully interchangeable with other fiat currencies. Interoperability of digital money should be pursued at both domestic and international levels. There are existing governance frameworks and standards setting bodies at both levels that could work to facilitate the development of principles and standards necessary to ensure that funds move securely and efficiently. This will all help to ensure continuing and effective competition.

 

  1.          Internationally it will be essential that global bodies like the FSB and related groups like the Committee on Payments and Market Infrastructure continue to maintain a focused agenda on cross-border payments that facilitates interoperability between existing payment systems and CBDCs. The UK should continue to contribute and, where possible, lead those discussions. There are also existing partnership models for central banks exploring interoperability of digital money across border. The mCBDC Bridge project run by the Bank for International Settlements Hong Kong Innovation Hub is an example of a collaboration that the UK could consider.

 

  1.          Domestically, the UK should continue to collaborate with standards setters like Pay.UK to ensure that CBDCs can be integrated into existing payments infrastructure approaches for Real Time Gross Settlement, Faster Payment Services and basic payment systems used across the country. Bringing CBDCs into the existing framework will reduce implementation-related friction while facilitating interoperability.

 

 

 

  1. How might a CBDC affect monetary policy?
  1.          The introduction of a CBDC could have an impact on the range and effectiveness of a number of monetary policy measures, and also a broader impact on markets. A CBDC should be designed so that it does not negatively impact the ability of the Bank of England to ensure financial stability and guide the positive development of the UK economy. We believe this may be possible but more research is needed to confirm the appropriate design considerations, as described below.

 

  1.          There have been suggestions that a CBDC should be directly interest-bearing. However, we believe that an interest-bearing CBDC should be avoided, and it would encourage a loss of bank deposits, which would threaten financial stability and wider economic growth. The October 2020 paper ‘Central Bank Digital Currencies: foundational principles and core features’[7], by the Bank of England and a number of other leading central banks, states that an interest-bearing CBDC would create financial stability trade-offs and that more research is required in this area if such a possibility is to ever be considered.

 

  1.          The Committee on Payments and Market Infrastructure (CPMI) has noted that greater demand for CBDCs could affect repo and government bill markets and also reduce interbank activity. CBDC design choices could therefore have broader implications for the role of central banks in the financial markets and monetary policy transmission mechanisms. These need to be carefully considered, and extending the Bank of England’s existing work to consider these impacts in more detail would be a positive and important step.

 

  1.          There is also the possibility that CBDCs could extend the range of policy options available to central banks and governments, via programmable money, or direct, and potentially conditional, fiscal transfers to citizens. Such proposals need to be very carefully considered from the perspectives of privacy and freedom of action. In addition, it needs to be carefully considered whether new approaches would offer clear benefits over the approaches which have been used in some countries during the COVID-19 pandemic.

 

  1.          In effect we recommend that a ‘do no harm’ principle, as put forward by the BIS in that report on CBDC principles and cited above, should be applied so that the risks associated with a CBDC are fully considered before implementation. CBDC implementation requires a fuller understanding of how consumers and the financial markets would react to digital money before they can be issued in confidence.

 

  1. How might a CBDC change the Bank of England’s role and responsibilities?
  1.          The Bank of England is responsible for ensuring the security of UK banknotes, stable prices, safe and sound banks and a resilient financial system, including payments infrastructure. The impact of a CBDC on the Bank’s role and responsibilities should therefore be viewed with all these elements in mind.

 

  1.          Fundamental to all of this is trust, both by the general public and commercial banks. The general public must trust that a CBDC is secure and stable. Commercial institutions must trust that settlement and liquidity provision will continue to operate as normal.
  2.          This is why it is so important that central banks proceed with due consideration when exploring CBDCs and in particular why there must be seamless interoperability with existing payments infrastructure. It is also why it is crucial that regulatory regimes encompass the full scope of digital money instruments, to ensure the overall safety and stability of the financial system. Authorities must apply supervisory and oversight capabilities and practise under the principle of ‘same activities, same risks, same rules’. This will be a critical component of a safe regulatory regime governing CBDCs, and other types of digital money, such as stablecoins and cryptocurrencies.

 

  1.          The design of wholesale and retail CBDCs will have a strong bearing on the role and responsibilities of the Bank of England.

 

  1.          Wholesale CBDCs are reserved for regulated financial institutions and build on the existing system, where the central bank is the foundation and banks and other commercial actors perform customer-facing activities. A CBDC could settle interbank transfers, operating in a similar manner to central bank reserves but with additional functionality, such as near-instant settlement and delivery. This could enhance the Bank of England’s existing Real Time Gross Settlement system.

 

  1.          For retail CBDCs, it will be important to understand the impact on commercial firms – both banks and non-banks – and the banking and payments system more broadly. The Bank of England determines who gains access to the Faster Payments Service in the UK, and therefore access to its balance sheet and on what terms. While in principle this would continue to be the case with a retail CBDC, as mentioned previously much would depend on the design of a CBDC and therefore the role of the Bank of England.

 

  1.          The governance of CBDCs along with questions around issuance, reserves, coin transfer and stabilisation should fit under the Bank of England’s existing remit, as well as the remits of other relevant supervisory authorities. This approach ensures that those with the greatest knowledge of financial sector risks and capabilities to regulate them effectively across the entirety of the financial sector are given the capacity to do so

 

  1. How should HM Treasury and the Bank of England engage with the public on the research and development of a CBDC?
  1.          The Bank and HM Treasury have been actively engaged with the public for some time on the development of CBDCs. The Bank of England has published two discussion papers[8] on the topic and have created both a CBDC Engagement Forum – of which HSBC is a member – and a CBDC Technology Forum, both of which are intended to support the joint Bank of England /HM Treasury CBDC Taskforce.

 

  1.          As this agenda progresses, we encourage the UK authorities to continue their open and collaborative dialogue with industry and the wider public. As part of this research, we would also recommend establishing an appropriate environment such as a regulatory Sandbox in order to actively test proposals. If a retail CBDC were to be developed, it would also be essential to conduct a robust and wide-reaching education and awareness raising programme to ensure that the public was informed fully about CBDCs.

 

  1.         How might CBDCs affect the economic foreign policies or geopolitical influence of different countries and economic areas? Are there implications for the effectiveness of economic sanctions?
  1.          There has been much recent interest on whether certain CBDCs – such as China’s e-CNY, a potential digital euro, or a potential digital pound – could threaten the reserve status of the US dollar.

 

  1.          Economists and economic historians often suggest that reserve currency status requires a large and stable economy, perceptions of political stability from investors (that is, that the rules of their investment will not be changed as they hold it), and deep, liquid and accessible financial markets in that currency. It is often also noted by economists that whilst some other global currencies have fulfilled these criteria for decades, they have not affected the US Dollar’s reserve primacy. It remains to be seen whether CBDCs change any of these considerations.

 

  1.          As outlined in our answer to question 1, the motivations of different jurisdictions for exploring CBDCs are many and varied. No major economy has yet fully launched a CBDC and most that are actively exploring or piloting CBDCs are largely focused on domestic retail models. As such, it is too early to accurately assess the overall potential geopolitical implications of CBDCs, if any. It does, however, seem fair to expect that CBDCs will only matter for reserve currency status in so far as they introduce economic and trade pattern changes.

 

  1.          This is a fluid and complex debate and we will continue to follow it with interest, but we caution against drawing any firm or sweeping conclusions at this stage.

 

14 October 2021


[1] Membership of CBDC Engagement and Technology Forums | Bank of England

[2] Executive paper - Central bank digital currencies: foundational principles and core features (bis.org)

[3] Enhancing Cross-border Payments: Stage 3 roadmap (fsb.org)

[4] Inthanon-LionRock to mBridge: Building a multi CBDC platform for international payments (bis.org)

[5] III. CBDCs: an opportunity for the monetary system (bis.org)

[6] New forms of digital money | Bank of England

[7] BIS, Oct, 2020: Central bank digital currencies: foundational principles and core features: Central bank digital currencies: foundational principles and core features (bis.org)

[8] New forms of digital money | Bank of England;

Discussion Paper - Central Bank Digital Currency: Opportunities, challenges and design (bankofengland.co.uk)