UK FINANCE – WRITTEN EVIDENCE (CDC0021)

 

CENTRAL BANK DIGITAL CURRENCIES INQUIRY

 

UK Finance is the collective voice for the banking and finance industry.

 

We represent 300 firms across the industry, we act to enhance competitiveness, support customers and facilitate innovation.

 

The provision of a stable currency to the UK market is a direct outcome of the Bank of England’s issuance of both wholesale central bank liabilities and liabilities held by UK consumers and businesses in the form of banknotes. Financial institutions which provide commercial bank money, and other forms of money, to the UK economy also have an important part to play in ensuring the effective provision of money to the economy. These activities, and the wider structure of legislation and regulatory activity that supports the issuance of pound sterling (GBP) to the UK economy, ensure that UK consumers and businesses have access to a currency that provides a reliable store of value, dependable medium of exchange and consistent unit of account, enabling them to make their financial decisions with confidence.

 

As the use of digital payment methods continues to rise, it is critical that the UK considers how its populace accesses and uses these digital services and, importantly, what changes may be required for the issuance of GBP to continue to meet these changing use cases. We are fully supportive of the investigation of the Bank of England and HM Treasury on the issuance of a central bank digital currency (CBDC) for the UK. The consideration of this proposal is taking place in conjunction with regulatory consideration of how to support the use of other new digital money (NDM), including private stablecoins. Our members are supportive of a UK economy that supports the coexistence of different forms of money for use by consumers, businesses and financial institutions.

 

There is still a large amount of work to be undertaken to fully understand how the issuance of a CBDC can resolve issues in the current use and access to GBP. There are risks to financial stability and the sources and cost of lending that we believe must be understood before deciding to proceed. Conversely, there may be potential benefits the issuance of a CBDC that industry and policy makers don’t yet recognise. We expect that industry will adopt a spectrum of approaches as NDM is adopted more widely by the financial sector, UK businesses and consumers. Different business models will be impacted differently by these changes.

 

We are supportive of the process and engagement that the Bank and HM Treasury have established to consider these important questions for the UK economy. There are many issues to be considered along the way, as evidenced by recent publications from the BIS,[1] the International Organization of Securities Commissions (IOSCO),[2] the Financial Stability Board (FSB)[3] and the G7.[4] We look forward to continuing to work collaboratively through the Bank’s engagement groups to further develop the proposal of a CBDC for the UK.

  1. What are the main issues driving central banks to explore CBDCs?

1.1.    From a broad industry level, we are seeing trends that indicate customers prefer to use digital payments mechanisms. Within this wider trend, drivers to adopt CBDCs differ between central banks and national entities. Recent BIS papers outline a number of potential drivers for the issuance of a CBDC:

      1.               Continued access to central bank money,
      2.               Resilience,
      3.               Increased payments diversity,
      4.               Encouraging financial inclusion,
      5.               Improving cross-border payments,
      6.               Supporting public privacy,
      7.               Facilitating fiscal transfers,
      8.               Enabling innovative monetary policy mechanisms.[5]

1.2.    The consideration of the Bank of England appears to indicate that they see the greatest benefit of a CBDC in providing enhanced resilience and trust in the financial ecosystem. Innovation, particularly in payments applications, are also potential benefits that are considered.[6]

1.3.    It is clear that the market is moving and that cryptocurrencies and assets are in increasing demand by consumers. Some estimates place the total value of cryptocurrencies at over $2 trillion.[7]

1.4.    In this light, some central banks may believe that the issuance of a CBDC is necessary to provide control and oversight of their national economies and currencies. We are supportive of the UK remaining a globally competitive financial services hub and note that there are several central bank pilots investigating the benefit of CBDCs, particularly as a response to the decline in cash,[8] to enhance cross border payments,[9] and provide smart contract applications.[10] These are compelling reasons to explore a UK CBDC.

1.5.    We are supportive of the Bank’s further consideration of the benefits and use cases for the UK economy of the issuance of a UK CBDC alongside the provision of private NDM. There is a possibility that the Bank’s issuance of a CBDC may not be able to answer some of the drivers for consumers and business to use and invest in cryptoassets. Many consumers could choose to acquire cryptoassets as an investment opportunity or due to a lack of trust in central bank fiat currencies. Given current trends, it is possible that UK consumers and businesses will continue to acquire cryptoassets regardless of whether a CBDC is issued by the Bank. UK Finance and its members remain in full support of a well-regulated and managed market to support a stable UK economy and the GBP. To ensure this stability continues, it may be necessary for regulation to bring the speculative use, and other uses, of cryptoassets into scope of regulatory supervision; alongside consideration of a UK CBDC.

1.6.    In investigating the potential issuance of a CBDC, the Bank and HM Treasury should clearly identify the benefit a CBDC can deliver to UK consumers and businesses and how a CBDC will interoperate with other forms of money. The Bank and HMT should consider both retail and wholesale use cases supporting applications such as micropayments, international payments, the provision of digital wallets, liquidity optimisation and enablers for monetary policy intervention. It is the interest of all parties for any investment in the issuance of a CBDC to be matched by widespread uptake of UK businesses and consumers.

1.7.    The Bank and HMT are already collaborating with industry through their taskforce and engagement forums. Our members believe that this collaboration will be essential to define the right outcomes and arrive at a feasible design to deliver against agreed outcomes. It may be that an initial pilot of a CBDC for wholesale use cases could provide the opportunity for the industry and regulators to test and learn ahead of a retail roll-out.

  1. Could the proposed benefits of a CBDC be achieved through improvements to existing payment systems?

2.1.    As discussed above, there are numerous potential benefits that could be realised through the implementation of a CBDC. There remains a need to clearly articulate what tangible benefits a CBDC will deliver for the UK market.

2.2.    The technical design of a CBDC will set-out these benefits, as well as any cost of implementation. Articulating these benefits and the means of achieving will take regulatory and industry co-ordination. Ongoing and proposed changes to infrastructure must be considered to understand where synergies can be exploited. These include: the Bank’s redevelopment of its Real Time Gross Settlement (RTGS) platform, the delivery of the New Payments Architecture and the growth of Open Banking and open API infrastructures.

2.3.    The Bank’s consideration of the benefits of a CBDC has mostly focused on the additional financial resiliency that the retail holding of central bank liabilities could have on the economy; particularly in light of the declining use of banknotes as a means of payment in the UK. Conversely, issuance of banknotes continues to rise.[11] It is relevant to note that most UK commercial bank money is guaranteed through the Financial Services Compensation Scheme (FSCS) to £85,000[12] per individual, per bank and National Savings and Investment (NS&I) provides consumers with access to HM Treasury backed savings products.[13] Given the existing access to risk free money and savings, this use case may require further analysis to determine its benefit to the UK market.

2.4.    The Bank has also suggested that the issuance of a CBDC could enhance the level of payment innovation in the market. There is extensive innovation and investment in payment mechanisms and significant change to the use of payment mechanisms, with infrastructure such as Faster Payments seeing a rise in its use for retail purchases. These factors will continue to foster innovation and support a competitive environment, driving benefits for UK businesses and consumers.

2.1.    All of the use cases noted in our response to the previous question are equally valid for the industry to consider. We believe that the Bank and HM Treasury’s CBDC task force should seek to investigate these use cases and, collaboratively with industry, reach a position as to which applications could deliver maximum benefit for the UK market. A CBDC can then be designed to meet all of these requirements.

2.2.    As part of this investigation, the Bank and HM Treasury will need to consider with industry whether the potential macroeconomic stability risks and changes in lending structures and costs associated with the Bank’s proposed asset backing requirements for a CBDC, and any privately issued NDM, are commensurate to the benefits achieved.

2.3.    Any adoption of a CBDC should be market led; supporting innovation and competition. As per the position outlined by the Bank in its 2020 consultation paper,[14] the industry supports a ‘platform model’ for the delivery of a CBDC, with the Bank providing ‘the minimum level of infrastructure for the system to be reliable, resilient, fast and efficient’ and the private sector taking ‘a leading role in responding to the needs of the end users.[15]

2.4.    We believe that there is a strategic opportunity for a UK CBDC to support initiatives to enhance cross-border payments; particularly the G20 cross-border payments roadmap.[16] We commend further engagement of the Bank and HMT with other central banks and other initiatives investigating this potential application.[17]

  1. How should the Bank of England and HM Treasury address concerns over privacy and traceability of payments when exploring CBDC design?

3.1.    In terms of the applicable rules governing what CBDC data can be used for, we believe that any UK CBDC should ensure that protections for the payments data of consumers and businesses remain at the same standard as for other payment methods.

3.2.    The wider migration of UK transactions onto digital platforms already creates opportunities and some concerns around transparency and traceability of data use, on a corporate and individual basis.

3.3.    As a starting point, common privacy rules should exist across all payment rails. For example as relates to the types of uses data can be put to, how data can be repurposed, etc, under the UK GDPR framework. In particular, rules around detection and prevention of money laundering and other economic crime should be consistent, effective in preventing criminal activity while balancing the privacy concerns of consumers and businesses. While a CBDC may be a more effective platform for managing economic crime, consideration will need to be given to whether this approach merely pushes criminals onto other payment channels.

3.4.    Nonetheless, incorporating technical measures, such as encryption, pseudonymisation, etc, into CBDCs could help reduce risks of data misuse or data breach.

  1. What effects might a CBDC have on the financial sector?

4.1.    A CBDC is likely to change the source and cost of lending for UK consumers and businesses. This is explored in the Bank’s ‘New forms of digital money’ discussion paper[18] and our response, jointly submitted with the Asset and Liability Management Association.[19] In our response we concluded that the Bank’s modelling requires further development, that the liquidity outcomes, and therefore costs, of a CBDC issuance could be felt asymmetrically across financial institutions as well as change the source of funding for highly regulated lending markets, such as mortgages. These effects are highly dependent upon the eventual demand for any NDM and any free market operations (such as lending or borrowing) of NDM holdings permitted by the regulatory framework.

4.2.    We believe the Bank should engage pro-actively with industry to understand the macroeconomic impact of CBC issuance. A common modelling approach should be agreed between industry, HMT and the Bank.

4.3.    A CBDC should not remove features of money that UK businesses, consumers and financial institutions rely on. We have explored this in a joint paper with EY[20] looking at the implications of the issuance of a CBDC on financial services, particularly in its implication on financial crime, tax and sustainability. Substantially, we believe that further analysis should assess the wider financial repercussions of the issuance of a UK CBDC.

  1. What effect might a CBDC have on competition and innovation in the payments and fintech sectors?

5.1.    A CBDC should increase competition and innovation in the payments and fintech sectors. Equally, private issuance of NDM could have a similar effect. The Bank and HMT should be mindful to balance the benefits of enabling a retail CBDC without overly restrictive regulation of private NDM. Achieving an appropriate balance will permit enhanced competition and innovation while helping to avert negative outcomes and manage unintended consequences.

5.2.    To avoid regulatory arbitrage, the principle of same risk, same activity, same regulation should apply to any issuance of a CBDC, and private NDM. This should be applied proportionally across smaller and larger businesses and facilitate a multiplicity of business models.

5.3.    The issuance of a CBDC and any other regulation surrounding the use of NDM by UK businesses and consumers should support the widespread holding, transacting in or otherwise benefiting from NDM and cryptoassets.

  1. How might a CBDC affect monetary policy?

6.1.    It is important that the issuance of a CBDC and adoption of private NDM to support the ability of the Bank, other central banks and industry to respond to rapid market changes and other stability considerations. Appropriate regulatory mechanisms should ensure that multiple NDMs can interoperate with any CBDC safely within the UK.

6.2.    The liquidity requirements of a CBDC could significantly impact macroeconomic stability. Increasing the velocity in which liquidity requirements could change in times of market stress, through retail deposit flight to a CBDC and the ensuing volatility of the market, could require additional controls and market balancing instruments to be introduced by the Bank, particularly given the ongoing low rate environment.

6.3.    The issuance of a CBDC could potentially deliver enhanced monetary policy controls and mechanisms to the Bank.

  1. How might a CBDC change the Bank of England’s role and responsibilities?

7.1.    The impact on the Bank’s roles and responsibilities will depend largely on the technical design of a CBDC, its supporting regulatory framework and the use case(s) it fulfils.

7.2.    We believe that the issuance of a CBDC should use common and open technical standards. In the event of issuance of a CBDC, mechanisms for the setting and implementation of standards to support interoperability with existing payment methods and with other national and international NDMs will need to be established.

7.3.    The Bank’s role in implementing the architecture necessary to support a CBDC could be very impactful. If the Bank takes a leading role in the design and management of this architecture, it could become a central partner in any attempts to adjust this architecture to enable innovation. The Bank may need support initiatives with lower prospects of widespread adoption while still maintaining tight control over the central platform of the CBDC. While the industry is supportive of the platform approach articulated by the Bank, how this operates in practice is still to be determined and may require the creation of appropriate forums to engage with industry and innovators.

7.4.    Some use cases, such as the development of ‘smart contracts’ could require the Bank to assume additional technical operational risk through the issuance of a CBDC, although this will be dependent upon architecture design.

7.5.    If an outcome of CBDC issuance is determined to require enhanced cross-border payments, the Bank would need to expand its engagement with other central banks and international payment stakeholders. This could entail co-ordinating with international partners to better manage in real-time incidents of international instability.

7.6.    The regulatory approach taken for a CBDC could also create a situation whether the Bank’s policies more directly impacts the financial lives of UK consumers. Under models considered by the Bank in its recent consultation on new forms of digital money, more liabilities could be held by the Bank (and more assets accordingly) resulting in an increased balance sheet and meaning its activities could have a much greater impact on the ability for consumers and businesses to find market credit from reliable sources.

7.7.    Finally, with an increased balance sheet, the ability of the Bank to act as a lender of last resort in times of financial stress could also be impacted. To manage the macroeconomic stability implications of changing liquidity structures, it may be necessary to develop appropriate financial controls for the Bank to maintain stability.

  1. How should HM Treasury and the Bank of England engage with the public on the research and development of a CBDC?

8.1.    The establishment of the Bank and HM Treasury task force is commended by our members, in particular their creation of industry and technical engagement forums. Their consultative approach on both the creation of a retail CBDC and wider private issuance of NDM has been warmly received by industry. We recommend that engagement with industry on the potential development of a wholesale CBDC should be actively considered by HM Treasury and the Bank. There are also opportunities for the Bank to utilise customer research in developing the understanding of the drivers for CBDC uses and its public adoption.

8.2.    The Bank should continue its international engagement through BIS and other international fora to promote the development of consistent regulatory approaches.

  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?

9.1.    A significant opportunity for the issuance of a CBDC exists in enhancing the facilitation of cross border payments. As technological barriers to achieving efficient cross-border payments fall to advances in technology, differences in national law and regulation may become more important to handle. The investigation of multi-CBDC[21] arrangements and enabling private NDM use cases are excellent opportunities for central banks and regulators to consider how to resolve these differences and support the G20 cross-border payments roadmap.[22] We have an opportunity to work with other national stakeholders to develop a better international financial ecosystem.

9.2.    The Bank should continue to co-ordinate internationally with other central banks to support cross-border payments and ensure alignment on regulatory and technical standards. Its support of the G20 cross-border payments roadmap will also be key.

9.3.       With these opportunities, there are risks to manage. Research by the ECB and the IMF hypothesises[23] that cross-border CBDCs could have unintended consequences on third-party economies, driving the substitution of domestic money and amplifying cross-border spill overs of monetary policy shocks. Their impact on sanctions should also be considered as the use of cryptoassets and private NDM may facilitate transfers of value outside regulatory perimeters and over routes not traceable by established financial institutions and regulatory bodies. As funds are moved back into fiat currencies there may be opportunities to raise concerns around source of funds and allow checks.


[1] https://www.bis.org/publ/othp42.htm, https://www.bis.org/about/bisih/topics/cbdc/mcbdc_bridge.htm

[2] https://www.iosco.org/library/pubdocs/pdf/IOSCOPD685.pdf

[3] https://www.fsb.org/2021/10/regulation-supervision-and-oversight-of-global-stablecoin-arrangements-progress-report-on-the-implementation-of-the-fsb-high-level-recommendations/

[4] https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1025235/G7_Public_Policy_ Principles_for_Retail_CBDC_FINAL.pdf

[5] https://www.bis.org/publ/othp33.htm

[6] https://www.bankofengland.co.uk/paper/2021/new-forms-of-digital-money

[7] https://coinmarketcap.com/

[8] https://www.reuters.com/article/us-cenbank-digital-sweden-idUSKBN20E26G

[9] https://www.bis.org/about/bisih/topics/cbdc/mcbdc_bridge.htm

[10] https://www.banque-france.fr/en/communique-de-presse/banque-de-france-conducts-successful-experiment-use-central-bank-digital-money-consortium-actors

[11] https://www.bankofengland.co.uk/quarterly-bulletin/2020/2020-q4/cash-in-the-time-of-covid

[12] https://www.fscs.org.uk/what-we-cover/

[13] https://www.nsandi.com/get-to-know-us/why-nsandi

[14] https://www.bankofengland.co.uk/paper/2020/central-bank-digital-currency-opportunities-challenges-and-design-discussion-paper

[15] https://www.bankofengland.co.uk/news/2021/june/new-forms-of-digital-money-discussion-paper-and-summary-of-responses-to-the-discussion-paper-on-cbdc

[16] https://www.fsb.org/2020/10/enhancing-cross-border-payments-stage-3-roadmap/

[17] https://www.bis.org/about/bisih/topics/cbdc/mcbdc_bridge.htm

[18] https://www.bankofengland.co.uk/paper/2021/new-forms-of-digital-money

[19] https://www.ukfinance.org.uk/policy-and-guidance/consultation-responses/uk-finance-response-bank-england-discussion-paper-new-forms-digital-money

[20] https://www.ukfinance.org.uk/system/files/CBDC-report-FINAL.pdf

[21] https://www.bis.org/publ/bppdf/bispap115.htm, https://www.bis.org/publ/othp40.htm

[22] https://www.fsb.org/2020/10/enhancing-cross-border-payments-stage-3-roadmap/

[23] https://www.imf.org/-/media/Files/Publications/PP/2021/English/PPEA2021048.ashx