BARCLAYS BANK – WRITTEN EVIDENCE – (CD0031)

 

BANK DIGITAL CURRENCY INQUIRY

 

Barclays is a British universal bank. We are diversified by business, by different types of customer and client, and geography. Our businesses include consumer banking and payments operations around the world, as well as a top-tier, full service, global corporate and investment bank, all of which are supported by our service company which provides technology, operations and functional services across the Group. For further information about Barclays, please visit our website home.barclays.

We welcome the opportunity to respond to the House of Lords Economic Affairs Committee Central Bank Digital Currency (CBDC) inquiry.  We believe that this as an important step by the authorities in exploring key considerations regarding new forms of digital money and agree that it is an important topic for Parliament to focus on.

In addition, we appreciate the work that UK is undertaking regarding CBDCs, especially the Bank of England (BoE) and Her Majesty’s Treasury (HMT) announcement of a public private Engagement Forum and a Technology Forum to foster collaboration with the private sector (which Barclays is participating in).  Further, we welcome the work that the BoE is undertaking with the Bank for International Settlement (BIS) and other policymakers regarding stablecoins and CBDCs given the need for interoperability of on new forms of digital money.

We are supportive of, and have participated in, the UK Finance response, however, given the strategic importance of this topic we want to highlight certain considerations by providing our own response. 

We hope that these insights are valuable and we would be happy to provide further detail if that would be helpful

  1. Key points

New forms of digital money: in this paper we consider that new forms of digital money include private stablecoins (a subset of crypto-assets) and central bank digital currencies (CBDCs).  Crypto-assets such as bitcoin are not viewed as money due to their volatility, rather we view them as speculative investments. 

Implementation considerations and recommendations: We believe that there are considerations and recommendations that are important to consider during a central bank’s investigation and consultative phase prior to potential implementation of new forms of digital money including:

-          Design choices:  We do believe that digital money can operate as an enhancement to our current financial system, however design choice is key in achieving this (and defining the right use cases) without incurring excessive risk.  Trust in CBDCs will be essential for adoption, policies about privacy and access to payment data will be key design elements in order to maintain public trust.  Therefore, it is essential that the authorities understand and analyse the benefits and risks of different design choices in continued and collaborative consultation with the industry with full transparency prior to making any decisions regarding the issuance of a CBDC or private stablecoinIt is important to note that this may include other design choices not currently publicly discussed by the authorities and that the best balance is likely to be leveraging existing infrastructure and safeguards. 

-          Migration phase and mitigants: We would encourage a central bank to take a phased approach, with the appropriate guardrails in place, which would allow both the industry and authorities to reassess the potential costs and benefits of different design choices (including further consideration and analysis of alternative assumptions and scenarios that is required) prior to any potential full implementation.  Mitigants may include very low holding limits and consideration of the role of the private sector.

-          Regulatory perimeter: As a broader range of firms from a diverse range of sectors participate in the payments ecosystem and potentially offer new forms of digital money, in particular private stablecoins, there is a need to ensure that consumers are provided with the same level of protections, and that all those participants who offer the same service, undertake the same activity, or expose consumers to the same risk are subject to equivalent regulatory requirements on a proportional basis. 

-          International collaboration and interoperability: Continued collaboration between the public and private sector is essential both domestically and also internationally given the need for CDBC systems to be interoperable if the full benefits are to be realised.  Therefore, we recommend that the UK authorities continue international engagement to understand how technical interoperability can be supported from a global perspective. 

Benefits: We recognise the need for the authorities to respond to the accelerating pace of digital money development in both the private sector and globally.  We also appreciate that there are potential benefits that may arise from issuing new forms of digital money including that it may improve financial inclusion; help counter anti money laundering (AML) and combat terrorist financing (CTF) (although it may also present challenges); in jurisdictions where cash is declining it provides a way for ‘public money’ to still exist; in certain scenarios it can assist with monetary policy; and it may assist in cross border payments.  These benefits will differ between jurisdictions and a number of the benefits exist for both private stablecoins and CBDCs with notable exceptions such as monetary policy.

Risks: We believe that there are risks for new forms of digital money including reputational risk; infrastructure costs (for instance a recent BIS paper highlighted that a ‘CBDC system would require some capital investment, including the costs of the central bank to set up the core system as well as some costs borne by the private sector to interoperate and provide services on top of the core system); privacy (whereas physical cash is anonymous it is unlikely that a CBDC would be and both stablecoins and CBDC use will result in a large digital footprint for a user); and disintermediation, particularly in relation to credit creation and macroeconomic stability if the wrong design choices are madeWith respects to the latter the risks are most pronounced for a CBDC, however are also applicable across a range of stablecoin models unless backed by real economy loans. Further, we have set out below some of the key considerations and potential risks with respects to credit creation and macroeconomic stability:

-          As the authorities appreciate, commercial bank deposits are key to credit creation, via a bank’s process of maturity transformation and taking on liquidity (as well as credit) risk.

-          A meaningful take-up of CBDC, may remove large portions of deposits from commercial banks.

-          Wholesale markets may not be able to sustainably replace the funding lost by commercial banks and it is currently not clear how the deposits held as CBDCs will fund the transformation required to replace their current role in credit creation[1].

-          Further we believe that it cannot necessarily be assumed that non-bank lenders would be willing/able to fill the potential gap in credit provision left by commercial banks.

-          As a consequence, any wide-scale displacement of deposit funding from the banking sector is likely to lead to a contraction in credit and/or an increase in the cost of that credit (absolute cost and volatility of that cost).  It is important that the authorities do not underestimate the combined impact of increased supply and reduced bank credit quality following their change in funding mix.

-          Dependent on the design choices there may be a material increase in the stress vulnerability of the banking sector.  In particular, increased reliance on wholesale funding and the existence of an alternative source of deposit provision to banks will heighten stress vulnerability.  UK banks have become materially safer since the financial crisis by reducing reliance on wholesale funding and these developments are a retrograde step in financial stability

-          .

In summary, we appreciate that authorities (both at home and abroad) are enabling and supporting payments innovation in the digital era and we understand the benefits of new forms of digital money. However, we also share the authorities concerns that wide-scale adoption of CBDCs and private stablecoins could present large risks to credit creation and financial stability.  We believe that further understanding and collaboration on design choices is required to help achieve an optimal outcome of delivering benefits without incurring excessive risk. Therefore, with that in mind, we welcome the opportunity to continue working with authorities on this important matter.

In the rest of this paper, we set out further detail on the above points in relation to 1) new forms of digital money and drivers 2) credit creation; 3) macroeconomic stability; (4) regulatory perimeter; and (5) other implementation recommendations.

  1. New forms of digital money and their drivers

 

Today, the United Nations recognises 180 currencies worldwide with these currencies being used to buy goods and services.   The value of most of these currencies is subject to minor changes on a daily basis, for instance a box of tea will standardly cost £1 in the supermarket and one does not have to worry that it will be £2 on any day that same month.  Whilst blockchain and crypto-assets have changed the way people think about money, one of the criticisms of a number of cryptocurrencies (a sub-type of crypto-assets), including bitcoin, as a means of payment, is the volatility in price fluctuations – the same box of tea could cost anywhere between 20p - £10 in a given day.  

 

‘Stablecoins’, another subset of crypto-assets, have characteristics that distinguish them from the categories mentioned above, most notably their stabilisation functionality.  In principle the main benefit generally associated with stablecoins, is that depending on how and what they are pegged to, they may not be subject to the extreme price volatility that other crypto-assets are affected by.  In addition, they could potentially in some cases offer global reach, with the ability to help the unbanked.  These reasons are why this class of crypto-assets are seen by some as an attractive means of payment.  However, it is important to flag that there are many different types of so-called stablecoins with some being neither stable nor a coin.

 

We believe that a CBDC would be a digital form of central bank money that could be used by consumers and businesses to make payments.  We support the Bank for International Settlements (BIS) definition of CBDC, namely that it is digital payment instrument, denominated in the national unit of account, that is a direct liability of the central bankCBDCs can be used in both wholesale and retail markets with different considerations required (for instance data protection challenges are more apparent with retail CBDCs).  In addition, it is important to note there is no “one-size-fits all” approach to CBDCs and that adoption strategies would need to be tailored to the economic structures and payment landscapes of individual jurisdictions. 

 

Further there are different drivers for CBDCs depending on the jurisdiction including (amongst others) promoting safety and robustness; improving domestic payment efficiency and cross border payments; new and evolving technologies changing expectations and needs of users; the digitisation of commerce; financial inclusion; the declining use of cash; global events such as the Covid-19 pandemic; privately issued stablecoins and geo political issues.

 

  1. Credit creation

Commercial banks are the primary providers of credit to the real economy, funded materially by deposits. In doing so, banks incur the liquidity risk of maturity transformation and allocate capital to provide credit.

We understand that design choices will affect the issuance and acceptance of a CBDC.  However, if the introduction of a CBDC or stablecoin results in the large-scale displacement of deposits from bank balance sheets, this will (all else equal) reduce the ability of banks to lend, driving up its cost Consequently, banks will no longer have funding to lend, and they will also likely be required to hold more liquidity against those deposits that remain on the balance sheet (section 4), further reducing capacity to lend.

We appreciate that authorities recognise this risk and we welcome the ability to work with the authorities to both understand the risks and help mitigate them. As noted above depending on design choices made this risk will vary.

Key points to consider include:

 

  1. Implications for macroeconomic stability

As noted by policymakers including the Bank of England, the issuance of a CBDC or private stablecoin could potentially create risks to macroeconomic stability in the form of reducing liquidity resilience of the banking sector. Specifically, through an increased reliance on wholesale funding and an increased likelihood of liquidity outflows in a stress.

If banks replace a material proportion of deposit funding with wholesale funding, this will increase the exposure of banks, and credit conditions, to refinancing risk and short-term volatility in market sentiment. Increased reliance on secured sources of wholesale funding would result in higher levels of encumbrance across the banking sector and increase the sector’s vulnerability to stress.

As a CBDC provides a safer alternative for depositors one of the key risks is that it will likely increase the likelihood of deposit outflows in a stress scenario (and to a lesser extent in the case of a privately provided stablecoin). By definition, this increases the vulnerability of the banking sector to stress, potentially destabilising credit supply and could require the Bank to act as lender of last resort more quickly than it otherwise would need to.

As deposit growth becomes more cyclical, this will increase the cyclicality of bank-supplied money and the provision of credit, which will likely have negative implications for macroeconomic stability and economic growth.

  1. Regulatory perimeter

The current regulatory framework follows an entity-based approach to regulation, mandating specific rules and requirements for traditional providers of financial services.  However, it is essential to consider all of the new and different players in the ecosystem (and their impact) as under the current approach to financial services regulation, these providers may not be subject to the same rules as traditional providers for the activity they are undertaking.

Consequently, as a broader range of firms from a diverse range of sectors participate in the payments ecosystem and potentially offer new forms of digital money (including both stablecoins and CBDCs), there is a need to consider the end-to-end regulation of the whole payment chain.  It is essential to ensure that the consumers are provided with the same level of protections, and that all those participants who offer the same service, undertake the same activity, or expose consumers to the same risk are subject to equivalent regulatory requirements on a proportional basis. 

Depending on the model and design choices a consequence may be that more participants need access to Central Bank support akin to that currently provided to commercial banks – and this in itself should create a pre-condition for higher levels of prudential regulation.  In particular, this is likely to involve increased regulation of non-bank credit lenders if their role is expected to increase.  

There is a danger that the emerging risks posed by significant market changes in the wider digital ecosystem will not be recognised by a perimeter-defined approach to regulation.  However, it is essential that non-banks or other entrants which undertake the same roles and activities that carry the same risks are subject to an extension of prudential regulation (on a proportional basis).

Furthermore, we believe it is important to highlight that systemic players should not be equated to mean only ‘large’ players.  It is important to recognise the risk to the financial ecosystem that small players could have if they occupied a strategic position within the market or if a group of players act in a correlated way. We fully support the principle of “same risk, same regulatory outcome” and it is critical that this is applied in the context of the private provision of stablecoins and the assumed provision of credit by the non-bank financial sector.

 

  1. Recommendations and considerations for authorities during the investigative phase

Barclays fully supports the public policy objectives of more efficient payments and enhancing financial inclusion, and we recognise the role that digital money may play in achieving those objectives.  However, there are necessary considerations, principles and processes that are required during the investigative phase prior to any potential implementation.

(a) Design choices

We appreciate that there are different benefits and risks that arise from issuing new forms of digital money.  These will differ based on whether it is for wholesale or general purpose/retail with the latter being more nuanced - for instance there will be greater data protection considerations given the amount of data that could be collected on a citizen in this new ecosystem. Further the benefits and risks will also be dependent on the specific use case. 

Furthermore, importantly, the risks (and benefits) will differ dependent on the design choice undertaken.  and it is important to highlight that there may be other models not currently being discussed that need to be consideredTherefore, it is essential that the authorities carefully and systematically set out and understand and analyse the benefits and risks of different design choices (transparently in continued consultation with the industry) prior to making any decisions regarding the issuance of a CBDC or private stablecoin.   This is necessary in order to define accurately the business case.  In addition, many important technology design choices will need to be made regarding the central bank ledger, payments processing, data standards, application programming interfaces, privacy, security, and interoperability. We welcome the opportunity to continue working collaboratively with the Bank on this work.

(b) Migration path

We appreciate that authorities (both in the UK and abroad) have highlighted the value of transitional arrangements.   According to a recent BIS report, risks to financial stability depend on the take-up, or rate of adoption, of a CBDC as well as bank funding, lending and resilience. They noted that if take-up is too fast, it could throw the existing financial and banking systems out of balance. As highlighted above prevailing fear is that the use of any CBDC would require a shift of funds out of bank deposits and into a CBDC.

We would strongly encourage the authorities to take a phased approach, with the appropriate guardrails in place, which would allow both the industry and authorities to reassess the potential costs and benefits of different design choices. This includes further consideration and analysis of scenarios that is required in addition to appropriate experimentation prior to any potential full implementation.  Lastly, design choices, in addition to implementation time, will be essential to ensure that digital money can operate as an enhancement to our current financial system

(c) Mitigants to risks including holding limits

As noted throughout the paper there are various risks in relation to the provision of credit and financial stability including concerns that you may see customers deposit in CBDCs causing digital bank runs.

Therefore, it is vital that the authorities (alongside industry) considers various mitigants including the necessary macroeconomic tools, such as holding limits, in addition to the role of the private sector in this new payments ecosystem. 

(d) International collaboration and interoperability

We appreciate that a potential benefit cited for CDBCs and stablecoins includes improving cross border transactions. Consequently, we believe continued collaboration between the public and private sector is essential both domestically and also internationally given the need for CDBCs to be interoperable. 

 

15 October 2021


[1] For instance, if the banking sector were to lose 20% of retail deposits (per the Bank of England’s illustrative scenario in their ‘New Forms of Digital Money’ paper), banks will need to either reduce lending and/or replace those deposits with alternative liabilities in the form of wholesale funding.