1. EY is a globally connected, multidisciplinary professional services firm providing assurance, consulting, strategy and transactions, and tax services to clients. Exploration of Central Bank Digital Currencies (CBDCs) has risen to prominence across the world and in responding to this inquiry our aim is to draw on our thinking and experience to set out some of the benefits and challenges of CBDCs and also the importance of understanding the local use cases. 
  2. The Atlantic Council’s CBDC Tracker[1], shows that 81 countries are exploring a digital currency, and five countries have launched a CBDC. Two major designs are under consideration globally, as well as hybrids:

         Wholesale CBDC – usage generally restricted to financial institutions as a settlement asset for large transactions (e.g. interbank payments and securities settlements)

         Retail CBDC – universally accessible[2] and available to the general public and business -  substitutes for, or complements, bank notes in circulation

  1. Seven central banks (Bank of Canada, Bank of England (the Bank), Bank of Japan, European Central Bank, Federal Reserve, Sveriges Riksbank and Swiss National Bank), together with the Bank for International Settlements (BIS), are working together to explore retail CBDCs[3]. The UK has recently published a G7 report setting out Public Policy Principles for Retail Central Bank Digital Currencies’[4].
  2. The architecture for a CBDC can be: indirect, where the customer relationship remains with financial institutions that hold wholesale accounts with the central bank; direct, where the central bank takes on the full customer relationship and maintains their accounts; or a hybrid, intermediated model (e.g. the “platform” model explored by the Bank) in which financial institutions manage the relationships with customers but maintain an account for each customer in the central bank’s ledger. In this written evidence we will focus on retail CBDCs with an intermediated architecture. There are many critical factors to consider, in addition to technology, in order to realise the opportunity and manage the risk around CBDC[5]. Most of the key considerations are covered in the responses to the Committee’s questions below but others include law, regulation, tax and sustainability.

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

  1. CBDCs are a way for central banks to take back some control over money supplies in response to the proliferation of decentralised, private sector stablecoins. However, CBDCs are also a response to some of the most pressing issues in a financial system. Hence the issues which drive central banks to explore CBDCs tend to be localised (e.g. a developing economy may have stronger motivations for issuing a CBDC to replace or supplement existing payment systems and address financial inclusion challenges). It is important to define the local use and problem case for a CBDC before a solution is decided upon[6]
  2. Issues driving the exploration of retail CBDCs include:

         Enhancing the efficiency, reducing the costs of, and/or increasing the resilience of domestic payment systems

         Supporting an increasingly digital society and/or facilitating a larger virtual assets ecosystem

         The falling use of cash and declining central bank influence on the payments system

         Digitising an economy reliant on cash

         Gaining full visibility of the financial system and enabling better supervisory control in the face of competition from dominant overseas and local payment providers

         Enhancing financial inclusion and banking the unbanked

  1. A few wholesale CBDC pilots are also seeking to facilitate cross-border settlement and interoperability challenges, for example, with a single CBDC which is accepted in multiple jurisdictions or linked, interoperable CBDCs[7]. 

What are the main benefits and risks of a CBDC?

  1. To build a use case, a retail CBDC would need to offer something over and above a jurisdiction’s existing payment systems. In particular, in countries where the payment system infrastructure already enables rapid, low-cost transactions among individuals and does not require improvement, one needs to look beyond the payment system for the problems which a CBDC would be solving and the benefits it would deliver.
  2. The main benefits and risks for the financial services sector will also depend on the policy objectives and design choices for a CBDC[8]. For example, whether a CBDC is designed to transfer value or whether it can also be used as a long-term storage of value – either internally (e.g. through payment of interest) or unintentionally (e.g. where a consumer leaves funds in the CBDC (‘lazy cash’) rather than transferring them back to their commercial bank). 
  3. In general, though, looking at pilots across the globe, the main benefits, and risks of a CBDC used for retail payments include but are not limited to the following:
  4. Benefits:

    Enhancing the efficiencies of payment systems - digital currencies, such as a CBDC, enhance efficiencies of payment systems by reducing transfer and settlement times (it can take up to three days for merchants to receive funds from ‘near instantaneous’ card payments). Efficiencies could also filter through to commercial banks. This is common reason cited for exploring CBDCs outside the G20.

       Reducing the costs of cash - from a public sector perspective, a cash-based system, that relies heavily on paper currency and coins is a burden for governments given the relatively high issuance, operating and maintenance costs. From a private sector perspective, cash is costly to store, count (reconcile) and move around. Digital transactions would cut these costs while simultaneously providing commercial banks and payment processors with greater insights into how customers spend and save. Efficiencies could also filter through to commercial banks.

       Financial Inclusion – in economies where mobile phone penetration is high but access to payment systems is low, a retail CBDC can have a high impact on financial inclusion. In particular, digital technology is able to reduce the cost of serving lower margin or unbanked customers, particularly in rural areas, leading financial institutions to discover that their small but ‘sticky’ deposits, when considered collectively, can be high value. However, there are complexities around how a CBDC could be used offline.

       Increased transparency - digitization is, by nature, highly transparent, thereby reducing opportunities for financial crime, including money laundering, terrorist financing and tax evasion, and encouraging moves to digital identification.

                          Maintaining access to state-guaranteed money - some advanced economies are witnessing a decline in physical cash, as it is replaced by electronic payments via debit and credits cards that are supplied by a few private and very often foreign companies. For example, the Sveriges Riksbank found[9] that in 2018 only 13% of residents paid for their most-recent purchase in cash and it has been predicted that Swedish retailers could stop accepting cash by 2023[10]. Wary of over-dependence on private sector e-payment providers, some governments are considering CBDCs to maintain access to state-guaranteed money and retain the public’s faith in their payment systems.

  1. Risks:

                     Disintermediationa successful CBDC would be expected to lead to some level of disintermediation for commercial banks, particularly without a limit on CBDC holdings. This could result in commercial banks having smaller balance sheets as households and businesses substitute monies from banking deposits with CBDC holdings. This loss of deposit funding could reduce the levels of credit that commercial banks are able to provide to the wider economy. There could also be other effects on bank balance sheets such as loss of seigniorage.

                     Anti-money laundering (AML) and Counter Financing of Terrorism (CTF) – the risk a CBDC could be used for illegal activity is one of the main concerns. This was considered in an Financial Action Taskforce report which found that while a CBDC could present a greater risk than cash, the “design of CBDCs will determine their risks” [11], which could therefore be lower. If there was any lapse in financial crime controls, or the CBDC was used for illicit purposes, this would have a negative impact on the reputation of the central bank which could affect public confidence in the further use of the CBDC.

                     Cybersecurity - security is a large component of a CBDC model for governments issuing CBDCs and there are risks for the wider society and financial institutions, should the government infrastructure be compromised.

         Privacy – there are concerns that storing large amounts of personal data on a centralised system and features such as traceability and transparency make CBDCs risky from a privacy perspective. However, in the Sveriges Riksbank ‘e-krona’ project, intermediaries remain responsible for due diligence and KYC processes for CBDC users and the Riksbank receives no information on account holders, only on the transactions and account balances.

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

  1. It is important to focus on the problem a CBDC is trying to solve and how best to achieve improvements. Key areas which are often cited when a central bank explores a potential CDBC include resilience of payment systems, competition, innovation and financial inclusion, however, the optimal outcomes may not necessarily require a CDBC.
  2. The need to improve the resilience of the domestic payment system is one of the most common drivers and use cases for the development of CBDC around the world. However, the Australian national digital payments infrastructure, which is competition friendly and has helped to drive down the cost of business-to-customer transactions, is an example of how an end result can be achieved without the use of a CBDC.
  3. In relation to financial inclusion, it is important to examine why people are not being included in the financial system. In the G20 it may be because they are locked out of the system as a result of identification requirements they cannot meet. Arguably, digital challenger banks in the UK and EU are successful, not because they are blockchain based, but because, amongst other things, they enable more efficient customer onboarding and better customer experience.
  4.          The IMF[12] has also explored the concept of a synthetic CBDC, as an alternative to a CBDC with the private sector issuing digital coins and the central bank providing trust by requiring the coins be fully backed with central bank reserves and by supervising the coin issuers.

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

  1. One of the key challenges for a CBDC is how to provide socially acceptable levels of privacy to users (e.g. cash-like privacy) that protect individuals rights under data protection legislation while offering appropriate traceability of payments to enable intermediaries to monitor transactions in the CBDC to combat financial crime. This balance will need to be determined by each jurisdiction at an early stage as it will drive the choice of design e.g. account-based CBDC versus token-based CBDC or a hybrid[13]. Technology, such as distributed ledger technology (DLT) and blockchain, can offer both anonymity and traceability depending on the design chosen.
  2.          It is also important to consider how a CBDC would impact the audits of participants and users and the requirements to obtain independent audit evidence of ‘digital cash’ transactions. The Bank currently provides a controls report to users of CREST and Real Time Gross Settlement which allows users and their auditors to evaluate the controls in place and reflect on the requirements that places on their own control environments. With a CBDC, this type of report would form the basis of the confirmation of ‘digital cash’ balances, a key basis of any statutory audit. 

What effects might a CBDC have on the financial sector?

  1. CBDCs have the potential to significantly change the payment landscape. As CBDCs are a new form of currency, not a new form of payment, commercial banks would require an alternative payment rail, but their role - distributing cash, processing payments electronically, safe holding of deposits, and capital lending – would not change. However, the precise impact on commercial banks will depend on the design and architecture adopted, including whether a retail CBDC is interest bearing or solely used for payment. 
  2. The effects, positive and negative, may include, but not be limited to:

                   The impacts of disintermediation - as noted above, one of the risks of a CBDC is disintermediation. To stem the outflows of customer funds, commercial banks might feel compelled to raise interest on deposits to encourage customers to only use a CBDC for transactions. However, if commercial banks were to find themselves competing with a central bank for deposits, this could lead to an increasingly unstable funding base – without which banks might be forced to deleverage by scaling down loan portfolios, thereby threatening net interest margins. Alternatively, or in addition, commercial banks may need to access more expensive (and volatile) wholesale funding. Such moves would raise their cost of funding, while lowering the volume of loans and increasing credit cost for businesses and individuals. A CBDCs could, however, be designed to ensure its demand vis-à-vis that for bank deposits remains manageable. Such risks could be mitigated in part by a CBDC that does not bear interest, or by limits on holdings to avoid non-transactional cash being stored in the CBDC.

                   Payments sector disruptions - a CBDC that is fast, efficient, widely available, and free to use could undermine business models for existing payments providers which charge network fees for facilitating payments. The business models of credit and debit card providers could also be impacted by the changes, such as large segments of unbanked populations in emerging economies transitioning from cash to smartphone payments and retailers providing online sources of buy-now-pay later consumer credit.

                     Smart contracts – related developments could include smart contracts which allow for end-to-end settlement without intervention, reducing both the need for reconciliations, financial market infrastructure and credit/settlement risk, though they may come with their own cyber risk implications.

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

  1. In an intermediated CBDC model, the private sector would be able to innovate in relation to the payment interface and fintech and we are already seeing this thinking in our conversations with the market. However, there is a possibility that CBDCs could accelerate the takeover of fintech firms by commercial banks that are seeking to accelerate their ability to offer innovative solutions and as any new regulatory requirements for CBDCs bite on fintech firms currently providing services in relation to unregulated cryptocurrencies.
  2. There is also a risk that, to replicate private money, innovation might lead to commercial banks issuing their own regulated stablecoins off the back of their CBDC holdings. However, this could provide a mechanism for central banks to spread the systemic risk arising from cyber as well as assist with the transmission of monetary policy via the prudential requirements placed on the stablecoins issued. How far CDBCs and commercial bank-issued stablecoins might work together as an infrastructure would be an issue for regulators.
  3.          However, more financial institutions would have direct access to a central bank through an intermediated CBDC. This would enhance competition between larger banks (which currently have settlement accounts at the Bank) and smaller banks, competition for payment systems and spread risk in the financial system.


How might a CBDC affect monetary policy?

  1. A CBDC could provide real-time insights on the economy that would help central banks when forming monetary policy. However, while all CBDCs could have significant monetary policy[14] implications, the effects will depend on the design and architecture adopted.  Issues to consider include but are not limited to:

    Reducing the risks of cryptoassets a CBDC could, by satisfying a need for better payment technology, reduce the risks to an economy created by a widespread and rapid adaption of cryptoassets[15], which impact the ability of central banks to effectively implement monetary policy. A retail CBDC providing digital cash could also counteract dollarization from private sector stablecoin offerings.

    Transmission of interest rates – a CBDC, particularly if holdings are unlimited, could be used to enable to transmit positive and negative interest rates on retail monetary assets[16]. However, for a negative interest rate to be effective, cash would need to be withdrawn from circulation to avoid any incentive to hoard large denomination notes to avoid the charge.

    Possible consumer flight to the central bank’s balance sheet - if a CBDC could be used a store of value, there is a risk that customers would jump from commercial banks onto the security of a central bank’s balance sheet in times of stress, significantly weakening the balance sheets of commercial banks. This might, however, be mitigated by providing commercial bank with greater access to the Bank’s balance in times of stress or by limiting CBDC holdings.

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

  1.          An intermediated model could be similar to the current arrangements, as intermediaries would be responsible for the applications that run the payments layer, while the Bank would be responsible for the interface model, clearing and settlement, and the standards and requirements. However, the Bank would need to be at the forefront of technology to maintain the security of a CBDC as technology failure or cyber-attacks would give rise to country-wide systemic risk.

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

  1.          We support the engagement approach taken by HM Treasury and the Bank as it is important to agree the problem a CBDC would solve with relevant stakeholders and ensure there is clarity on the risks and benefits before an informed decision can be made.

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. If a CBDC could be held outside the jurisdiction in which it is issued, it might become a ‘safe haven’, for example, to avoid runs on, or the devaluation of, another currency, however, this could prompt dollarization or variations thereof. Furthermore, this could equally open the CBDC up to financial crime if used to hide or facilitate the transfer of funds from illegal activity. Also, by facilitating payments between jurisdictions that do not flow through existing payment systems, CBDCs could be used to circumvent economic sanctions (and financial crime-related) legislation.


26 October 2021

[1] https://www.atlanticcouncil.org/cbdctracker/

[2] https://www.bankofcanada.ca/2020/06/staff-analytical-note-2020-10/

[3] https://www.bis.org/publ/othp42.htm?motivation=1

[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.federalreserve.gov/econres/notes/feds-notes/preconditions-for-a-general-purpose-central-bank-digital-currency-20210224.htm?stream=business

[6] https://www.theclearinghouse.org/advocacy/articles/2021/07/072721_us_central_bank_digital_currency_whitepaper

[7] https://www.bis.org/publ/bppdf/bispap115.htm

[8] https://www.bis.org/publ/arpdf/ar2021e3.htm

[9] https://www.riksbank.se/en-gb/payments--cash/payments-in-sweden/payments-in-sweden-2019/the-payment-market-is-being-digitalised/cash-use-in-constant-decline/some-find-it-difficult-to-pay/

[10] https://knowledge.wharton.upenn.edu/article/going-cashless-can-learn-swedens-experience/

[11] https://www.fatf-gafi.org/media/fatf/documents/recommendations/Virtual-Assets-FATF-Report-G20-So-Called-Stablecoins.pdf

[12] https://blogs.imf.org/2019/12/12/central-bank-digital-currencies-4-questions-and-answers/

[13] https://blogs.lse.ac.uk/businessreview/2020/05/26/central-bank-digital-currency-the-devil-is-in-the-details/

[14] https://www.bankofcanada.ca/2020/02/staff-analytical-note-2020-4/

[15] Crypto Boom Poses New Challenges to Financial Stability’ - https://blogs.imf.org/2021/10/01/crypto-boom-poses-new-challenges-to-financial-stability/

[16] Seizing the opportunities from digital finance https://www.bankofengland.co.uk/-/media/boe/files/speech/2020/seizing-the-opportunities-from-digital-finance-speech-by-andy-haldane.pdf?la=en&hash=508F4972D17DE5A6DE3E0A1439A284BE904AC1C5