Digital Pound Currency: Time for the UK banking sector to be involved in CBDCs?
In the last few years, there has been a global interest increase in CBDCs (Central Bank Digital Currencies) by Central banks, which are developing themselves as a new settlement service to support digital currencies on a real-time basis. As clearly described by the Atlantic Council website (Atlantic Council, 2021), “a Central Bank Digital Currency (CBDC) is the digital form of a country’s fiat currency (meaning a government-issued currency that is not backed by a commodity) that is also a claim on the central bank. Instead of printing money, the central bank issues electronic coins or an account backed by the full faith and credit of the government”. Around 46 Central banks around the world are already far ahead and have built their own CBDCs with China leading the way, while Sweden started its pilot phase in February 2020, which is due for completion in February 2021, and Japan initiated their proof of concept in August 2020. The European Union is already exploring a digital Euro currency, with the United States still running their decision-making phase. The United Kingdom has been one of the slowest countries to look into this area, but has recently started moving on it too.
The Bank of International Settlement Innovation Hub's priority is to initiate the proof of concept in 2021(BIS, 2021), as one of the 6 key topic themes between green finance, open finance and cyber security. For that reason, it has launched the Innovation Network with 63 members (central banks) expected to share knowledge and technology project ideas and controls to overcome any issues.
The Bank of England (BoE) is developing the new settlement service to support the Digital Pound Sterling as a top-up capability of existing electronic payments infrastructure, which serves around £1b in transactions on a daily basis. According to BoE plans, it is expected to be available in early phases from 2022 and will provide better interoperability and user functionality. We should also not forget how much support is offered to users and companies through Open Banking technology. The Digital Currency is expected to be based on DLT (Distributed Ledger Technology), a technology which can be found in blockchain cryptocurrencies. However, various concerns and issues are making financial analysts think about the potential risks associated with blockchain security and scalability issues sitting at the top of their list. Moreover, DLT technology includes private and permissioned networks but there are still privacy issues to consider with more parties accessing confidential data, as part of banking decentralisation.
On the other hand, a digital currency could benefit the UK and Central banks in various ways: it would inject liquidity into the UK economy and support Sterling denominated accounts in UK; it would make the current Electronic Payments Network more stable and enable better efficiency on cross-border payment systems (cheaper and faster) especially now in a post-Brexit period. Last but not least, the Bank of England would be able to regain control via CBDCs of private-issued money. From 2006 until 2018, according to financial data, cash usage in the UK has decreased about 40%, from 63% to 28%, while debit card payments saw a similar increase from 12% to 39% (BoE, 2020).
Apart from the Digital Currency, another innovation that central banks are looking to apply in the payments framework is called Stablecoin. Andrew Bailey, Governor of the Bank of England, explained in his speech to the Brookings Institution last year (Bailey, 2020) that crypto-assets such as bitcoin have been proven to be unsuitable for widespread payment use and stablecoins’ aim is to cover this gap. If stablecoin is used to transfer iconic money for buying goods or paying debts, then it becomes a payment mechanism. The stablecoins could apply to new technologies and change the traditional payment framework and more specifically, instead of transferring just money from one account to other, the customer will transfer real assets. As per Dr. Bailey, there are various benefits to providing stablecoins, such as payments friction reduction, increased speed of payment and lowering the cost with an expansion and integration to social media and retail technology. That’s the reason stablecoins should follow equivalent standards to current payment methods, so they can be taken seriously by commercial banks, provide value stability and be redeemed at par in fiat currencies.
Furthermore, a recent Clifford Chance report (Clifford Chance, 2020) briefly states that a stablecoin-based system could make a key difference when compared with the traditional banking account-based model in respect of two key elements : first, the ability to transfer millions of crypto coins easily and secondly, issues of security. Crypto assets are highly secure due to the private encryption keys held by its owners (like bank notes being kept under a mattress). From a customer perspective, the average user would utilise some form of wallet service and use this account for everyday banking. From a bank perspective as a service provider, they will see customers purchasing stablecoins instead of depositing money into a current or savings accounts and this could result in additional fees.
Overall, the most important aspect in relation to digital currencies is the regulatory framework and supervision of the new infrastructure. According to the survey provided by the Financial Stability Board (FSB, 2020), currently, there are no available regulatory regimes specific to crypto currencies even if the other existing regulatory controls would be applicable for risk management purposes. Some jurisdictions have suggested potential regulatory controls application, others are developing new legislations from scratch. A few of them have decided just to warn the public, regarding the risks without further actions and some others, have totally prohibited the concept. Most of the current AML (Anti-Money Laundering) and CFT (Counter Financing Terrorism) regulations are applicable to crypto currencies while other regulations such as customer and investor protection, issuance of currency and market integrity are applicable to just a few of them. Potential gaps in existing regulatory frameworks domestically, include incomplete FATF (Financial Action Task Force) standards, inability to supervise GSC (Global Sanction Compliance) arrangements, insufficient risk mitigation tools and inadequate completion policies to protect customers and businesses to join GSC arrangements. Further work will be required over the next few years, to establish a proper global environment where crypto-currencies will be assessed.
The Chartered Banker Institute will need to explore the new infrastructure and understand how to equip Future Bankers with the appropriate toolkits and knowledge to support a digital currency. In doing so, the Institute should stay focused on the potential ethical gaps and adjustments, which the new currency could bring to those working with it and provide the necessary guidelines and training to improve the ways of working for future bankers. A key focus would be to connect banking professionals worldwide to share the new concept and learn from the proof of concepts and trials.
Throughout, the Chartered Banker Institute will continue to play a very important role by providing and accrediting revised and enhanced training modules/courses, executive MBA programmes or Diplomas, training and certificates focusing on digital banking, customer experience, risk management, green finance and other key aspects of banking. I speak from personal experience, that being an Institute member gives you the opportunity to expand your network, share common practice, increase and improve your knowledge, apply professional ethics in such a way that the banking environment remains a sustainable and appropriate sector for professionals to work in. Being a member, you make a difference and are making a personal commitment and contribution in a highly competitive and responsible future banking environment.
Atlantic Council (2021), The rise of Central Bank digital currencies, https://www.atlanticcouncil.org/blogs/econographics/the-rise-of-central-bank-digital-currencies/
BIS (2021), BIS Innovation Hub sets out annual work programme and launches Innovation Network, https://www.bis.org/press/p210122.htm
BoE (2020), Central Bank Digital Currency: opportunities, challenges and design, https://www.bankofengland.co.uk/paper/2020/central-bank-digital-currency-opportunities-challenges-and-design-discussion-paper
Bailey, A. (2020). Reinventing the wheel (with more automation) – speech, Bank of England, https://www.bankofengland.co.uk/speech/2020/andrew-bailey-speech-on-the-future-of-cryptocurrencies-and-stablecoins
Chen, James (2021) - Fiat Money https://www.investopedia.com/terms/f/fiatmoney.asp
Clifford Change (2020), Central Bank Digital Currencies and Stablecoins – how might they work in practice?, Clifford Change, https://www.cliffordchance.com/briefings/2020/09/central-bank-digital-currencies-and-stablecoins--how-might-they-.html
FSB (2020), Regulation, Supervision and Oversight of “Global Stablecoin” Arrangements, Financial Stability Board, https://www.fsb.org/2020/10/regulation-supervision-and-oversight-of-global-stablecoin-arrangements/