Future Forum | Bank of England

Digital Cash

by
Simon Youel
Simon Youel | 3 months ago | in Money, Money, Money

The Bank of England should introduce a central bank digital currency. This could be achieved by opening up Bank of England reserve accounts to non-bank companies and individuals. Doing so would address some of the problems associated with the decline of cash, make the payments system more resilient and could promote competition and innovation in payments and current accounts.

What is a central bank digital currency?

A central bank digital currency refers to a universally accessible, 100% risk-free form of digital currency that operates 24 hours a day, 365 days a year. It is distinct from existing digital currencies in that it would be denominated in sterling, and represents a claim on the Bank of England. A central bank digital currency should be complementary to physical cash and not be a replacement for physical cash. It would exist as an risk-free alternative to commercial bank deposits, which are currently the only means of making digital payments in sterling.

How would it work?

The Bank of England already issues a digital currency, in the form of deposits held by commercial banks in accounts at the Bank of England. These are commonly known as central bank reserves. It can provide a digital currency simply by making these accounts available to non-bank companies and individuals. This can be achieved using existing technology and without the need for a Bitcoin-style distributed ledger payment system.

Digital currency accounts would be opened up via an “indirect access” approach, whereby the Bank of England would create and hold the currency, but the payments and customer services would be operated separately.

Under this model, the Bank of England would provide everybody with the option to hold electronic money in an account at the central bank. The Bank would perform certain core functions, such as receiving deposits and facilitating withdrawals and transfers between accounts. A standardised interface would allow external providers to offer payment services linked with the accounts, without the Bank having to be responsible for the direct relationship with the end customer.

These external providers would have responsibility for providing payment services, debit cards, account information, internet and mobile banking, and customer support. Any funds paid into the digital currency account would be electronically held in full at the Bank of England, so that each provider could repay all its customers the full balance of their account at all times.

The account providers would also allow customers to make payments via the normal payment networks, such as BACS or Faster Payments. This would enable people to spend the central bank digital currency in the same way that they can spend bank deposits. But unlike a bank, the account provider would be prohibited from lending or taking any risk with their customers’ funds.

The providers of digital currency accounts could be fintech firms, other technology companies or existing financial institutions. There is also a strong case for a public payments provider with a specific remit to provide services to people whose needs are not being met by the existing market. Access to payments is as important as access to water or electricity, and should be treated as such.

What would be the benefits?

A central bank digital currency can address some of the issues associated with the decline of cash. Although the disappearance of cash is not inevitable or desirable, its long term decline poses important challenges for the future of the payments system. Increasingly, the mediation of payments takes place via a handful of private actors. If consumers wish to make electronic payments, they are currently only able to do so using money stored directly or indirectly on the balance sheet of a commercial bank. Even non-bank payment providers such as credit unions store their funds on banks’ balance sheets, and use commercial banks to settle payments. A central bank digital currency would offer households access to a completely safe form of central bank money, and reduce the payments system’s reliance on a handful of private institutions.

In doing so, a central bank digital currency would make the payments system more resilient. As it stands, the technological failure or financial collapse of one of the major banks would mean that millions of people are unable to access their money, with catastrophic consequences for the wider economy. A central bank digital currency would provide a risk-free alternative to commercial bank deposits as a means of making electronic payments, and isolate the payments system from bank’s risky lending activities.

The issuance of a central bank digital currency would remove one of the key reasons for banks being regarded as “too big to fail”. Because bank deposits are the only means by which the general public can make electronic payments in sterling, it has become necessary to guarantee those deposits to preserve the integrity of the payments system. Deposits are guaranteed up to a certain amount via the Financial Services Compensation Scheme, and although this is ostensibly funded via a levy on financial institutions, in 2008, the scheme had to borrow billions from the Treasury in loans that may never be paid back. Furthermore, the potential cost of compensating depositors in institutions like RBS was one of the main reasons why the government regarded them as “too big to fail”. By effectively guaranteeing banks’ liabilities in the event that they cannot do so themselves, the government creates perverse incentives, and potentially encourages banks’ risk-taking. If the payments system were to operate using genuinely risk-free central bank money rather than bank deposits, this need for taxpayer-funded bailouts would be reduced.

The model of digital currency proposed could also encourage competition and innovation in the provision of payments and current accounts. Institutions wishing to provide current accounts are currently obliged to store their customers’ funds in accounts at larger banks, even when they take no risk with their customers’ money. In order to connect directly to the major UK payment systems, such as BACS, FasterPayments or CHAPS, an entity must have an account at the Bank of England. Currently, only a handful of big banks have those accounts, and although non-banks are eligible for settlement accounts, these are subject to certain key restrictions. Therefore, in order to process payments or offer current account services, other banks or financial institutions must enter into an “agency” arrangement with a larger bank. But these larger banks have no interest in encouraging competition, and their clients have complained of high costs and other constraints. By ensuring universal access to Bank of England accounts, new entrants into the payments market would be able to compete on a more level playing field with existing institutions.

Another potential benefit of issuing a central bank digital currency is that it would allow the Bank of England to recapture a portion of seigniorage. This is the profit or proceeds that come from being able to issue money. Since most electronic money currently exists in the form of bank deposits which have been created by commercial banks when they make loans, those banks benefit from seigniorage totalling £23bn each year. But if consumers chose to hold electronic money in a central bank digital currency instead, that money would accrue to the Bank of England, and be passed onto the Treasury.

Designed in the right way, a central bank digital currency could also improve financial inclusion. Many people who currently choose to manage their money in cash are excluded from, or have chosen not to use accounts at a commercial bank. This may be because they have had a previous bad experience with a bank, fear hidden fees and charges or associate banks with debt. A central bank digital currency would provide people with a way to save their money and make electronic payments without having to rely on a bank. Alongside a central bank digital currency, the introduction of a public payments provider should be introduced meet the needs of people who are currently excluded from making electronic payments. In addition, by making it easier for alternative providers to enter the payments market, it increases the likelihood that innovators will develop services which appeal to different demographics.

Would it make banks obsolete?

It is not proposed that digital currency accounts would accrue interest. Therefore, under normal circumstances, commercial banks would have no problem attracting customers by offering a rate of interest above that offered by the Bank of England. The negative effects on financial stability would therefore be negligible.

In times of financial unease, the search for safe assets would make holding digital currency a more attractive prospect, particularly as an alternative to deposits over and above those guaranteed by the Financial Services Compensation Scheme. But in such circumstances, the availability of a central bank digital currency would have the effect of isolating the wider economy from the effects of a potential bank failure, by ensuring that consumers have access to a safe form of money.

To mitigate against the effect of an “instantaneous bank run”, the central bank digital currency could mimic some of the characteristics of physical cash. For example, the Bank of England could place limits on the value of deposits that can be converted in any single day. Compared with bank runs where depositors withdraw their money in cash, this would allow the authorities to manage financial crises in a more orderly way, without queues outside bank branches, and without any knock-on effects to other transactions between central bank accounts.

 

Shelley (BoE Moderator) 3 months ago

Thank you for your post - this is very thought provoking and i would be interested in others views. Remember you can post questions to our Governors too!

Ian Collier 3 months ago

Whilst a CBDC has certain monetary policy benefits, it could also destroy the fabric of UK industry and commerce by negatively impacting on the ability of commercial banks to finance companies should they no longer receive deposits from their normal customers under the fractional banking system.

Simon Youel 3 months ago

Commercial banks' financing of companies could hardly be much worse than under the current system! Only a small fraction (around 10%) of bank lending goes to productive enterprise, while the vast majority (about 80%) goes towards bidding up the price of already existing assets.

Rather than relying on fractional reserve banking to finance industry, a better solution would be to set up national and regional investment banks, which a CBDC could help facilitate.

Andy Philpott 3 months ago

The Swedish Deputy Governor of the Riksbank Cecilia Skingsley, spoke in November 2016 to the Financial Times about issuing e-krona as a digital currency. She said
“It’s not an option for us not do anything. It’s not an option for the public sector to stay on the sidelines and see the private sector cut off access to central bank money for individuals”.
What does the Bank of England’s own Deputy Governor have to say now about a digital currency in the UK after Mark Carney has shied away from announcing this anytime soon?
When the Riksbank says that they have the tools to manage any outflow and financial stress and maintain stability, is it not the case that the Bank of England needs to step up and deliver a digital currency for the good of our economy?

Shelley (BoE Moderator) 3 months ago

Thank you for contributing to the discussion. Please continue to share your thoguhts and views across the Forum.

Simon Youel 3 months ago

Like clockwork, the head of the IMF has just come out in favour of such a proposal:

"The advantage is clear. Your payment would be immediate, safe, cheap and potentially semi-anonymous... And central banks would retain a sure footing in payments."

https://www.bbc.co.uk/news/business-46203869

Will the Bank of England be at the forefront in reaping the advantages of a central bank digital currency?

Shelley (BoE Moderator) 3 months ago

Thank you for sharing. Did you know you can post your questions to our Governors and they will try to answer them all. We have Sam Woods on Thursday and Jo Place on Monday. Please feel free to visit the question pages and post on there.

Sabrina Rochemont 3 months ago

The thought of a CBDC effectively sparing the public from further "too big to fail' commercial banks (such as 2008) by routing deposits to central banks really is pleasing... what a change in operating model though!

Colevcook 3 months ago

A most irritating website. A full page width banner keeps dropping down to exclude205 of the page and the list of SHARE sites blocks the line beginings of the bottom 50% of the screen.
But the content is good

Believing CBDC 2 months ago

Good post. But don't think opening reserve account for everyone is the best option. There will be a lot more works and risks for the BoE. There is better option with the "value based" CBDC, that works similar to cash. The Riksbank has published several reports on the e-krona, and has talked about the "value based" design.

https://www.riksbank.se/en-gb/press-and-publi...or-the-e-krona/

Sabrina Rochemont 2 months ago

This recent article may complement this debate, esp the commercial shake up, and adding the perspective of cross-border transactions.. http://www.theactuary.com/features/2018/12/take-the-reins/

Believing CBDC 2 months ago

Perhaps this paper lacks depth of knowledge with technology aspect particularly. Also, central bank electronic money with reserve accounts for commercial banks is not CBDC. Technology for value based model CBDC is not limited to the extremely inefficient Bitcoin class of blockchain or DLT. More advanced central banks that have done the proper hands-on research already know the DLT type model is infeasible. I doubt the Riksbank would still be considering the value based model if the option has to be the bitcoin type of cryptocurrency - that require mining. But true the details are not available now.

Operating model should not change much - for central banks or commercial banks - with value based model CBDC. Account based model for CBDC is another story. This link explains more:

https://bankofenglandfutureforum.co.uk/post/631147?forPhase=23041

Understandably the paper seems to evaluate the impact of CBDC to commercial banks with account based model CBDC. From commercial banks and financial incumbents' perspective, it highlights very well the fears toward CBDC, which are: "bank runs" and "bank runs" and "bank runs" - every other reason and fears are derived from bank runs.

Amy Buckingham 1 month ago

This idea has been advanced to the current phase

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