As the world hurtles inexorably into a digital imprint of itself, a fast-emerging perceived wisdom is that digitalisation is always – purely in and of itself – a big step forward in all aspects of our daily lives. I steadfastly push back on such “wisdom” as the ‘digital = good’ mantra invariably masks how much thought has gone into whether it brings real and sustained improvements to end users at all times.
In the narrow confines of life around banking and finance, digitalisation is always thrust forward as an essential and vital step. Sure, seeking innovative applications and solutions has its place as businesses and consumers look for ways to improve access to and control over finances and providers seek ever-more efficient [read: cheaper and more profitable] delivery channels. But it’s certainly reasonable to question innovation for innovation’s sake as a digital arms race gathers pace with questionable thought about whether it does indeed bring sustained improvements with a clear-headed view of unintended consequences.
I was drawn to this perhaps rather ponderous place as I scanned the report from the British House of Commons Treasury Committee published on December 2nd, the latest in a “The digital pound: still a solution in search of a problem?” series. The report made a series of level-headed recommendations about the direction of travel regarding UK retail CBDC developments.
The provocative title needed little more to further the conclusion: “while there are some potential benefits to a digital pound, their extent is unclear and there are significant risks and challenges to be worked through, particularly in relation to privacy and financial stability. It is not clear to us at this stage whether the benefits are likely to outweigh these risks”.
This latest Commons Treasury Committee report follows an inquiry and report conducted by the House of Lords Economic Affairs Committee in 2021/2022, which similarly concluded: “We have yet to hear a convincing case for why the UK needs a retail CBDC … it could present significant challenges for financial stability and the protection of privacy”. That report referenced two incoming comments about a digital pound: “no obvious current market failure that warrants a retail CBDC”; and “an expensive and lengthy process with unclear benefits”.
Indeed, Andrew Bailey, Governor of the Bank of England Andrew Bailey, has previously said he was “not convinced about some of the problems that we might be trying to solve. I am not necessarily convinced that the retail payment systems need this sort of upgrade at the moment.”
Doesn’t this all point to a clear-cut case of ‘if it ain’t broke …’?
Notwithstanding the underwhelming evidence for a digital pound, the Bank and HM Treasury believe a digital pound will be needed in the future so will continue with their preparatory design work – although it is too early to commit to building the required infrastructure. The parliamentary report summarises the Bank and HM Treasury’s two primary motivations for a digital pound are:
1.) Sustaining access to UK central bank money ensuring its role as an anchor for confidence and safety in our monetary system; underpinning monetary and financial stability and sovereignty; and preventing risks to the uniformity of money in the UK (by replacing the role of physical cash in a highly digitalised economy);
2.) Promoting innovation, choice, and efficiency in domestic payments as our lifestyles and economy become more digital.
Other potential benefits highlighted – supporting innovation in domestic payments while guarding against some of the risks posed by new forms of private digital money; and supporting the UK’s international competitiveness in payments and related technologies – are much less convincing. On the down side, digital market innovation can result in concentration as a small number of firms establish dominant market positions, reducing competition by raising barriers to entry to new firms and potentially reducing innovation in the longer term, the Commons Committee report notes.
From the perspective of banks, a digital pound continues to throw out existential risks, where in a worst-case scenario (worst case for banks, that is) customers yank deposits out of banks and switch them to digital pounds under the aegis of the Bank of England in a new-fangled iteration of an old-fashioned bank run, a CBDC version of what sent Silicon Valley Bank to Boot Hill.
It's not just a case, in extremis, of leading to bank failures. Switching retail deposits into digital format could, the Commons report notes, increase the cost of bank loans. The Bank of England estimates (albeit with considerable uncertainty) that if 20% of retail deposits held in commercial banks switched to new forms of digital money, bank lending rates could rise by 20bp as banks replace deposits with more expensive wholesale funding. Other estimates put the increase as high as 80bp; bank lobby group UK Finance (with a soupçon of scaremongering?) reckons it could be even higher.
Concerns around financial stability can be assuaged if, as it widely expected, holdings of digital pounds are limited. The Commons report says “to reduce the risk of large-scale outflows from bank deposits into digital pounds, there could be merit in a more cautious approach of a lower initial limit on individual holdings than the £10,000-£20,000 limit proposed by the Bank of England and Treasury, with a view to increasing it over time”.
Paying interest on digital pounds is not part of the current design blueprint as they’re designed to be a means of payment not a savings product. But paying interest could have direct monetary policy benefits as it would relieve depositors of reliance on banks, which have shown themselves to be extremely unwilling to pass on rate rises. The report recommends further analysis on the monetary policy impact of paying interest on digital pounds.
Privacy and data protection concerns have long been and continue to be associated with CBDCs. This is certainly warranted in the UK, as the government is already seeking powers to view the bank accounts of people claiming social security benefits, ostensibly as a way to combat fraud. This has thrown up a series of privacy red flags. There remain grave concerns that digital pounds can give governments the power to control how we spend money. “The prospect of having one’s every transaction observed, stored and analysed in perpetuity is dystopian, and yet within reach”, the Electronic Money Association says.
The report recommends that any primary legislation to introduce a digital pound does not allow the Government or Bank of England to use the data derived from it for any purposes beyond those already permitted for law enforcement. Similar concerns are out there regarding the misuse of consumer data by the digital intermediaries that interface with the Bank of England’s core digital ledger and provide us with digital wallets.