On 7 February 2023, the Bank of England and HM Treasury jointly launched a consultation on the potential for a digital pound, a UK-based central bank digital currency (‘CBDC’). No decision has yet been made on whether to introduce a digital pound, but the Bank and HM Treasury have concluded from their work to date that it is likely that one will be needed in the future. They are therefore seeking feedback on the policy and technical work undertaken so far, with a view to proceeding to the next stage of the digital pound’s development: the design phase. If the government then decides to proceed with the project, the digital pound would be built and introduced in the second half of this decade.
It is important to note at the outset that the consultation seeks views on a ‘retail CBDC’, designed for payments by consumers and businesses. This contrasts with a ‘wholesale CBDC’, which would be used to settle high-value payments between financial institutions – although this is briefly discussed in the consultation, a wholesale CBDC is not the focus of the proposals.
How would a digital pound work?
A digital pound would be issued by the Bank and would serve as digital money for use by households and businesses for their everyday payments. The digital pound would function like a digital version of a physical banknote – like with cash, consumers would have a direct claim on the Bank (‘central bank money’). This contrasts with bank deposits, which are privately issued by commercial banks and consumers’ claim to their money is instead against the bank holding the deposit (‘commercial bank money’).
It is proposed that the digital pound would be delivered through a public-private partnership: the Bank would run the core infrastructure, whilst regulated private companies, referred to as ‘Payment Interface Providers’ (‘PIPs’) would provide users with wallets to hold and manage their digital pounds.
The digital pound would share features of both cash and bank deposits. Like physical banknotes it would have no interest paid on it and it would be readily interchangeable with cash or bank deposits. However, like bank deposits, PIPs (and in certain circumstances, law enforcement agencies and competent authorities) would have access to users’ personal data in relation to any transaction. It is intended that the digital pound would have at least the same level of privacy as a bank account and would allow users to make choices about data use.
Why is a digital pound necessary?
The Bank and HM Treasury argue that the creation of a digital pound is necessary for two main reasons. Both justifications are motivated by the decline in physical cash, which, according to UK Finance’s 2022 UK Payment Markets Summary, now accounts for just 15% of transactions, down from 55% in 2011. The first is to maintain access to central bank money, ensuring that it continues to anchor confidence and safety in the monetary system and underpins UK monetary and financial stability and sovereignty. The second is to support innovation, choice and efficiency in the domestic retail payments industry.
What are the risks of a digital pound and how will these be mitigated?
The paper also considers a number of risks which a digital pound could pose, which would need to be managed before it could be introduced more widely.
Impact on banks’ business models and cost and availability of credit
As households switch some of their bank deposits to digital pounds, commercial banks’ deposit bases would be reduced. Depending on the speed and scale of the loss of deposits, this could have implications for financial stability. Banks might then be forced to borrow more in comparatively expensive wholesale funding in order to maintain credit for customers. Banks could pass these higher costs on to consumers or they might reduce the quantity of credit available. This problem could be particularly acute in periods when the speed and size of outflows to the digital pound are less predictable – for example, during the transition phase to the digital pound or during moments of financial stress.
The Bank and HM Treasury therefore propose placing a limit of £10,000 to £20,000 for individual holdings of the digital pound, at least during its introductory period. According to the consultation, this would allow between 75% and 95% of income earners respectively to hold in digital pounds: i) their monthly salary, ii) any rolled-over balance from the previous month and, iii) an illustrative 10% bonus/overtime payment.
This arrangement seems like it could be technically complex to manage, a point which is acknowledged in the consultation: for example, the paper discusses the possibility of a mechanism to automatically sweep payments into a nominated bank account if they would otherwise take a user’s holdings of digital pounds above the limit.
Data privacy and protection
The Bank and HM Treasury acknowledge that addressing privacy concerns is critical to ensure trust and confidence in the digital pound. Consequently, they propose that the digital pound is at least as private as current forms of digital money, such as bank deposits. The need to prevent financial crime means that the digital pound would not be anonymous - PIPs would be required by law to hold users’ personal data in order to carry out KYC checks and comply with AML regulations. Although the Bank and the government would not ordinarily have access to this data, law enforcement agencies would be able to obtain access under limited circumstances – in the same way as they can in relation to other digital payment methods.
In addition, users would be able to make choices about how their data is used. This might allow for different levels of wallet functionality based on the level of identification a user is willing to provide, or personal data to be used by PIPs for commercial purposes if a user consents.
Digital and financial exclusion
The consultation is a potentially significant step forward on the UK’s journey to a CBDC. We have already considered the economic impacts of the decline in cash in our blog post on the Bank’s June 2021 discussion paper on digital money, but one point that deserves further discussion is whether the introduction of a digital pound will improve financial inclusion.
The Bank and HM Treasury are both mindful that any digital pound should be designed in a way which can provide for those who are digitally excluded to avoid driving further exclusion from innovative and valuable new financial services. Accordingly, one of the motivations set out in the paper for developing a digital pound is financial inclusion. The paper notes that the introduction of a digital pound could encourage the industry to tackle existing financial inclusion issues, for example, consideration of how to get payments to those who do not have a bank account.
However, changes on this scale can often result in slow and uneven adoption, and we question whether groups which are already considered financially and digitally excluded will feel empowered to use a digital pound. It seems more likely that the introduction of a digital pound will result in them facing even greater challenges. However, we welcome the attention on this area which has been on the Bank’s radar for some time, being a core design principle for a CBDC set out in its March 2020 discussion paper.