The prospect of digital currencies becoming part of our everyday lives has been on the agenda for the last decade.
The closest they have come to impacting the mainstream financial system and economy in the West was the stablecoin Libra, later renamed Diem, proposed by Facebook in 2019. This attracted a significant backlash from regulators and concerns from the wider
public around data privacy.
The project was wound down in 2022 but interest in the concept remains. In February 2023, the Bank of England and HM Treasury published a consultation paper to seek feedback from the public on a set of design proposals for a digital pound. No final decision
has been made on the introduction of a digital pound, but there is a clear direction of travel.
Put simply, the idea is that individuals would be able to deposit funds digitally with the Bank of England, through a payment interface provider (PIP), in much the same way as they do currently with physical cash and banks. Crucially, though, this set-up
could operate without the involvement of a bank or financial institution at all, unlike more established initiatives such as Google Pay or Apple Pay that act as a digital layer ultimately tied to individuals’ bank accounts.
There are a number of potential benefits to such a set-up, not least the potential for tech firms and other PIPs to innovate and improve efficiency for consumers at lower costs. But for commercial banks, there are also risks.
Perhaps the biggest concern relates to the financial intermediation role of banks, and with that the financial system more generally. The model for many tech companies or social media platforms is to ensure a critical weight of people use it, in a winner-takes-all
manner.
Should a provider come to dominate, it could lead to significant amounts of money being moved out of retail deposits in commercial banks, from either current accounts or savings.
Banks would then find themselves having to replace these funds, which are traditionally the main source of other activities, such as lending. That could mean wholesale borrowing, which generally costs banks higher rates of interest. In turn, that would make
the cost of other services, such as mortgages or loans, more expensive, and banks less competitive, as well as harming the wider economy.
There are legitimate questions around regulation, and whether it’s fair to allow tech firms or other PIPs to provide payments if they’re not so heavily regulated.
However, there are even greater concerns over the risk of a dominant tech player that issues its own stablecoin that becomes widely used in the economy emerging, as was the original goal of Facebook.
A tech company in that position would have a lot of power, and could potentially use this to their advantage by charging higher fees for merchants or controlling which organisations can sell on a particular platform. A possible solution to this, hence one
of the main reasons for the consideration of launching a digital pound, is that the Bank of England itself offers an equivalent form of digital money that is widely interchangeable with bank deposits and stablecoins so that it may help prevent the threat of
such a 'walled garden' environment.
There’s also potential for more serious financial stability situations that could be triggered by a digital pound in the event of wider financial concerns. It’s possible that any digital currency would have relatively low levels of usage in normal circumstances.
However, if people become concerned about the health of a financial institution – as happened during the global financial crisis in 2008 or even more recently last year with the collapse of Silicon Valley Bank and Credit Suisse – it could see a surge of
money leaving commercial banks and heading to digital providers even more readily than deposits can currently flee from banks in our current digital age. That could potentially lead to a run on even more banks, and make those institutions more likely to fail,
even if they weren’t originally in trouble.
Another possible concern of stablecoins that the digital pound attempts to address relates to the sovereignty of the pound itself. Stablecoins denominated in pounds can vary from a one-to-one value from the pound, and the private providers of stablecoins
may make them difficult for people to convert back into a more conventional format.
Different valuations for stablecoins could also be used as a means of encouraging people to use a particular platform in the first place, which could then change over time. Which is why if a digital pound were to be issued, the Bank of England and HM Treasury
have affirmed that “£10 of a digital pound would always be worth the same as £10 in banknotes or coins”.
Further down the line, it’s possible that tech companies or PIPs could encroach further into the commercial banks’ traditional territory, such as lending. Tech firms by definition have significant technical capabilities and thrive on a culture of innovation.
Banks and financial institutions, meanwhile, still largely rely on old computer programming and legacy platforms, and find it hard to adapt to emerging trends.
Another issue is that in recent years the technical teams in banks have become more separated from the bankers, managers, and boards; so there’s less understanding of the role technology plays as part of the business. Technical people should be involved
at a senior and middle management level so there’s a better understanding between those in IT and the bankers.
There’s a degree of complacency that products such as savings, mortgages, and loans will be sufficient to ensure the survival of banks, but it’s essential that they can adapt to provide digital pound accounts to their customers while also increasing digital
payment efficiency and innovation for the standard deposit accounts for competing with new tech players.
There remains some doubt over how the digital pound will develop, and when, however. The European Central Bank is further ahead in its plans to launch a digital euro, and there is potential to see how things progress there, and to learn from any experiences.
There is also a question over the demand for a digital pound, and what the levels of usage would be if it was to arrive. My personal view is this will be needed and valuable someday, but it’s hard to say whether that will be in five or fifteen years’ time.
Banks and financial institutions need to be looking into it now, and make sure they’re ready when it does come. Those that fail to adapt may struggle to survive.
Authors from the Gillmore
Centre of Financial Technology at Warwick Business School have kicked off the Gillmore Centre Series, which explores new innovations in fintech from an academic perspective. Keep an eye out for more articles from the Gilmore Centre to learn more about
new developments in the field.