Chancellor Rishi Sunak recently announced several significant updates to enhance the UK’s competitive advantage in fintech, one of which pertains to exploration of a retail central bank digital currency (CBDC).

A CBDC is a central bank-issued digital money, denominated in the national unit of account, representing a liability of the central bank and would be available for use by households and businesses. The idea is generating significant interest from central banks across the globe, including the Bank of England (BoE) as Sunak revealed.

Sunak’s announcement outlined the launch of a new fintech taskforce “to coordinate exploratory work on a potential central bank digital currency” led by the UK Treasury and Bank of England. The Taskforce will:

• Coordinate exploration of the objectives, use cases, opportunities, and risks of a potential UK CBDC.
• Guide evaluation of the design features a CBDC must display to achieve our goals.
• Support a rigorous, coherent, and comprehensive assessment of the overall case for a UK CBDC.
• Monitor international CBDC developments to ensure the UK remains at the forefront of global innovation.

In addition, the BoE announced the creation of a CBDC Engagement Forum and a CBDC Technology Forum to engage stakeholders and gather strategic input around the challenges and opportunities the currency presents.

Despite marked progress being made in jurisdictions such as China, Sweden, Jamaica, and The Bahamas, until this announcement the BoE’s approach and status to developing a framework for CBDC exploration had been at an earlier stage. It had previously discussed the potential opportunities that CBDC might bring, for example in promoting more efficient domestic and cross-border payments, financial stability, and financial inclusion. This week’s announcements confirm that the Bank of England is becoming more ambitious in its CBDC exploration. 

Shiv Chowla, a senior manager in the BoE’s new CBDC Unit, said, “the announcement of a joint Taskforce with HMT and stakeholder groups is an important milestone in thinking through the case for a potential UK CBDC.”

The CBDC Unit was announced as part of the Bank’s update this week and is to be overseen by the deputy governor for financial stability, Jon Cunliffe.

As of January 2021, the Bank for International Settlements (BIS) reported that around 86% of central banks are engaged in CBDC activity. Activity is weighted toward central banks in larger jurisdictions, but also explains that there a stronger perceived need for CBDCs in emerging markets and developing economies (EMDE). This need correlates with their advanced timelines and perhaps explains why certain countries reached pilot testing or implementation phases quickly.

This provides somewhat of an explanation behind divergences in status between countries, and further, as the BIS survey notes, seven out of eight central banks in advanced stages of CBDC work are in EMDEs.

China’s central bank, the People’s Bank of China (PBoC), is forging ahead with their CBDC strategy, aiming to become the first major central bank to issue a CBDC and reported strong results from its pilot that ran April through August in 2020.

“To protect fiat currency from crypto assets and safeguard monetary sovereignty, it is necessary for the central banks to digitise bank notes through new technologies,” Fan Yifei, deputy governor of the PBoC told the Sibos audience in 2020.

Earlier this year, the central banks of China and the United Arab Emirates joined co-creation initiative Multiple CBDC Bridge, run in partnership with the BIS Innovation Hub, the Hong Kong Monetary Authority and the Bank of Thailand. Its aim: developing a proof-of-concept prototype to facilitate real-time cross-border foreign exchange payments on distributed ledger technology (DLT). In March 2021, China also proposed a new set of global rules for CBDC usage.

It is this pace that sparks questions around progress being made by certain G7 nations.

The G7 tortoise and the hare?

Published in December 2020, a paper by the Whitechapel Think Tank Future of Payments Working Group (WTT FPWG) states that political stakes in this dynamic are especially high at present, and that there is a need to reconcile the technical liberation from sovereign boundaries inherent in a digital currency, with their imperative to manage and control domestic money supply.

It observes that “China’s burgeoning economy threatens to over-shadow – and potentially soon eclipse – the world’s incumbent dominant economy. Historically, one reserve currency has ceded its status to another off the back of the rising wealth of the new reserve currency’s issuing nation.

“If China does indeed assume global economic dominance, precedent would suggest an ultimate transfer of reserve currency status from the US dollar to the renminbi. Such transfers have previously been accompanied by domestic and international political trauma and contention, which have often resulted in military conflict […] There is also scope for a first-mover advantage here; the country or countries that are earliest in issuing well-designed CBDCs will likely experience rapid uptake of those CBDCs both domestically and internationally.”

This is not a unique view by any means. The ECB’s International Policy Analysis Division issued a paper late last year in which an economist wrote: “CBDC increases asymmetries in the international monetary system by reducing monetary policy autonomy in foreign economies, but not domestically, suggests that introducing a CBDC sooner rather than later could give rise to a significant first-mover advantage.”

Geopolitical pressures

Jannah Patchay, director of Markets Evolution and co-author of the WTT FPWG paper also warns that the geopolitical impact of the CBDC as a new paradigm and currency should not be underestimated.

She explains that PBoC is going to great lengths to set up an interoperable payments infrastructure that can work with other digital currencies and traditional fiat, and if China “uses its influence with the Belt and Road initiative to start saying that all payments should be made by its new payments infrastructure, it would immediately impact monetary policy of quite a few other countries.”

Patchay believes that not only is there huge first or early mover advantage in the CBDC space, “a CBDC that is really well structured, that is interoperable with other CBDCs and with existing payment infrastructure, that is trusted, and that offers sufficient functionality, will see huge demand for adoption and to build it into different applications.”

As one would expect, recent comments by head of the Federal Reserve, Jerome Powell, seem to adopt a less dramatic tone. Suggesting that the US is in no hurry to issue its own CBDC, he told a Yahoo Finance webinar audience: “since we are the world’s reserve currency, we think we need to get [CBDC] issuance right. We don’t feel an urge or a need to be first.”

Asked if there is a risk that the UK is on the backfoot, Chowla, who leads the Bank of England’s internal thinking around CBDC, doesn’t feel that’s the case.

“We have a really close relationship with other central banks, particularly with the ECB and the Federal Reserve.” 

Under the auspices of the BIS, the BoE is part of a core group of central banks including the Bank of Canada, Riksbank, the Bank of Japan, the Swiss National Bank, ECB and the Fed, who are jointly exploring CBDC.

“Central banks recognise the need to explore this in a collective manner because the common set of questions around CBDC apply to all of us, but there is not a race here. Each central bank will have its own reasons to explore this and, ultimately, CBDC is a domestic decision for each of these countries.”

He doesn’t see a risk in the BoE somehow falling behind the curve, rather, given its collaboration with other central banks, he prefers to think that the Bank of England’s work will allow it to have an important role in the international debate. With this week’s invigorated strategy  for CBDC it appears that this outlook has been bolstered by framework.

Stablecoin: central banks’ wakeup call?

The narrative that CBDC is gaining traction as a reaction to private-sector stablecoin proposals, like Facebook’s Diem, is not adopted by the BIS, and Chowla concurs that there are multiple factors contributing to central banks’ acceleration of CBDC exploration that are not tied to concerns around who will control money issuance.

The BIS survey states that stablecoins are being analysed by most monetary authorities, with two thirds of central banks studying the impact of stablecoins on monetary and financial stability. Yet, it qualifies that despite the attention stablecoins are receiving, “concern about their emergence as an alternative payment method are not a widespread motivation for work on CBDC – only a handful of central banks included them in their rationales for possible CBDC issuance.”

Regarding the Bank of England’s interest in CBDC, Chowla comments that “there is a backdrop here where cash use for transactional purposes is declining - that's something that we take very seriously. There is also a wider context with proposals around privately issued forms of money like stablecoins. More generally, the economy is digitalising.”

In the context of the BoE’s mandate and remit around monetary and financial stability, Chowla explains that when new forms of innovation like CBDC emerge, the Bank has a role to play in exploring these issues robustly. 

“We don't come at this with any prior about what the right answer is. We need to take our time very carefully to explore this because it is a large and complicated issue.”

“We must consider how it relates to our remit, whether it at the very least does no harm to our ability to delivery monetary and financial stability, and ideally, enhance it. We need to think about how CBDC compares to what the private sector proposes to do, we need to think about issues like the degree to which access to central bank money matters. This really is a long-term, wide-ranging program of work.”

There is a complicated backdrop for payments in the UK at present, with sizeable resource committed to delivering the New Payments Architecture, the Real-Time Gross Settlement renewal program, Brexit management and of course Covid-19. The BoE is obligated to manage competing pressures and take every factor into account to come to a neutral, thorough analysis of whether CBDC is appropriate or not, in the context of its remit.

This question of CBDC issuance is still very much undecided, Chowla and the BoE announcement makes clear.

“There is no inevitability here. For some central banks, the answer will be affirmative, for others it won’t be. Clearly each individual central bank has its own set of considerations and timeline.”

Conversely, in its report, the WTT FPWG ultimate consensus is that “the global implementation of CBDCs is inevitable, particularly in light of recent developments around private global stablecoins,” further, “as private global stablecoins grow in use, their operators’ holding of underlying currency to back them has the potential to create exchange rate fluctuations.”

Cross-border payments remain alluring

Nations are view potential in the future of CBDC in diverse ways. Certain jurisdictions value a focus on financial inclusion, others on monetary control, but a core motivation that most central banks agree on, is that of cross-border payments and interoperability.

“One reason why central banks should try to be on broadly compatible timelines or at least work collaboratively, is about cross border payments […] For all of these individual countries exploring CBDC, we should do so in a manner that recognises that at some point in the future, were we to go ahead with CBDC, that they should be designed in a way that is highly interoperable so that they can, collectively, be a building block to better cross border payments. That's one reason for collaboration.”

“We also recognise the value both bilaterally and multilaterally from sharing information and collaborating to understand each other's experiences.”

Jim Ford, co-author of the WTT FPWG paper, refers to the Financial Stability Board’s (FSB) ‘Enhancing Cross-border Payments: Stage 3 Roadmap’ published in October 2020, which outlines a focus area which promotes exploration of the potential role new payments infrastructures and arrangements may bear in the cross-border payments sphere.

He explains that this report is the first step to seeing how an effective CBDC infrastructure could be designed. “It has to be designed for the future. The way to do this, is for central banks to work together on things like the harmonisation of standards - both message standards and technical interfaces – and harmonisation of regulatory and legal schemes in parallel with the development of CBDC.”

Naturally, this requires international cooperation and collaboration on a massive scale.

The first action in the FSB roadmap tied to the ‘Stocktaking and analysis of different CBDC’ designs is timetabled to conclude by July 2021, while the ‘Design study and dissemination’ where the IMF and World Bank are scheduled to provide technical assistance on how to facilitate cross-border use of CBDC is ambitiously timetabled to commence from July 2022 onwards.

In his closing remarks during a conference in March 2021, Fed chair Jerome Powell elaborated that the goal of the FSB roadmap is simple: “to create an ecosystem for cross-border payments that is faster, cheaper, more transparent, and more inclusive. A year into the process, I am encouraged that we are making meaningful progress.” 

He stated that the existing cross-border payment system while safe and dependable, suffers from frictions, including processes that make it difficult to comply with AML and CTF requirements, managing payments across time zones, bear a reliance on outdated technology and contribute to higher costs for cross-border transactions.

Ensuring CBDC promotes financial inclusion

As alluded to earlier, financial inclusion sits as a significant concern attached to CBDC issuance in certain jurisdictions – the UK being one of these.

Chowla makes a strong case for considering financial inclusion when exploring CBDC, noting that with cash use in already in decline, and “in a world where cash-use declines further, and the unbanked are unable to access online digital financial services, they can’t play their full role in the economy.”

This would be a clear concern “as we know that financial exclusion is associated with all other types of exclusion. The logic would be that CBDC could be designed to be very accessible to the general public in a way that perhaps other forms of private money might not.”

Specifically, a private sector issuer may not have the commercial cause or justification to make sure that their digital currency can be widely used by all aspects of society. Whereas, for a central bank this would be very important.

The BoE’s announcement cemented its focus on this concern, stating that “a CBDC would be a new form of money that would exist alongside cash and bank deposits, rather than replacing them; the Government recognises that cash remains important to millions of people across the UK, and has committed to legislating to protect access to cash.”

While not advocating for a digital ID solution to co-exist with a potential CBDC, Chowla acknowledges that exploring the idea of a digital ID makes sense.

“The model of CBDC we envisage is an ecosystem that includes private sector players, who would be intermediaries between the central bank and the end user. , To promote competition in that world you want people to be able to move between those intermediaries, without too much friction, cost or effort. It’s an open question but there may conceivably be a role for digital ID within that.”

In addition to financial inclusion – or perhaps even bolstering it - Patchay notes the potential CBDC also holds with regard to the promotion of fintech and finance sectors leveraging digital currency to better deliver government policy decisions.

We anticipate that the Bank of England will publish a Discussion Paper on digital currencies in the coming months.

Additionally, we look forward to further contributions from a UK CBDC initiative currently being founded by select members of the Future of Payments Working Group.