This week, two big things happened in the CBDC arena. One of the world’s oldest central banks, the Bank of England, and the British government jointly confirmed that a digital pound would probably be necessary at some point in the none-too-distant future. While they were saying that, lengthy queues were forming at ATMs across Nigeria, the first largish economy to launch a central bank digital currency (CBDC), as most Nigerians struggle to access physical money following the government’s disastrous demonetisation campaign.
“A New and Trusted Way to Pay”?
Let’s begin with the UK, whose latest Chancellor of the Exchequer Jeremy Hunt this week described CBDCs as potentially “a new and trusted (state-backed) way to pay” that is likely to emerge some time this decade. John Cunliffe, Deputy Governor for Financial Stability of the Bank of England (not to be confused with the creator of the children’s books and animated TV series, Postman Pat) said:
Our assessment is that on current trends it is likely that a retail, general purpose digital central bank currency — a digital pound — will be needed in the UK.
With cash usage in rapid decline in the UK, a digital pound would perform the “anchor function” which cash currently carries, allowing the holder access to Bank of England money, Cunliffe said. It would also counter the risks posed by so-called “stable coins”, which are relatively new forms of cryptocurrency that are pegged to the value of a fiat currency (e.g, the dollar or the euro), while also ensuring that certain tech firms are not able to monopolize areas of the online market with their own coins.
These are all classic justifications for launching a CBDC. But not everyone in the UK’s political establishment agrees that they constitute sufficient cause. For example, the former governor of the Bank of England, Mervyn King said in January, 2022: “By far the most important question is what is the problem to which a CBDC is the solution?” King said a number had been proposed but “none of them were terribly convincing”.
Also, the House of Lords’ Economic Affairs Committee recently concluded that it is “yet to hear a convincing case” for why the UK needs a retail CBDC. On the contrary, while a CBDC “may provide some advantages”, it could present “significant challenges” for financial stability and the protection of privacy.
But the Bank of England and the UK Treasury respectfully beg to differ.
“A digital pound would be a very substantial financial infrastructure project that would take several years to complete,” Cunliffe said in a speech to UK Finance, a trade association representing over 300 firms in the UK’s banking and financial services sector. “It would, as many in this audience know, have major implications for the way we transact with each other and, more broadly, for the financial sector and the economy in general.”
An Extra Layer of Operations
One major implication is the impact it could have on the current banking system. As the UK-based economist Richard Werner and author of the critically acclaimed book, Princes of the Yen, has noted, if central banks were to offer retail CBDCs directly to individuals and businesses, meaning they would all be able to hold the equivalent of a current account at the central bank (as long as they have a smart phone and don’t engage in the wrong sorts of behavior), it would more or less mean the end of banking as we know it:
“All you would need is a shock or a crisis. All the money would move from the bank deposits to the central bank and the banking system shuts down.”
This would lead to the creation of what Werner calls “mono-banking,” in which just one lender, the central bank, is able to operate.
To avoid this outcome, the BoE is considering imposing a limit on the holdings of the new digital pound of £10,000 to £20,000 ($12,017 to $24,033) once it comes into existence. The digital pound would also not bear interest.
The last thing the world’s central banks want to do is wipe out large private banks, whose interests they tend to serve above all else. In fact, central banks are working hand-in-glove with many TBTF lenders to set up the CBDC infrastructure. Instead, what the BoE and many other central banks are talking about doing is creating an extra layer of operations within the financial system. And while the BoE (with help from the private sector) will create the currency, private banks will be the main public interface for that new layer, as Cunliffe himself posited in a panel discussion last June:
We will produce the asset and the rails but the interface with the public would actually be done by private-sector payment providers. It could be banks that will have the customer accounts payable to integrate money into their digital applications…
There are other models. One model is we allow the private sector to do the tokenization, to provide their own money that we back one-for-one with central bank money.
So, CBDCs will probably not be used to supplant the entire private banking system, as some feared. But what they could — and probably will — end up doing is put out of business small, local banks and credit unions, which will not be able to cope with the added layers of regulatory costs, burdens and complexities. In the US, the National Association of Federally-Insured Credit Unions (NAFCU) warned last year that the issuance of a digital dollar could erode financial stability, arguing that the costs and risks associated with introducing a CBDC are likely to outweigh the touted benefits.
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