Bank of England states central bank-issued digital currency will compete with commercial banks

Bank of England (BoE) Chief Cashier and Director for Notes, Victoria Cleland, recently gave a speech highlighting the Bank’s work on central bank-issued digital currency (CBDC). Clelands keynote presentation was given at the second international workshop for P2P Financial Systems in London on Sept. 8 and 9. The BoE co-sponsored the event with Bank of Canada, Deutsche Bundesbank, House of Finance, Federal Reserve Bank of St. Louis, and UCL Research Centre, bringing together scholars, regulators, and practitioners.

“We are undertaking more fundamental long-term research on the wide range of questions posed by the potential of a central bank-issued digital currency […] We need to understand the potential economic impact of extending access to central bank money.”
— – Cleland

Cleland was appointed in March 2014, and her signature appears on british banknotes. However, her role covers “far more than signing the banknotes,” the Chief Cashier explains. “I am responsible for meeting public demand for banknotes and maintaining confidence in the physical currency.”

In a September 2015 speech at the University of the West of England in Bristol, Cleland stated that “although my team is responsible for a much older payment method, we are not luddites, and we welcome the additional choice and convenience that consumers can now enjoy.”

Cleland confirmed the Bank’s research into the “potential breadth of access to CBDC” at the workshop last week. She described two extreme possibilities; limiting access to only financial institutions, or giving access to everybody. The latter would allow businesses and households to “hold balances in central bank money and to pay each other in real time with full and final settlement, in an electronic format.” Introducing a CBDC “could fundamentally change the structure of the financial system,” where everyone currently uses commercial banks or other financial institutions to make electronic payments.

“If a CBDC provided competition for commercial bank deposits, one outcome could be a reduction in deposit funding available to commercial banks, undermining their ability to provide credit to consumers.”
— – Cleland

This is not the first time a central bank has contemplated competing with commercial banks. In November 2015, the Bank of International Settlements (BIS) published a report on digital currencies asserting that blockchain or distributed ledger technology (DLT) “could present a hypothetical challenge to central banks.”

Increasing usage of the technology could reduce or even remove the functions of a central body. However, central banks have options to respond to the threat such as “using the technology itself to issue digital currencies,” the BIS wrote.“The question is whether such digital liabilities should be issued using new technology and be made more widely available than at present.” The BIS referenced the BoE and it’s ongoing research.

In March, the Bank’s Deputy Governor of Monetary Policy, Dr. Ben Broadbent, gave a speech at the London School of Economics asserting that there are two major implications of CBDC that compete with commercial banks.

“Shifting deposits away from commercial banks, and towards the central bank, would therefore make for a ‘narrower’ banking system – a ‘narrow’ bank being one whose assets are as liquid as its liabilities. In principle, it would also make for a safer one.”
— – Broadbent

Currently, retail deposits at commercial banks are backed mainly by illiquid assets that cannot be sold on the open market. If all accounts are closed at once, banks wouldn’t have the liquid resources to meet the demand. A central bank, on the other hand, “holds only liquid assets on its balance sheet,” Broadbent said, so they cannot run out of cash. However, he cautioned that “taking deposits away from banks could impair their ability to make the loans.”

In June, Bank of England Governor, Mark Carney, discussed the prospect of CBDC for the UK at the Lord Mayor’s Banquet for Bankers and Merchants of the City of London. “In my view, still some way off,” he said.

“A DL [distributed ledger] for everyone could open the possibility of creating a central bank digital currency. On some levels this is appealing. For example it would mean people have direct access to the ultimate risk-free asset. In its extreme form, it could fundamentally and perhaps abruptly re-shape banking.”
— – Carney

A BoE staff working paper on the macroeconomics of CBDC, published in July, suggests that it would be “economically equivalent to the establishment of an online-only, reserve-backed, narrow bank alongside the existing commercial banking system.” It would increase competition for deposit accounts and rapidly increase the adoption of innovative technologies and account offerings, the authors explained. CBDC could also have other advantages such as raising the country’s GDP by as much as 3%, according to one of the models discussed in the paper.

In a one-off inquiry into distributed ledger, or blockchain, technology at the House of Lords, also in July, a few industry experts participated including Dr. Catherine Mulligan, Research Fellow at Imperial College Centre for Cryptocurrency Research. “In terms of central bank crypto-backed fiat currency, it does have a potential impact on monetary policy,” she told the Lords, citing its potential to move money away from commercial banks towards a central bank. “It’s a matter of balance,” she said. “You got to think about that carefully to make sure the commercial banks don’t just collapse.”

At the same inquiry, Broadbent reiterates the prospect of CBDC substituting commercial bank money, but concurred with Carney that it’s “some way off.”

Any central banks issuing their own digital currencies would be directly competing with commercial banks, Senior Advisor to MIT’s Digital Currency Initiative, Michael Casey, explained during the “Bitcoin and the Digital Currency Revolution” panel at the DTCC Blockchain Symposium.“Why would you hand over money to a commercial bank with all the risk that entails without any of the benefits?” he asked. “You’re going to have people looking to store short-term custodial funds with a central bank.”

“The very idea that central banks will effectively be positioned in the competition with private banks, which I think is the endgame, is profound.”
— – Casey

The BoE is not the only central bank to consider issuing their own digital currency. Bank of Canada has also considered issuing its own digital currency. One of the objectives in the Bank’s Research Plan for 2016-18 was investigating whether the Bank should issue its own digital currency and what it would look like. In June, the Bank reportedly gave a private presentation in Calgary unveiling its project to develop an electronic version of the Canadian dollar using a token named CAD-Coin.

Digital currency is also in the works in China. In February, Zhou Xiaochuan, People’s Bank of China Governor, revealed that “Digital currency will co-exist with cash for quite a long time before it finally replaces cash." However, “with the transaction costs of paper money rising, people will be motivated to opt more for digital money,” he believes.

Dutch central bank, De Nederlandsche Bank (DNB), is also actively studying its own prototype cryptocurrency,‘DNBCoin.’ In June, the bank unveiled three models of the Coin.

According to an August World Economic Forum report, over 90 central banks are engaged in DLT discussions. The total DLT investments have exceeded US$ 1.4 billion over the past 3 years from over 24 countries.

While central banks are researching DLT as a way to issue digital currencies, “could, and should CBDC be delivered using DLT and is this technology the best way to achieve the necessary scalability and resilience?” Cleland concluded her speech. “We also need to understand the technology options.”