Central Bank Governor says Digital Currencies could displace traditional banking systems

The Governor of the Bank of England (BoE) and Chair of the Financial Stability Board and Monetary Policy Committee, Mark Carney, recently gave a speech about FinTech, financial inclusion, and BoE research into Central Bank Digital Currencies (CBDC).

“Looking ahead, it is possible that virtual currencies and FinTech-based providers, particularly where they gain direct membership to central bank payment systems, could begin to displace traditional bank-based payment services and systems.”
— – Mark Carney, BoE Governor

Carney gave his speech at the Deutsche Bundesbank G20 conference, “Digitising finance, financial inclusion and financial literacy,” in Wiesbaden, Germany. Carney outlined the Bank’s work and suggested new approaches to help grow the Fintech sector.

While noting FinTech’s potential in promoting financial inclusion, Carney said that “authorities have essential, supporting roles in reinforcing them and managing the associated risks to financial stability.”

The BoE is already expanding central bank access to Payments Service Providers (PSPs), that are not banks, which Carney first announced in June last year. There were over 1,000 non-bank PSPs as of June, but they currently have to rely on one of four agent banks for settlement.

The central bank governor said that as they grow, some PSPs will want to rely less on the very banks with whom they are competing, “re-selling services ultimately provided by banks limits these firms’ growth, potential to innovate, and competitive impact.”

Opening up the Central Bank system to PSPs will allow them to compete directly with banks. While some banks’ profitability may be hit, overall this “supports innovation, competition and financial stability,” Carney states.

The Central Bank Governor also discussed third-party payment service innovations offered by FinTech providers, indicating that the entire financial services value chain is being disrupted by companies that have not chosen to undertake banking activities. While the disruptions may be small today, it could change in the future.

Carney embraced the change in his speech, specifically mentioning how new service providers that offer diversification could be positive for the overall financial stability. “The existing tiered and highly concentrated system has created single point of failure risks,” Carney said.

Piling the pressure on traditional banks, Carney delved deeper into BoE research on the policy and technical issues posed by CBDCs. The Bank has been researching the possibility of issuing its own digital currency for over a year now. Not only has the Governor talked about it, but the Deputy Governor, Dr. Ben Broadbent, discussed it in his speech at the London School of Economics in March last year. The Bank subsequently published a Staff Working Paper, in July,  exploring various models of CBDCs that they can deploy.

“On some levels this is appealing; people would have direct access to the ultimate risk-free asset. In the extreme, however, it could fundamentally reshape banking including by sharply increasing liquidity risk for traditional banks.”
— – Carney

While the Bank of England may have been the first to publically discuss the use of a CBDC, the European Union has been looking into cash-like digital currencies for nearly as long. A speech given by Yves Mersch, a member of the Executive Board of the European Central Bank (ECB), discussed the details of a CBDC in January, that he referred to as Digital Base Money (DBM).

As with the BoE, Mersch said that the ECB is currently considering some type of CBDC, but unlike the BoE, he noted that currencies could come in one of two forms. Either they are centrally-controlled accounts like debit cards or Paypal accounts, or they could be anonymous, cash-like currencies, designed more like a cryptocurrency. The effects of the latter type would make the CBDC more like cash, which Mersch hinted would be far more accepted.

“As long as DBM mainly replaces cash, negative side effects of DBM might be unlikely. In this context, consideration could be given to making DBM as cash-like as possible, at least initially, until more experience is gained.”
— – Yves Mersch, Executive Board of the European Central Bank

The People’s Bank of China (PBoC) has also been exploring the use of a CBDC. At a January 2016 summit on digital currencies the PBoC Governor, Zhou Xiaochuan, said that “digital currency will co-exist with cash for quite a long time before it finally replaces cash.” Xiaochuan added that “the cost for cash transaction will gradually increase in the later stage […] With the transaction costs of paper money rising, people will be motivated to opt more for digital money.”

The Governor then explained that China’s central Bank is also looking at two different types of CBDC, as with the ECB, one is account-based, and the other is not. The non-account type could use a Blockchain and would be decentralized. "These two technologies can co-exist by being applied to different layers," the governor said at the summit, adding that a CBDC should be designed to protect privacy, which makes blockchain technology a good choice.

“Digital currency can be converted freely but its convertibility will also be controlled. We think, therefore, as a legal tender, digital currency must be issued by the central bank. The issuance, circulation and transaction of digital currency will follow the same management principles of traditional currency.”
— – Zhou Xiaochuan, People’s Bank of China Governor