REGULATION

How will the BoE's digital pound work? Will it impact commercial banks?

2023/2/13

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Summary:
1. The digital pound is an extension of cash
2. The digital pound will exist in mobile wallets or cards issued by commercial banks
3. The public will not need to open an account with the central bank
4. The central bank will limit the amount of digital pounds individuals can hold

The Bank of England (BoE) and the Treasury jointly released a consultation paper on the Digital Pound last week (2/7).

In a press release, BoE described the digital pound as a "new form of sterling," essentially a digital version of traditional banknotes for everyday transactions by households and businesses. The digital pound will coexist with cash and bank deposits, allowing the public to easily convert between the forms.

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However, this does not mean the digital pound is a foregone conclusion; the central bank emphasizes that this is preparatory work.

In recent years, cash transactions within the UK have sharply declined. In 2008, cash transactions accounted for 60% of total transactions, whereas now they only make up 5%.

The central bank stated, "It is sensible to plan early for the digital pound."

Digital Pound Is Not a Cryptocurrency

Previously, the name Britcoin circulating in the media was too similar to Bitcoin, leading some people to mistakenly believe that the digital pound is a type of cryptocurrency.

The central bank clarified that the digital pound is fundamentally different from cryptocurrencies like Bitcoin. Unlike Bitcoin, which has no intrinsic value, the concept of the digital pound is more akin to a stablecoin, backed by assets approved by the central bank.

Accessible via Mobile Phones and Cards

The Bank of England stated that the spending model for the digital pound is similar to financial cards, credit cards, and digital payments (such as Apple Pay). The digital pound can be stored in mobile wallets or in cards issued by private companies (commercial banks/tech firms).

Since the wallets are issued by private companies, these wallet service providers will establish accounts with the central bank to offer digital pound services to the public, eliminating the need for individuals to open accounts directly with the central bank. Additionally, wallet service providers must comply with KYC and anti-money laundering regulations and safeguard user data.

The central bank and the treasury are concerned about potential monopolization of the digital pound by a few companies. For instance, if Wallet A does not support platforms related to Wallet B, measures are being considered to prevent such occurrences.

Impact on Commercial Banks?

As widely known, one of the core businesses of banks is lending.

User cash deposits are one of the sources of reserves for banks, and the loss of deposits could impact their business. In response, the central bank stated in its report that banks can meet reserve or capital adequacy requirements by borrowing in the money markets to sustain their operations.

The costs of these borrowings may be passed on to consumers, or banks might reduce related services.

On the other hand, the central bank is also concerned that the digital pound might trigger a run on commercial banks during financial crises. This is because the digital pound is issued by the central bank and is considered a liability on its balance sheet. In theory, these digital pounds are equivalent to cash, so during crises, people may prefer holding cash rather than deposits in commercial banks.

While the consultation report mentions the potential for runs on banks, in the modern financial system, banks are supported by the central bank. In times of liquidity crises, the central bank can inject reserves into commercial banks through borrowing or asset purchases.

Individuals' Digital Pound Holdings Will Be Limited

Despite the central bank's efforts to avoid competition between the digital pound and commercial banks by setting various conditions and restrictions, including no interest on the digital pound, holding an excessive amount of digital pounds could still squeeze the survival space of commercial banks.

Therefore, the central bank may limit the amount of digital pounds individuals can hold. Bank of England Deputy Governor Jon Cunliffe mentioned that this limit should be between £10,000 and £20,000 (approximately $12,000 to $24,000).