Innovate Finance is the independent industry body that represents and advances the global FinTech community in the UK. Innovate Finance’s mission is to accelerate the UK's leading role in the financial services sector by directly supporting the next generation of technology-led innovators.
The UK FinTech sector encompasses businesses from seed-stage start-ups to global financial institutions, illustrating the change that is occurring across the financial services industry. Since its inception in the era following the Global Financial Crisis of 2008, FinTech has been synonymous with delivering transparency, innovation and inclusivity to financial services. As well as creating new businesses and new jobs, it has fundamentally changed the way in which consumers and businesses are able to access finance.
Introduction
As highlighted in the Kalifa Review of UK FinTech, the introduction of a Central Bank Digital Currency (CBDC) would be a significant development which could help support the adoption of new technologies (e.g. blockchain) in financial services and deliver huge efficiencies in the payments system. Innovate Finance supports the work of the Bank of England in exploring the potential of CBDC and other forms of digital money, such as stablecoins.
Our regulatory bodies are global leaders in developing new rules for innovative approaches, products and services. We have the conditions to build on digital money activity in the UK and develop a CBDC that commands the confidence of consumers and businesses. However, the UK must act quickly if it is to keep up with the pace of change, the growing customer interest, and developments in other markets. Already, six countries have developed a proof of concept and fourteen are running CBDC pilots. The UK is one of many more countries at an earlier research phase for CBDC.
Potential benefits
The Bank of International Settlement (BIS) has identified six broad areas or ‘motivations’ for the adoption of CBDCs:
- Payments safety: including enhanced cybersecurity and consumer protection.
- Financial inclusion: including solutions for the ‘unbanked’, with access to digital money for those without a bank account.
- Payment efficiency for domestic payments: with reduced costs and immediacy of payment. Whilst payments have been transformed in the last ten years, a CBDC (as well as stablecoin) has potential to reduce costs further.
- Payment efficiency across borders: again, a CBDC can reduce costs. This may depend upon frameworks for connecting different national CBDCs or potentially the acceptance of a CBDC in different countries (perhaps with a number of CBDCs emerging as global currencies).
- Monetary policy: an interest bearing CBDC (including negative interest) would provide an additional central bank tool for macroeconomic policy.
- Financial stability: the rapid development of digital money (including stablecoins) is inevitable and already significant. A CBDC provides the central bank with an additional tool for mitigating instability including ensuring a stable alternative to trans-national private stablecoins.
These categories apply to both retail and wholesale payments, providing benefits to individual consumers, retailers and corporate and Financial Institutions' transactions. A wholesale CBDC could open up the benefits of the Bank of England’s Real-Time Gross Settlement (RTGS) system to a wider group of players, enabling more financial providers and corporates to move money in real time between account holders, with final and risk-free settlement.
It is worth noting that an unlimited, direct retail CBDC (even where delivered via intermediaries), where the general public could call upon the central bank for unlimited amounts, is most unlikely to be feasible given its impact on stability, deposits and central bank resources (deposits would migrate to the central bank). A direct retail CBDC would need to have a value limit or cap. An alternative model to providing consumer benefits of CBDC may be one that combines wholesale CBDC with regulated stablecoin for consumers.
The systemic scale of a CBDC means that no one use case will in itself be the main motivation - rather it is the combined effect. Many use cases will emerge over time.
It is therefore important to have in place some principles and tram lines for the development of a CBDC which we briefly explore below. Please note that these are our initial observations and we expect these to evolve as debate and practical pilots around the world develop.
UK FinTech benefits
From a UK ecosystem perspective, the development of a UK CBDC will play an important role in maintaining and developing the UK as a leading global centre for financial innovation:
A global beacon
If the Bank of England and UK Government make a commitment to implement, pilot and launch a CBDC, this would send a powerful message internationally about the UK’s continuing role as a global hub for innovation. They have indicated that no decision to go ahead is likely before late 2022. The UK is seen as a leading global centre for FinTech. CBDC is a powerful sign to the rest of the world that the UK is committed to further developing and nurturing innovation and attracting innovators. The UK has the opportunity to be the leading G7 country in developing and introducing a CBDC.
A crucible for new CBDC service providers and intermediaries
A decision to go ahead with a UK CBDC would stimulate an industry of UK FinTech providers, to provide infrastructure for a CBDC and supporting or acting as service providers (a retail CBDC should be delivered through intermediary providers rather than direct to end users by the Bank of England). This will create an opportunity for the UK to build global capability and expertise which can be exported to other countries adopting a CBDC and to international financial institutions.
A new phase of payments innovation
Payments was an early area transformed by FinTech, leading to disintermediation and new services. The UK is a global leader in payments. This has continued with data and AI driven products, open finance, embedded finance and finance platforms. CBDC, together with stablecoin, has the potential to drive a new transformation of payment services. A UK CBDC would help maintain the UK at the forefront of this.
Principles for an innovation ecosystem
In order to support innovation in the UK and further develop the UK as a global centre for FinTech start ups and scale ups, any CBDC should be designed around the following principles:
Co-existence with a diverse and competitive stablecoin sector
CBDC should not crowd out private sector stablecoins (cryptoassets that aim to reduce volatility by pegging their value to government-sponsored – or ‘fiat’ – currencies). It should be looked at alongside regulation of stablecoin, to create a complementary financial system. The parallel Bank of England work on regulatory models for stablecoins is an important part of the jigsaw - which could enable public-private sector collaboration with central banks providing settlement finality to privately issued stablecoins and increase trust for consumers.
CBDC may indeed help manage some of the potential stablecoin risks of reduced deposits and funding for lending to the real economy by providing a digital tool for stimulating lending. A CBDC may also help to manage risks of potential concentration of stablecoin in time into a few monopolistic private currencies. It would also mitigate the risk of ‘walled garden’ ecosystems - overcoming current reluctance by private institutional stablecoin issuers to facilitate payments between each other. If regulated stablecoin is developed alongside wholesale CBDC, competition rules may be needed to ensure interoperability between stablecoin providers. Controls should also be put in place to ensure a CBCD does not in itself create a state monopoly that crowds out the private sector.
Competition and diversity of providers
For a retail CBDC, the implementation model should be designed to support the development of a diverse and competitive group of service providers (e.g. wallet providers). These service providers will be well placed to offer innovative products and services, for example combining CBDC payments with digital ID to create frictionless purchases. As with open banking, some form of independent oversight and/or a clear set of market competition rules for intermediaries may be needed to ensure fair access by a large range of providers and avoid a concentration of solutions by established financial institutions.
Design of the CBDC should ensure that service providers are not limited to existing commercial banks and other Financial Institutions. Wholesale CBDC should be accessible by a much wider group than the banks, building societies and other institutions who can currently access the Bank of England’s Real-Time Gross Settlement (RTGS) system. This should support greater competition and diversity in the provision of business banking and payments services.
Interoperability
CBDC design principles should include the issue of interoperability - with other CBDCs, and stablecoins; and possibly with other forms of decentralized finance. This should also allow for effective interaction with open banking. A critical decision for the UK is whether the UK CBDC can be used overseas; if so, interoperability (as well as wider stability issues) will need to be carefully addressed.
Credit for the real economy and FinTech SME lenders
CBDCs (particularly retail) could cause volatility in deposits and lead to long-term reduction in deposits, which could undermine the commercial viability of the banking sector. The Bank of England has identified the possibility that deposits migrate to new forms of digital money, leading lenders to rely on longer term debt funding. This could lead to more volatile interest rates for borrowers, especially small and medium sized enterprises (SMEs) and non-bank lenders may face higher costs for accessing wholesale capital compared to traditional banks. The Bank of England suggests that mitigation should include an open, digital platform for SME finance (extending open banking to SME finance). Innovate Finance analysis demonstrates that alternative lenders (FinTech based providers) are now the major providers of SME finance in the UK. CBDC (and stablecoin) therefore creates both risks and opportunities for maintaining and growing this diversity of finance for small firms. CBDC design will need to include or be accompanied by measures to support continued innovation in the SME market, including open banking.
Trust and financial crime
As noted above, a CBDC offers potential benefits in terms of payments and consumer safety. A critical element of design will be mitigation of financial crime and procedures for managing issues in the context of delivery by intermediaries. Responsibility for addressing fraud against consumers will need to be clearly drawn, between the Bank of England as issuer of CBDC and intermediaries as the consumer interface where fraud may occur. Equally, especially if a CBDC becomes a safe haven currency for overseas citizens, the KYC requirements for intermediaries will need to be considered.
Wider system change
CBDC is not being developed in isolation. We envisage open banking extending to other areas of finance, with widespread adoption of open finance and data sharing (perhaps based on a citizen’s right to data). Work is underway to develop a UK digital identity which could drive innovation, efficiency, financial inclusion and crime prevention in financial services. Interaction of these should be a part of the CBDC design - ensuring a future-proof approach and maximizing collective benefits.
Societal impact and engagement
A CBDC will be a part of a revolution in financial systems. The social implications need to be explored and positive, sustainable societal outcomes need to be baked in. As identified above, CBDC has the potential to create solutions for financial inclusion. Alongside enabling the positive outcomes, CBDC must be designed in a way that does not create or exacerbate financial exclusions; this not only includes access to cash but also distribution models and use of data and algorithms.
CBDC has the potential to be a powerful and positive tool for public services, including welfare. The ethical dimensions of this need to be properly discussed and explored, and safeguards put in place for areas of consensus. Without democratic guards, a CBDC could be abused, or be perceived as misused by Government.
This leads us to our final point. Innovation thrives when people have trust and confidence in it. Mistrust can occur if people have not been engaged or misunderstand an innovation. Widespread public debate, dialogue and education is critical for the adoption of a CBDC - and could perhaps include citizens assembly type approach and more interactive engagement and public involvement and information in envisioning what the future of money could look like.
This should also engage a wide variety of businesses, including small firms and retailers. Ways should be found to bring to life what a CBDC might look like. Discussion with businesses should be cross-organisational, to reflect the potential multi-faceted benefits and elements of a CBDC.
A wider debate on what a digital democracy model for finance looks like would help - how do we best develop a digital world that protects consumers and supports innovation, and avoids the risks of overbearing government or private monopoly and guards against cyber crime. This would help design a model that reflects our societal norms and expectations and a vision for the future of banking and finance. This could include the other features mentioned above - digital ID and open finance, as well as stablecoins.
This public engagement will be a major undertaking. It should start very soon as urgency is required if the UK is to develop a globally-leading position in this area.
