Out-Law Analysis 5 min. read

Digital pound may be a not too distant reality in the UK

A recent report by the House of Commons Treasury Committee assesses some of the benefits and risks of introducing a possible digital pound as a new electronic form of money for retail payments in the UK.

Although the committee concluded in its report that it is not yet clear if the benefits of a digital pound would outweigh the risks, it supports further exploratory design work so one could be launched provided the benefits of doing so increase and data privacy and financial stability risks are addressed. A digital pound would be a retail central bank digital currency (CBDC), akin to a digital banknote.

The report explores whether the digital pound is a ‘solution in search of a problem’. It comes nearly 10 months after HM Treasury and the Bank of England in February this year issued a consultation paper setting out their analysis on the potential use case for a UK CBDC and consulted on the key features of a potential model. That consultation closed in June.

The report discusses the potential benefits and risks of introducing a retail digital pound and the ‘platform model’ proposed by the Bank of England and HM Treasury to support its introduction, as well as some of the potential implications for consumers and businesses. It acknowledged that different considerations would apply to a wholesale CBDC.

The risks and benefits of a digital pound

The report highlighted some of the possible benefits of a digital pound including potentially fostering financial innovation, maintaining public access to central bank money in the face of decreasing physical cash usage, and avoiding some of the risks associated with new forms of private digital money. It notes that the US is not pursuing a CBDC “with any urgency”, and some respondents argued that similar benefits to a retail CBDC could be achieved through private sector initiatives instead of a government-led digital pound. As it happens, HM Treasury published proposals for regulating fiat-backed stablecoins in October and the Financial Conduct Authority is now seeking feedback to help shape its approach to regulating stablecoins as part of a publications package with Bank of England and the Prudential Regulation Authority.

The report also identified some risks and challenges associated with the introduction of a digital pound. These include financial stability risks; and considerations with respect to privacy, inclusion, competition and monetary policy.

In terms of financial stability, the report highlighted the potential risk of bank ‘disintermediation’ if account holders switch from deposits with banks into digital pounds, which could lead to a reduction in the availability of credit and an increase in systemic risk. Privacy considerations in the report mainly relate to concerns that the use of a digital pound could enable greater surveillance of individuals' financial transactions and about the protection, access to and use of users’ personal data.

Inclusion concerns focus on those who are not digitally literate or have limited or unreliable access to digital infrastructure, as they may be excluded from using a digital pound. The report also flagged the related concern that a digital pound could exacerbate financial exclusion by accelerating the “demise” of cash.

According to the report, the introduction of a digital pound could potentially reduce competition if it leads to the concentration of market power in the hands of a few large firms and could complicate the implementation of monetary policy and the transmission mechanism of interest rates.

Treasury Committee recommendations

In the report, the committee referred to the Bank of England and HM Treasury’s statement that they "judge that it is likely a digital pound will be needed in the future. It is too early to commit to build the infrastructure for one, but we are convinced that further preparatory work is justified".

The report recommends that the government and Bank of England set out in more detail the criteria they will use to inform the final decision on whether to launch a digital pound in the future. According to the report, the decision on whether to proceed will depend on a range of factors, including if the use of physical cash continues to fall, the emergence of new forms of privately issued digital money, and international developments in CBDC and private digital money. An important element in the launch decision will also be the cost of the necessary infrastructure for a digital pound.

Privacy elements are seen by the committee as a particularly important issue, and the report recommends that any primary legislation used to introduce a digital pound should not allow the government or Bank of England to use the data from a digital pound for any purposes beyond those already permitted for law enforcement. The report highlights the importance of transparency for digital pound users about how their data could be used and for them to have clear, usable opt-outs in relation to the collection and use of their personal data by user-facing firms managing digital pound wallets. The report highlights that such firms will need to be subject to robust conduct and prudential regulation and, because of the potential commercial value of customers’ data, be subject to “strong penalties” for misusing it.

To reduce risks of significant reductions in bank deposit balances from possible outflows into digital pounds, the committee suggested a lower initial digital pound holding limit for individuals than the £10,000 - £20,000 proposed by the Bank of England and HM Treasury, which could subsequently be increased. The design of the possible digital pound should be amenable to the possibility of interest payment the committee said, in tandem with its recommendation that the Bank of England and HM Treasury conduct further investigations into monetary policy implications of interest being paid.

If a digital pound were to be launched, to bolster financial inclusion the committee concluded it would be important to explore the possibility of offline payments to enhance access by users with limited or unreliable internet access, and for all UK adults to be granted at least basic digital pound services.

Next steps

According to the report, the Bank of England and HM Treasury have now moved into the ‘design phase’ of the possible digital pound, which is expected to run until 2025-26 during which they will invest further in the policy and technical development of the proposed model.

There will subsequently be a decision on whether to build a digital pound, the report said, dependant on the findings from the design phase, and on how the payments landscape evolves in the UK and abroad and. If a decision is taken to proceed with building a digital pound, it could be launched in the second half of the decade. The report referred to the House of Lords report into CBDCs published in 2022, which recommended parliamentary scrutiny should be “an essential part” of assessing the case for a CBDC. The report notes that government has now committed to introducing primary legislation before it launches a digital pound.

Some of the key challenges and risks with a potential digital pound that need to be addressed, as identified in the consultation in February, include: ensuring its interoperability and compatibility with existing payment systems; balancing privacy and data protection with financial crime prevention; managing the impact on bank lending and monetary policy transmission; and ensuring public trust and adoption.

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