In a recent speech, Carolyn Wilkins, an external member of the Bank of England’s (BoE)’s Financial Policy Committee talked about the three main design principles for a Central Bank Digital Currency CBDC). It should stay focused on core public policy objectives. It should identify and mitigate financial stability risks. It should also set high standards for technology.
Over the past decade, central bank digital currency has evolved from being the topic of interesting research to actual pilots. Today there are over 100 central banks working on CBDCs, and CBDCs are being piloted or have been introduced in 29 jurisdictions. No central bank with a live CBDC or pilot is remunerating CBDC, and the latest Consultation Paper in the UK made it clear that remunerating a digital pound to make monetary policy more effective was not a motivation.
It is essential for central banks to stick to the core purpose of money in the design of a CBDC. Governments should consider carefully codifying this purpose in legislation, including restrictions to its design if they are required. This will build trust that mission creep will not appear down the road.
Introducing a CBDC in a system where banks have some market power in the deposits market may result in higher deposit rates, but not necessarily a contraction in bank lending. However, in a perfectly competitive banking system, disintermediation is unavoidable if the CBDC is too attractive. That is what makes remuneration such an important factor. A high enough interest rate on CBDC can lead to bank disintermediation, with this being much less of a concern in normal times if the CBDC is unremunerated. So again, it is encouraging that UK authorities have made it clear that the digital pound would be unremunerated.
There is a present and a stark reminder that old-fashioned deposits runs can still happen today. The recent experience with the run on SVB’s UK subsidiary, which experienced deposit withdrawals amounting to some 30% of deposits in one day, is a case in point. The concern is not that a CBDC would be the cause of a run; that is typically the result of some underlying problem with the bank itself or contagion from panicked depositors. Rather, the concern is how the run unfolds, and whether or not the CBDC and accompanying policies, including bank liquidity regulations, will be stabiliszng forces.
When it comes to dealing with runs, the place to start should not be to axe plans for a CBDC. It should be to make sure that sound regulation and supervision are in place to reduce the chance of a run. While UK banks have robust capital and liquidity positions, it is a good idea to learn lessons from recent events in the US banking system.
Where the rubber really hits the road in the design of a CBDC is in the choice of technology. Here the bar must be set high, particularly given the central role a retail CBDC would have in the financial system and the reputational implications for the central bank of any flaws.
For the Bank of England and many other central banks, the technological design phase is still very much a work in progress and will involve making policy decisions involving important tradeoffs. The Bank has said that this phase will take another couple of years, and only then will a decision be taken as to whether to build a CBDC.