The Digital Pound: A Game Changer for the UK’s Commercial Banks and PSPs / News / Currency Research

The Digital Pound: A Game Changer for the UK’s Commercial Banks and PSPs

Posted on Jun 02, 2023 by Graeme Donald, former Head of Industry Development, Lloyds Banking Group, Currency Research Member of the Board

On 7 February, the Bank of England and HM Treasury announced the intention to consult on the introduction of a digital pound. My name is Graeme Donald, I'm retired now and spend my time with my family, on the golf course and travelling. Prior to that I led engagement with the UK payments industry and payment regulators for Lloyds Banking Group. I'm a banker of 40 plus years and have worked right across payments for the last 25 of those years. So why am I putting pen to paper now?

Having read the extensive Bank of England consultation — The Digital Pound: A New Form of Money for Households and Businesses — this points to an exciting if not challenging future for my successors who have taken up the mantle of working across the payments industry in the UK for the good of citizens and businesses. The introduction of a digital pound is one of those game changing moments you see once in a generation; had I been in my old job this would have been one of my top priorities and I'd have been all over the detail. For the UK this has the potential to be as big as the introduction of Bacs in 1968 and, in my view, potentially bigger than the advent of Faster Payments in 2008.

PSPs and Commercial Banks Must Engage

Immersing myself in the concept of a digital pound — looking at the practical aspects and how it will work for citizens and businesses — piqued my interest to write this piece. This is a nudge to payment services providers (PSPs) and commercial banks to deeply engage with the development of the digital pound now to make sure that the opportunity doesn't pass them by, and encouragement to work with the Bank of England and other stakeholders to ensure the digital pound hits the ground running and that it really works for citizens and businesses across the UK.

This is not to say that engagement and collaboration is not happening now, but this initiative has the potential to be huge in terms of both the size of opportunity for citizens and businesses and the impact on existing ways we make and receive payments in the UK. So the digital pound needs dedicated attention from those with knowledge and experience of the UK payments ecosystem.

The Bank of England's comprehensive document from early February tells us a lot about how the digital pound is shaping up and what it will look like for PSPs/commercial banks, citizens, businesses and other stakeholders across the UK. The document also leaves a number of key questions open that in turn provide an opportunity for PSPs/commercial banks to engage now to work with the Bank of England to shape the outcome around these key points. Many of the open questions may in turn become opportunities and challenges, and they are certainly often interlinked. Payments, and in particular the design of new ways to make payments (and let's face it, that's what a digital pound will be), need deep collaboration between stakeholders from the outset because one PSP’s outgoing payment will be another PSP’s inbound payment, with two customers reliant on that interaction working seamlessly.

UK Payments: Setting the Scene

Before getting into more detail on some of the key questions and points about the digital pound, I'd like to set the scene about the current UK payments landscape that a digital pound will bump into on its journey.

The UK has a sophisticated and diverse payments landscape. Its batch-based payments system, Bacs, is a real workhorse that allows millions of citizens and businesses to receive regular salary, wages, dividend and pension payments and pay utility bills and other repeat scheduled payments. Card payments, particularly debit cards, are well embedded across the population and businesses have seen a sharp rise in these payments being made via contactless means.

The UK has had an immediate payments system with ubiquitous reach, Faster Payments, operational since 2008. This allows citizens and businesses to make payments that reach the beneficiary in no more than 15 seconds, but very often in less time than it takes to refresh your browser. The UK RTGS, CHAPS, has operated successfully since 1984. It is currently being re-architected and just now does what you would expect a RTGS to do. The UK still has paper cheque clearing; this was digitised a few years back and now offers convenience and faster clearing for those citizens and businesses who still use cheques.

Last, but no means least, the UK still uses cash to make and receive payments. Cash is still easy to access and spend (although this is now becoming an area of focus for the Bank of England and other regulators), it is still preferred by some citizens and businesses and its importance for payments inclusion is well understood and recognised. The UK also has Open Banking that amongst other things has opened up the market and encouraged new actors into the ecosystem.

So what does this mean for a digital pound? Well, in short, it has big boots to fill and some tough acts to follow. The depth and sophistication of the UK payments ecosystem has also taught us all some key lessons over the years that will in turn translate into learning opportunities for the launch of a digital pound.

A Digital Pound for the UK

So what will a UK CBDC look like and what do we know so far from the Bank of England consultation? The model for the digital pound will be:

Based on a public-private partnership.
Used by households and businesses.
Public digital money issued by a central platform operated by the Bank of England.
Seamlessly exchangeable with other forms of money, including cash and bank deposits.
Wallets to hold digital pounds offered by the private sector.
Accessed by users through smartphones or cards.
Privacy protected like for cards and bank accounts, but not anonymous.
No interest paid.
The Bank of England and the Government would not see any personal data.
Limited amount per user, at least initially.
Accessible to UK and non-UK residents.
Used for everyday payments online and in store.

The Bank of England has confirmed that firms providing wallets would be regulated to ensure payments using digital pounds are resilient, reliable and compatible with other payments. HM Treasury and relevant regulatory authorities will consult on the details of the regulatory regime in the future. Standards for participating firms would be set in such a way that encourages a competitive and innovative ecosystem.

The Bank of England consultation document is extensive, and from this it is clear that the digital pound will have a profound impact on the UK’s current payments ecosystem. As mentioned earlier, the consultation poses a number of questions, many of which are interlinked. This in itself needs careful consideration and, on occasion, deep thinking to mitigate against unintended consequences.

Let's now take a look at some, but by no means all, of these questions in turn.

If a digital pound is going to compete with and complement cash and digital payments as a means of payment, there are a number of boxes that need to be ticked as part of its design and deployment:

Trust, acceptability and reach: A digital pound will need to be widely accepted and trusted as means of making payments. To be successful a high percentage of citizens and businesses need to be able and willing to accept a digital pound as payment (to establish reach) as well as a good penetration of citizens and businesses who are willing to hold digital pounds with a view to using them to make payments. This was one of the major challenges that the UK overcame when it launched Faster Payments, where the industry worked together to ensure 99%+ of sort codes were Faster Payments addressable and thereby establishing ubiquitous reach. How will this reach be achieved for digital pound payments?
Transmission: How will a digital pound payment be sent from the payer to the payee? Will it be as simple as the citizen or business who wants to send a payment using their CBDC wallet to generate a token that can be sent to the payee via a messaging application (email, text, WhatsApp or other social media messaging app)? This would certainly minimise infrastructure costs; however, what happens if the payee receives this token and doesn't have a CBDC wallet? In the UK, work has progressed at pace to protect payer and payees from different types of payments fraud with the introduction of services such as Confirmation of Payee and Money Mules. Great care will need to be taken to ensure the simplicity of making a digital pound payment doesn't become a feeding ground for fraudsters.
Protection for citizens and businesses: Will some form of consumer protection be put in place to underpin the use of the digital pound for payments? This has been a key component behind the success of debit and credit cards in the UK. Will the use of a digital pound for payments require authorised wallet providers to protect citizens and businesses from fraud? Will this be left to the market to determine, or will the Bank of England make sure this is set up from the outset?
Rules and an orderly market: Some form of rules framework and oversight are likely to be needed to underpin the launch of a digital pound. This framework and oversight will need to consider the authorisation of wallet providers, whether there is a need to mitigate liquidity risk, settlement risk and counterparty risk and to provide absolute clarity of the point of irrevocability and settlement finality after which no transaction can be unwound. Will this framework and oversight be light-touch or more akin to the oversight of the UK's payment systems and cash circulation? Much heavy lifting will be required to drive forward rules and standards.
AML and sanctions: It will be important for the Bank of England, working with other regulators and law enforcement bodies, to design systems and processes from the outset to mitigate sanctions and money laundering risks. Experience of existing UK payments systems are that retrofitting sanctions and AML screening is very time consuming and expensive; therefore, it will be preferable to tackle these requirements up front.
Impact on existing UK payment systems and cash: The economics of payment systems, including cash, used by UK citizens and businesses today are that the costs of operating the various infrastructures are largely fixed. Therefore any significant migration of transaction volumes away from these payment systems and cash to a digital pound will drive up unit costs for payers and payees, while at the same time introducing new costs for the implementation and operation of the digital pound. Joined up thinking is needed here to make sure that ways are found to reduce costs as volumes fall across existing payment systems and cash, while taking advantage of the potentially lower operating costs of a digital pound.
Types of payment journeys supported by the digital pound: The Bank of England has already indicated that it expects the digital pound to be used for “everyday payments online and in store.” Now is also the time for PSPs and commercial banks to engage with stakeholders to drive out the next level of these use cases. Will the digital pound wallets support overlay services such as Request to Pay and will the functionality of these wallets and any overlay services be left to the private sector to determine? The use cases supported by UK payment systems and cash today are broad and diverse and cover the following holistic use cases: push payments, pull payments, online transactions, face-to-face transactions, PoS transactions, attended transactions, unattended transactions, single payments, batch payments, repeat payments, future dated payments, etc.

As previously noted, these are a few of the big topics that will come up as the journey to a digital pound gathers pace. There will absolutely be others that come up on the journey and some, indeed, that I may have omitted from the outset.

Challenges Ahead for PSPs and Commercial Banks

So why do PSPs and commercial banks need to sit up and take notice of the digital pound and engage extensively and constructively in the dialogue that starts with the Bank of England consultation? And what are some of the key considerations they will face? We know that the digital pound will be used both as a means of storing value and for making payments and as such its introduction presents a number of strategic and practical challenges for PSPs and commercial banks:

Will a PSP/commercial bank become an issuer of digital pound wallets or, to put it another way, can the major PSPs/commercial banks in a market afford not to issue digital pound wallets?
What functionality will a PSP/commercial bank enable in its digital pound wallet? It is assumed that the wallet will have value storing capability, including any necessary reporting of value to the Bank of England. Will the commercial bank remunerate the value held in digital wallets, will this be permitted by the Bank of England and will it use this to drive digital pound holdings over traditional savings accounts?
Will PSPs/commercial banks provide the functionality to pay digital pounds into traditional payment accounts or convert digital pounds into cash at ATMs and branches? Will this be from digital pound wallets issued only by that commercial bank or from a wallet issued by any commercial bank in that market?
What sort of payments functionality will PSPs/commercial banks want to build into their wallets and be supported by the digital pound ecosystem? Some of this functionality will probably need the development of overlay services (e.g. Request to Pay).
How will PSPs/commercial banks organise themselves? The development of digital pound payments capability will require commercial banks to collaborate across a number of design features to ensure reach, and that digital pound payments flow seamlessly for citizens and businesses. This will require PSPs/commercial banks to commit significant resources to the development of digital pound payments.
Developing digital pound payments functionality will require a PSP/commercial bank to integrate its digital pound wallet with a number of downstream systems or develop completely new systems for its digital pound wallet: transaction gateway; digital pound ledger to mirror the value of digital pounds held on all digital pound wallets issued by that PSP/commercial bank; a ledger or similar system to store individual digital pound wallets; funds checking; fraud capability; sanctions screening; AML scanning; central reporting; etc.
How to realise the opportunity to reduce the potential for financial crime? If built around digital IDs, a digital pound could bring a new level of transparency to the financial system, potentially reducing financial crime. Of course, the flipside is also true — like any digital currency, a digital pound may present new opportunities for criminals.

Next Steps

The Bank of England has laid out an indicative digital pound roadmap with three phases. Phase 1 Research and Exploration ends with the consultation that closes on 30 June. Phase 2 Design is estimated to run from this year to 2025/26. Phase 3 Build will start in 2025 at the earliest.

It is crucial that PSPs/commercial banks engage in this roadmap. The consultation is one way that PSPs/commercial banks can start the process of engagement that will lead to collaboration in the areas that are always necessary for a payment to work seamlessly for citizens and businesses. However, this consultation and engagement is UK-centric and I do believe that there is a need and opportunity for stakeholders to engage more widely to learn from what's happening in other countries.

The digital pound and other central bank digital currencies cut right across current payment and cash ecosystems, as well as the commercial development of digital currency that has gathered pace over the last few years. PSPs and commercial banks need to enter this dialogue now to avoid getting left behind and to take the opportunity to help shape the future. Maintaining or widening access to payments needs to be one of the success criteria for the digital pound. Data will be key to providing transparency regarding the impact that the launch of a digital pound has on digital payments and cash and, in particular, to measure the impact of the transition over time.

Join the Debate

Currency Research provides a range of conference and networking opportunities that are right in the sweet spot for this dialogue and engagement through its premier events — The Central Bank Payments Conference, The Digital Currency Conference and The Currency Conference. Currency Research also hosts regional payments and cash seminars where this topic will also become increasingly prominent. In addition, Currency Research and Enryo are in the process of building a Universal Access to Payments (UA2P) Index that is ready-made to measure the impact of the transition to a digital pound and enable comparison and shared learning with other countries that have embarked on a similar journey.

I know Currency Research would love PSPs and commercial banks to join the debate. If you are interested, more information can be found on the Currency Research and UA2P websites.