Are central banks a relic of the Industrial Revolution?

Are central banks artefacts of the Industrial Revolution, like canal networks or newspapers, or are they indispensable to the operation of the modern economy? To be honest, I tend to the more revolutionary perspective. National currency and central banks were of their time. We didn’t used to have them and we won’t have them in the future. (I’m writing a book about this at the moment.) But in the short term, should these relics of a bygone monetary era embrace digital cash? Here’s why I’m asking, as summarised nicely in the Deutsche Bank Research note on the “Instant Revolution of Payments”. They say:

When looking at the potential long-term effects of payment market evolution, a new question arises: which money will we pay with? Today, we mostly pay with commercial bank money… Given the wide range of potential instant payment services, bank deposits as the main form of money could lose importance if non-bank providers gain a dominant position in the retail payments market.

You can see the broad outline of the debate forming. Should central banks issue their own digital money? Should they allow commercial banks to continue to do it? Or should they sit back and let a thousand flowers bloom as Facebook, Amazon, Verifone and Apple issue digital money? They have to do something. After all, there is a steady decline in the use of physical cash. If the Bank of England does not replace physical cash with its own electronic equivalent then it is in effect supervising the slow motion privatisation of the nation’s currency.

Let’s examine a case for central banks to stay involved. The new Positive Money report on Digital Cash recommends that central banks should issue digital cash for six main reasons: it widens the range of options for monetary policy, it can make the financial system safer, it can encourage innovation in the payment system, it can recapture a portion of seigniorage, it can help to develop alternative finance businesses and it can improve financial inclusion.

(They use the term digital cash to refer to electronic central bank money, whereas I would prefer the term digital currency to distinguish the unit of account from other forms of digital cash.)

At the heart of the Positive Money argument is the idea that digital currency should be the province of specialist payment service providers rather than banks, because banks are primarily lenders and should be focused on that. How would banks compete with specialist providers? Until now banks have had an effective monopoly on payment services. Consequently, banks have had very little competition for the provision of basic payment accounts. In my opinion, it’s a business they might not want to be in at all, frankly, and they could focus on their core banking businesses instead, leaving payments to the specialist providers (that might, of course, include their own subsidiaries operating under Payment Institution licences).

What would the business model of the specialist providers be? Should digital currency be remunerated? Should these specialist providers be paid by the central bank? The Positive Money people feel strongly that it should not, which means that other players in the digital currency supply chain would need to find their own ways of raising revenue. I doubt this would ever come from fees so it would be more to do with the information around payments and flows, but that’s not really what I wanted to talk about here, which is the question of issuing the digital currency.

Why have these specialist providers at all? Why not just get the Bank of England to do it? The report notes digital that digital currency does not mean cryptocurrency or require the distributed ledger, there a plenty of existing technologies that could do the job. As I wrote recently, the Bank of England could provide accounts for all citizens, along with payment cards and Internet access and so on.

imagine something like M-PESA but run by the Bank of England. Everyone has an account and you can transfer money from one account to another by a mobile phone app (that uses the secure TEE in modern mobile phones) or by logging in with two factor authentication to any one of a number of service providers that use the Bank of England API to access the accounts or by phoning a voice recognition and authentication service.

From Britcoin or Brit-PESA? | Consult Hyperion

However the Bank of England, the Positive Money report says, is likely to see this as something of a burden. Personally I’m not sure about that line of thinking. I’m not sure it would be that much of a burden because if everyone had such an account, that you wouldn’t need payment cards or checks or giro payments or anything else, because all payments would be transferred between these accounts through transactions that would be initiated in most cases by a mobile app or through a call centre. The Positive Money guys prefer the idea of digital cash account providers, which would essentially be something like Electronic Money Institutions (ELMIs) are now but with a 100% reserve in central bank money.

(In the report they also talk about the concept of helicopter drops of digital cash to citizens via these accounts, as an alternative to “traditional” quantitive easing., but that’s a topic for another day.)

Anyway, on to a quick run through the key points. 

Why might central banks choose to issue digital currency?

The six main reasons that are presented in the report are:

  1. Overcoming the zero lower bound on interest rates. Enabling new instruments of monetary policy such as that helicopter money.
  2. Promoting innovation in payment system. I’ve written a couple of times before, both when looking at the options for central-bank digital cash and also when reflecting on our experiences with population scale schemes such as M-PESA in Kenya, that providing a good API on top of the system and allowing innovators to build new products and services on top is transformational and, to my mind, much more likely to lead to real innovation, making the payment system serve the wider economy more efficiently and more effectively.
  3. Increasing financial stability by providing a risk-free alternative to bank accounts. Increasing financial stability by reducing the concentration of liquidity risk and credit risk. Non-bank financial institutions, in particular, would benefit from being able to hold funds in central bank money rather than the form of uninsured bank account. The implications of having competing currencies might be uninteresting in usual times, just as the competition between cash and bank money is uninteresting in usual times, but it will be important to understand the implications in times of crisis to make sure that the system would not collapse. This is because the existence of digital cash might well exacerbate bank runs as people, for whatever reasons, retreat from other forms of liquidity to risk-free central bank money. The existence of risk-free digital currency in the UK could plausibly lead to an inflow of funds from foreign banks into sterling digital cash and that could push up exchange rates.
  4. Recapturing a portion of seigniorage. In the UK, the interest earned on physical currency peaked at £2.4 billion just before the financial crisis. I see this as a kind of stealth tax although although I suppose it might be fairly argued that it’s a pretty reasonable stealth tax as it falls largely on drug dealers and money-launderers. In the current year seigniorage will be in the region of only 500 million or so. Cash in circulation in the UK currently stands at around £67 billion (and it’s increasing about £15 million per month) of the total amount of cash in circulation at any one time around £10 billion is sitting in bank tills and in ATMs (in the UK about £15 billion is withdrawn from cash machines every month). This suggests that the other £42 billion is circulating hand-to-hand outside the banking system (in the Bank of England classifications this money is either being hoarded, stashed or exported). The banks cash flow to £10 billion can be taken as the best estimate for the population’s preference for cash over above immediate spending needs. All things considered I think that the seigniorage argument is not terribly persuasive one way or the other. It is plausible that the Bank of England might roughly double its seigniorage revenue if most people switch most of their spending from bank accounts to digital cash.
  5. Alternative finance. Separating the creation of money from bank loans might mean a reduction in lending which would have implications for the economy. There are implications for banks in the supply of credit but also implications for the potential for alternative finance to fill the gap.
  6. Increasing financial inclusion. I don’t want to get into the complexities of the relationship between financial and social inclusion, and the implications for other regulatory frameworks such as KYC and AML, but I see financial inclusion through ready access to low-value digital currency accounts as one of the main reasons for wanting to do it. Remember people who are trapped in a cash economy on the margins are the people who suffer most from its existence.

So What?

Well, I thought the report was very interesting  and thought provoking, so I am very happy to say that Ben Dyson from Positive Money will be giving a talk based on the report at this year’s 19th annual Consult Hyperion Tomorrow’s Transactions Forum in London on 20th-21st April 2016. Thanks to the amazing generosity of our sponsors, this year the tickets for the Forum are only £295 + VAT. Not a misprint: I really do mean the negligible sum of only two hundred and ninety five great British pounds Sterling.

As always, the Forum will be limited to 100 places, so book your place now!

Denmark shows us the mobile way

News arrives that our Scandinavian cousins are getting serious in the war on cash.

The Danish government has proposed getting rid of the obligation for selected retailers to accept payment in cash, moving the country closer to a “cashless” economy. Nearly a third of the Danish population uses MobilePay…

[From Denmark moves step closer to being a cashless country – Telegraph]

Actually half of the adult population of Denmark use MobilePay, the mobile-initiated account-to-account (mA2A) immediate payment services, the equivalent of Barclays’ PingIt, that is offered by Danske bank in Denmark. It was launched two years ago and has attracted more than two million users out of a population of 5.5 million which, when you look at the demographics, means that already has around two thirds of its total addressable market (i.e., Danish smartphone users aged 13 and up). Right now it is processing around 200,000 transactions per day with an average value of around €33.


The mobile phone provides a secure and convenient A2A initiator.

MobilePay has over 7000 merchants signed up and has an “small business acceptance” app in place so that merchants can accept electronic payments without a POS terminal. They charge merchants a flat 1% fee (with a maximum of five Danish Krone, or abut 50p) for payments and I’m told (by a very reliable source) that the fraud levels through this channel are significantly lower than they are on cards. They are now extending the app to provide a contactless NFC and Bluetooth option for point of sale. What interests me most about their roadmap is that they have a very good API and are now trialling it with some merchants because, as we all know, merchants want on their own apps to deliver the best customer service and the future is “app and pay”. I saw a very good example of this using a Copenhagen coffee shop app.

Direct A2A payments from inside merchant apps look set to grow.

In the UK, we have two mA2A mobile-centric front ends to the faster payments service (FPS). These are the aforementioned PingIt, offered by Barclays, and Paym, offered by everyone else. Paym has around two million people registered and transferred around £26m in 2014, We happen to be a Barclays-centric household, so I use PingIt all the time and find it very convenient. Therefore I was very excited that they decided to extend their addressing from mobile phone numbers to Twitter names!

Barclays has declared on 25 February that it will be the first British bank to allow people to pay each other and small business through their Twitter handles from 10 March.

[From Barclays uses Pingit to become first UK bank to process Twitter payments – Real Business]

If you want to try this out for yourself by supporting a good cause, by the way, then simply fire up the PingIt app on your mobile phone, select a modest amount for test purposes (say, £250) and send it to @dgwbirch. I will let you know as soon as your payments reaches the Dave Birch Holiday Home in the South of France Emergency Appeal Fund. Both PingIt and Paym are a long way from being used by half the adult population of the UK and edging cash out of the way for the person in the street but, back across the North Sea, Mobile Pay is playing a key role is edging Denmark closer to cashlessness.

The Danish government said as of next year, businesses such as clothing retailers, petrol stations and restaurants should no longer be legally-bound to accept cash. The proposal is part of a pre-election package of economic growth measures aimed at reducing costs and increasing productivity for businesses.

[From Denmark moves step closer to being a cashless country – Telegraph]

They are doing this because to try to get the total cost of the payment system in Denmark down to the lower levels that are seen in, for example, Finland and Norway.

if you include household costs, the total social cost of payments in Denmark is calculated at 0.55% of GDP, of which 0.35% is attributed to cash and 0.15% to the domestic PIN debit scheme.

[From I trashed my cash]

The context here is specific to Denmark. In common law countries (e.g., the UK and the USA) there is no requirement for retailers to accept any form of payment at all, cash included. It’s a misunderstand of what “legal tender” means to imagine that they do. But in Denmark, the law says that certain types of retailer must accept cash and so the law is being changed so that they don’t have to.

Copenhagen Parade

The Danes are very welcoming to visiting consultants.

I think it is really interesting to see this approach to national payment strategy – that is, one based on productivity and economic efficiency – in contrast to the UK’s where the mere idea of ending cheque clearing in a decade was enough to induce apoplexy in the shires and a shake up of the UK payments industry governance.

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