The facade of the Royal Exchange in the City of London
iStock

The Bank of England’s proposed “digital pound” could cut banks out of payment transactions, reduce deposits and raise funding costs, says Moody’s Investors Service in a new report.

Last week, the central bank issued a consultation paper on the proposed launch of an official digital currency that could be used for payments by both households and businesses.

Issuing a digital pound that’s interchangeable with traditional currency “would support monetary sovereignty and financial stability by allowing the central bank to promote greater use of risk-free public money,” the rating agency said.

However, the digital pound being proposed in the paper would also pose a threat to the traditional banks, it said.

“Under the consultation proposals, a digital pound would be a claim directly on the BoE, which would issue and record them on a core ledger of all digital pounds. Private companies would enable end-users to access digital pounds via pass-through wallets that would send transfer and payment instructions to the core ledger,” the report said.

This would allow for cutting out the banks as middlemen for payments and reduce bank deposits.

“Disintermediation will likely increase banks’ funding costs as they replace lost deposits with relatively expensive alternatives, consequently raising the cost of credit,” it said.

While the proposal indicated that the central bank will aim to minimize transition risks with the launch of a digital pound, Moody’s noted that the BoE also declared that it is not seeking to ‚Äúpreserve the status quo structure of the financial system or to protect any business model within the commercial banking sector from the impact of technological innovation and competition.”

Indeed, it’s expected that the digital pound could increase the speed and efficiency of payments.

Moody’s noted that, since digital payment providers would not hold the digital currency themselves, they would not represent any counterparty risk, or credit risk, to users. Therefore, they would likely be left to focus on innovation rather than meeting stringent regulatory standards.

“An interoperable paradigm would lead to more efficient payments in terms of speed and likely cost, giving [payment interface providers] the chance to earn revenue from merchants as well as through use of data. Effectively, technology, e- commerce and media companies would be able to integrate digital pound payments into their own systems,” Moody’s said.

The proposal is out for a four-month consultation period, with a final decision on whether to launch a digital pound to be made “once the design phase has completed within two to three years.”