Digital currency proposal needs more legal clarity

On February 10, 2022, the Central Bank of Kenya (CBK) released a discussion paper on Central Bank Digital Currency (CBDC) inviting comments from the public on the potential use of the CBDC in Kenya. The public has until May 20, 2022, to share their representations with the CBK.

The CBK discussion paper was released a day after the IMF issued a discussion paper on the same topic of CDBDC. As the IMF discussion paper has interrogated the question of legal foundation, this piece will make some references to it.

This piece is drawn from the note prepared by the author to be shared with the CBK. Although the CBK does not commit itself to much in the discussion paper, there are some legal implications arising from the CBDC that are ripe for discussion.

The CBDC would be a digital equivalent of the Kenyan shilling that the CBK would issue to Kenyans. This would make it more comparable with e-money such as M-Pesa than cryptocurrency such as bitcoins.

The CBDC will be a digital currency that will be legal tender in the same manner as the banknotes and coins.

On page three of the discussion paper, the CBK notes that “the CBDC…. comes with……. unknowns on how it would impact central banks’ core functions of monetary policy, financial stability, and payment systems oversight.”

The functions are the CBK’s constitutional role under Article 231(2) of the Constitution of Kenya 2010 (Constitution). The CBK has to ensure that any step it takes concerning the CBDC does not make the CBK unable to perform its constitutional role as such steps would be unconstitutional.

The IMF discussion paper notes that the CBK’s primary role is national financial security through a cyber-resilient CBDC. It may be time to rethink the CBK’s charter and consider expanding it to cover planning, organising, and supervising of the CBDC which would have to be anchored in an appropriate legal foundation.

For example, will we see the CBK take up the option of establishing branches countrywide as provided in section 5(2) of the CBK Act? Can the CBK outsource some of the work? These questions will need legal answers.

The CBK has authority under the Constitution to issue currency. As to whether the CBK can issue the currency directly to individuals as proposed in the CBK discussion paper, Article 231(2) of the Constitution contains no restrictions.

However, the Constitution is set up to ensure checks and balances and separation of power. The principles of good governance, transparency and accountability in the Constitution could be raised to question the wisdom of allowing direct issuance of currency by the CBK.

As the IMF discussion paper notes, the CBK ought to identify envisioned legal reforms to entrench a proper legal foundation for the CBDC.

This is particularly because individuals would have to open accounts with the CBK which would result in collection of individuals’ data. Additionally, the CBK would take on the role of determining whether to charge transaction costs and handling cross-border payments.

Under the National Payment Systems Act 2011, the CBK is the regulator of Kenya’s National Payment System. If the CBK was to offer itself as a peoples’ bank, it would raise significant questions around the doctrine of separation of powers and checks and balances. Who will regulate the CBK?

At several parts, the CBK suggests that the CBDC would lower costs. This is in reference to among others lowering transaction costs, cost of printing money, and cost of cross-border payments. While cost reduction would be the target, the CBK ought to evaluate how litigation against the CBK would impact cost.

The CBK presents three options for how the issuance of currency would be structured. First is the direct issuance of currency by the CBK to individuals. The second and third options allow for CBK to use intermediaries to handle the issuance of currency to individuals.

The risk of litigation would arise regardless of how the CBDC is structured. Notably, the direct option may result in more litigation than the other alternatives.

What potential litigation would the CBK face? The Constitution contains numerous rights such as the right to privacy, the right to property, and access to information.

For example, if an individual discovers that their CBK bank account balance is low, who would they approach for resolution of the problem? The IMF discussion paper notes that there is need to identify the rights of holders and dealing with insolvency of any authorised issuers of the CBDC.

The CBK and its employees are protected from liability under Section 33M of the CBK Act. The protection extends to actions done in good faith and during the course of their official duties. It is unlikely that the protection would safeguard the CBK against all potential litigation.

Lastly, the CBK has not clearly indicated the role it envisions for other institutions. From the CBK discussion paper, it seems clear that the Communications Authority of Kenya and the Office of the Data Protection Commissioner may be involved.

This is with regards to the CBDC infrastructure and privacy aspects. There is need for clarity on how other institutions would participate.

The CBK and the IMF discussion papers agree that there is need for legal reflection rather than using a “law follows technology” approach on CBDC.

The public should take some time to make representations as the CBDC may have potentially far reaching implications. With sufficient input, it is possible the CBK may identify and address some of the issues to ensure the problems do not come back to haunt all of us.