In January 2020 the European Central Bank (ECB) started to study the issuance of a Central Bank Digital Currency (CBDC), or the so-called digital euro.
The decrease in the use of cash was one of the reasons that led the ECB to consider the creation of a European CBDC. This is because the decline of cash would weaken the ECB’s key role in payments and make it challenging for it to ensure the complementary and convertibility of public and private money.
In an interview ECB president Christine Lagarde gave to French business magazine Challenges in 2020, she said that “the issuance of a European CBDC would ensure that the general public remains able to use central bank money even if the use of physical cash eventually declines”.
Payments are undergoing a disruptive transformation, as people are increasingly paying digitally instead of using cash. In that regard, a digital euro would be an electronic means of payment for retail payments (not as a form of investment) issued by the ECB.
According to an ECB report titled “ECB intensifies its work on a digital euro” published in October 2020, “a digital euro would preserve the public good that the euro provides to citizens: free access to a simple, universally accepted, risk-free and trusted means of payment”.
As such, a digital euro would not replace cash, but complement it, allowing central bank money (public money) to also be used in digital form.
However, the decrease in the use of cash was not the only reason that pushed the ECB to be interested in a European CBDC.
Other reasons include the combination of global technology firms – the so-called “BigTechs” – entering the global cross-border payments area, as well as the possibility of stablecoins being used by the BigTechs to offer innovative cross-border payment solutions.
In a speech titled “A digital euro for the digital era” by Fabio Panetta, member of the executive board of the ECB, in October 2020, he argued that the creation of a digital euro would help “shield us from the risk that a private or public digital means of payment issued and controlled from outside the euro area could largely displace existing domestic means of payment”.
Key objectives of the digital euro
Protecting against such a risk is one of the key objectives of the ECB creating a digital euro. There are others, as Lagarde and Panetta wrote in an ECB blog post (“Key objectives of the digital euro”) in July this year.
In July 2021 the governing council of the ECB decided to launch the digital euro investigation phase, which aims to address key issues regarding design and distribution and will run until October 2023. This phase will assess the possible impact of a digital euro on the market, identifying the design options to ensure privacy and avoiding risks for euro area citizens, intermediaries, and the economy.
In their analysis, they wrote that the digital euro “would protect the strategic autonomy of European payments and monetary sovereignty, providing a fall-back solution if geopolitical tensions intensify”.
They added: “A digital euro would also help to avoid market dominance, improve the efficiency of the payment system and foster innovation in the private sector. We could, for instance, allow intermediaries to offer innovative services based on the digital euro. This would make it easier to quickly roll out payment solutions across the entire euro area, and for smaller firms to offer more advanced services at competitive prices”.
According to the ECB, a digital euro must respond to the needs of its users: it should be widely accepted, easy to use, free of charge for customers, fast and secure. It should also benefit people who, so far, have limited access to digital payments and thereby support financial inclusion.
In addition, a digital euro must have the highest standards of privacy protection and let people be able to choose how much information they want to disclose.
The investigation phase
In July 2021 the governing council of the ECB decided to launch the digital euro investigation phase, which aims to address key issues regarding design and distribution and will run until October 2023.
This phase will assess the possible impact of a digital euro on the market, identifying the design options to ensure privacy and avoiding risks for euro area citizens, intermediaries, and the economy. It will also define a business model for supervised intermediaries within the digital euro ecosystem.
In September, the ECB published a report on the progress they were making on the investigation phase, and highlighted three key next steps for the eurosystem in this area.
First, there will be further exploration of a digital euro solution, in which transactions would be made online and would be validated by a third party, as well as a peer-to-peer validated solution for offline payments.
Second, there will be exploration of options that could allow a digital euro to replicate some cash-like features and enable greater privacy for low-value transactions (full anonymity is discarded by the ECB as it would raise concerns about the digital euro potentially being used for illicit purposes).
Third, there will be an examination of incorporating a limit on the holdings of individual users and remuneration-based tools in the design of a digital euro to curb its use as a form of investment.
Key considerations
Although we can agree with the need and the objectives of a digital euro, certain issues should be considered and investigated further.
First of all, there needs to be consideration of the risks to monetary policy transmission and financial stability that could be associated with the conversion of large parts of euro area bank deposits into the digital euro.
Another concern about financial stability is the role that financial intermediaries would play in distributing the digital euro.
Additionally, due to the nature of the digital euro, in times of financial stress, citizens could rapidly move significant amounts of bank deposits into a digital euro, with potentially adverse effects on financial stability and the role of the banking sector in the economy.
As Fabio Panetta pointed out in a speech (“The digital euro and the evolution of the financial system”) in June 2022: “Deposits represent the main source of funding for euro area banks today. If not well designed, a digital euro could lead to the substitution of an excessive amount of these deposits. Banks can respond to these outflows, managing the trade-off between funding cost and liquidity risk. The attractiveness of commercial bank deposits will also influence the degree of substitution”.
To avoid this risk, the ECB is considering different tools. These include imposing quantitative limits on individual holdings and discouraging the use of the digital euro as a form of investment, by disincentivising remuneration above a certain threshold, with larger holdings subject to less attractive rates.
A quantitative limit on individual holdings should be the option to ensure a digital euro is only used for transactional purposes. Fixed limits to individual holdings would reduce the risk of bank runs, disintermediation, and financial instability.
In this regard, a 1,000 digital euro limit to individual holdings would still fulfil the monthly payments needs of EU citizens, based on the average use of cash and the net salary differences that exist between European countries (cash withdrawals and payments by cards on PoS), according to ECB Payments and Settlement Systems Statistics (2019).
The analysis of these elements should be the main priority, as they need to be decided with sufficient time before the introduction of the digital euro. It is imperative that we know that the proposed tools would be sufficient to preserve financial stability and the transmission of monetary policy.
To read other articles by CaixaBank in this series, see below:
The battle for private banking’s next generation
Banking of the future – key considerations for success
Strengthening Europe’s banking sector through consolidation
Sustainable banking is coming of age