Central bank digital currencies (CBDCs) are being considered by most central banks as a complement to physical cash. Only a handful of countries have taken the step to officially launch a CBDC, but their potential is being explored seriously by both small and large jurisdictions.
In the EU, the European Central Bank (ECB) has a project to evaluate the possible design and use-cases for a retail CBDC, colloquially known as the digital euro.
While no decision has been taken to launch the digital euro, steps are being taken to create the legal framework for it. On June 28, 2023, the European Commission published three separate proposals. Taken together, they aim to provide the ECB with the authority to issue the digital euro, recognise it as a form of payment, and preserve the utility of physical cash alongside it.
How would the digital euro change the current monetary and financial system?
Under the current monetary system, central bank money takes two forms: physical banknotes and coins; and electronic book entries. The latter is, generally, open only to commercial banks, reflecting balances held on account with central banks.
Typically, when depositors deposit money with a commercial bank, the bank takes the deposit onto its balance sheet and makes payments at the request of the depositor in commercial bank money. It uses the deposited money for its operating purposes and as a capital reserve to support loans also made in commercial bank money (i.e., under the model known as fractional reserve banking).
Central banks can increase the supply of commercial bank money by, for example, entering into repo transactions with commercial banks. This increases the amount of central bank money in the accounts of the commercial banks, which expands the capital base of the banks.
The result is that the lending capacity of the banks increases, in multiples of the reserves held by them. All of this takes place through accounting entries in the books and records of the banks, rather than in the form of physical cash.
When loans are made to bank clients, their accounts are credited with commercial bank money. The client acquires credit risk towards the bank holding its deposits, but the commercial bank manages its own risk position through holdings in central bank accounts.
The digital euro would transform this model. It is not expected that retail-level users would have holdings directly with the ECB or other central banks in the euro system (users would have no account or other contractual relationship with the ECB or national central banks).
Instead, they would have a digital euro account with their commercial bank (or another payment services provider — PSP), sitting alongside their regular euro-denominated accounts. The need for two sets of accounts is expected to keep separate the user’s holdings in central bank money and commercial bank money.
As claims on the central bank, the former would be insolvency-remote upon the failure of the commercial bank (or another PSP), and the depositor could expect to recover their holdings. Commercial banks (or other PSPs) would not be party to the direct liability held by digital euro users (but would act on their behalf), so their failure would only impact deposits in commercial bank money.
Because of the differences in credit risk exposure, there is a concern that the digital euro could drain regular euro deposits from the banking system in times of market stress. To manage this risk, the intention is that holdings of the digital euro would be subject to ceilings at a level that allows for regular personal transactions but does not destabilise commercial banks.
How will payment services providers be affected?
The vision for the digital euro is that it could be transferred both online and offline. Payment cards, mobile phones, and other electronic wallets in hardware or software form are anticipated, along with bank accounts. To support this, PSPs would be able to provide digital euro payment services without needing additional authorisations within the framework of the Payment Services Directive (which is expected to be replaced by a new regulation and directive in the PSD3 package).
The provision of digital euro services by PSPs would be limited, however, to natural or legal persons residing or established in: (i) a member state whose currency is the euro; (ii) a member state whose currency is not the euro, subject to an agreement entered into between the ECB and the national central bank of that member state; or (iii) a third country, if the EU and that third country conclude an international agreement and the ECB and the non-EU national central bank enter into an arrangement specifying the necessary implementing measures.
PSPs will be limited in their ability to charge fees for basic digital euro payments services, to avoid the digital euro becoming more expensive to use than other forms of money. Merchant service charges or inter-PSP fees will be regulated so that they do not exceed the lowest of the following amounts: (i) the relevant costs incurred by PSPs, including a reasonable margin of profit; or (ii) fees or charges requested for comparable means of payment.
To maintain the singleness of money in a payment services context, digital euros distributed by PSPs will have to be convertible at par with scriptural money and electronic money denominated in euros.
What are the next steps?
The proposed regulation is subject to the ordinary legislative procedure, which means that both the European Parliament and the Council must now consider, amend, and adopt it before it enters into force.
Once the regulation enters into force, all member states in the euro area will be required to monitor acceptance of and access to cash in their territory, to report the results of their assessment annually to the European Commission and the ECB, and to take remedial measures if necessary.
Francesco Assi is a senior associate, Etay Katz is a partner, Simon Helm is counsel, and Bradley Rice is a partner in law firm Ashurst.
