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Fanny Solano Agramonte examines the rationale behind a European Central Bank issued digital euro and how it could be implemented to maximise public good and avoid negative effects on financial stability.

Fanny 2021

Fanny Solano Agramonte, head of digital and retail regulation, CaixaBank

January 2020 the European Central Bank (ECB) started to study the issuance of a Central Bank Digital Currency (CBDC), a digital euro (D€).

The decrease in the use of cash was one of the reasons that led the ECB to consider the creation of a European CBDC, due to the fact that this decline would weaken the ECB key role in payments, and it would not be possible to ensure the complementary and convertibility of public and private money. In an interview in “Challenges” magazine (2020), the president of the European Central Bank, Christine Lagarde, pointed out that “the issuance of a 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 D€ would be an electronic means of payment for retail payments (not as a form of investment) issued by the ECB. According to the report “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”. Therefore, a D€ 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. 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 payment solutions across borders, were other reasons. As Fabio Panetta, Member of the Executive Board of the ECB, pointed out in his speech “A digital euro for the digital era” in October 2020, “(…) It would also 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 D€

As stated by Christine Lagarde and Fabio Panetta in the text “Key objectives of the digital euro”, posted on the ECB Blog in July 2022, the digital euro “would protect the strategic autonomy of European payments and monetary sovereignty, providing a fall-back solution if geopolitical tensions intensify”. “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 D€ 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 D€ 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 D€ investigation phase, which aims to address key issues regarding design and distribution, and will last until October 2023. This phase will assess the possible impact of a D€ 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 D€ ecosystem.

In September 2022, the ECB published a report on the “progress on the investigation phase of a digital euro.” Regarding the next steps, the report stated that the Eurosystem: (i) will further explore a D€ 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; (ii) will explore options that could allow a D€ 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 D€ potentially being used for illicit purposes); and (iii) will consider the incorporation of 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 D€, certain issues should be considered and investigated further.

First of all, 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 D€. Another concern about financial stability is the role that financial intermediaries would play in distributing the D€. Additionally, due to the nature of the D€, in times of financial stress, citizens could rapidly move significant amounts of bank deposits into a D€, with potentially adverse effects on financial stability and the role of the banking sector in the economy.

As Fabio Panetta pointed out in his 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: imposing quantitative limits on individual holdings, and discouraging the use of the D€ 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 D€ 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 D€ 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 D€. We need to know if the proposed tools would be sufficient to preserve financial stability and the transmission of monetary policy.

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