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28 November 2023

The digital euro: will policymakers choose team people or team banks?

The current proposal on the digital euro is a missed opportunity.
The digital euro: will policymakers choose team people or team banks?
By Vicky Van Eyck

As with all ambitious and novel political projects, the merits of the digital euro project has been the subject of much debate, controversy and confusion. Different stakeholders have sought to influence the project to protect their vested interests, with none being more successful than the banking sector.

The debate on the digital euro is often placed within the narrative pushed by the banking sector, which is that the introduction of the central bank digital currency (CBDC) will result in imminent financial instability. This has been to the detriment of a broader conversation about the merits of the digital euro in addressing an important societal need, namely, the need for public money in an increasingly digital age.

The issue has been further compounded by policymakers, such as the European Central Bank (ECB) and the European Commission (EC), who have weaved the arguments of the banking sector into their proposals on the digital euro to such an extent that the project no longer provides a solution to the problem it originally set out to address. This has in turn led to the digital euro being coined ‘a solution seeking a problem’.

The difference between public and private money

In order to understand the need for a digital euro, we need to understand the difference between private money and public money, and the merits of the latter. 

Private money is money created by the private banks, which is the money in our bank account. Public money is money created by the central banks, and the only form of public money that people have access to today is cash. Private bank deposits are a direct claim on the private bank, while cash is a direct claim on the central bank, which is a public institution, albeit politically independent from the government. 

The merits of public money: cash

The cash issued by central banks, such as the ECB, plays a crucial role in establishing trust. People trust that the moment that they want to withdraw money from their bank account, they can convert their bank deposits, which is private bank money, immediately into cash with an equivalent value, which is public money.

Cash is the most liquid, anonymous and risk-free asset that people have access to in an economy today. It is risk free because it’s a promise from the central bank to pay the owner of the money what the banknote states is its worth, and, as opposed to private banks, a central bank cannot go bankrupt. 

The decline of cash and the need for a digital equivalent

Today, cash accounts for less than 15% of money in circulation in the real economy in the Eurozone. This decline of cash has serious implications for our society. Without it, people will only be able to make payments through the private banking system. This reliance on banks to provide payment systems ultimately results in large numbers of people who are financially excluded. Today, 13% of Eurozone residents do not have or use a debit or credit card. Among the 40% of people with the lowest income, this number is estimated to be between 16% and 22%. (1) 

Without cash, people would no longer have access to the safest and most liquid asset in the economy today. They would instead have to rely on bank deposits, which are inherently risky, as we have seen during the numerous banking crises, including one just earlier this year.

Finally, without cash, people would lose access to an anonymous means of payment. It would mean even more transfer of personal data into the hands of the private banking sector.

Alongside the Regulation on the digital euro, the EC has also published a Regulation on the legal tender of cash, which is intended to ensure continued acceptance of cash, and to address the issues of access to cash resulting from the closures of ATMs and bank branches by the commercial banks.

However, faced with an increasing demand for digital payments, it is then clear, based on the merits of public money described above, that we need a cash equivalent fit for the digital age. 

Team people or team banks?

The digital euro is an opportunity to provide a universally accessible and safe electronic form of public money. This is precisely what the ECB initially set out to do. In 2020, it announced that it would start investigating the issuance of ‘a digital equivalent of euro banknotes’. However, the ECB quickly backtracked on this ambition and reduced it to simply offering a digital means of payment, and not digital public money. (2) 

This distinction is key. If the digital euro is simply a means of payment, then people cannot store or save it; they can only use it to carry out payment transactions. Money, on the other hand, can be stored, as well as used for payment transactions. (3) So why has the ECB and EC adopted this approach?

The key reason is that if people could store digital euros, then private banks would have to compete with the ECB to attract deposits by, for instance, offering more attractive interest rates on deposits. A little bit of competition sounds like a silver bullet solution to getting the private banks to finally start increasing the interest rate on people’s bank deposits. (4) However, the banks have taken the argument further. They cry wolf that there will be massive financial instability due to the sudden and large outflow of bank deposits towards the digital euro. This in turn, so the argument goes, would lead to bank disintermediation and threaten the socially important role that the banks play in extending credit to the economy.

These arguments, or rather, assumptions, of financial instability and bank disintermediation need to be taken with a pinch of salt. There are numerous studies, including from the Bank of International Settlements, that show that the risk of bank runs are unlikely and that CBDCs could in fact increase the resilience of the financial system. Other studies have shown that CBDCs could help mitigate the risk of runs because they would allow for real-time information on the flow of bank deposits into digital euros. This in turn, as Cyril Monnet and Ted Keister point out, would allow ‘policymakers to identify and resolve weak banks sooner, which also decreases depositors’ incentives to run’. Finally, studies, including from the Bank of Canada, show that even under extreme circumstances, banks would be able to cover large outflows of bank deposits to CBDCs. On the argument of bank disintermediation, Rohan Grey has rightly pointed out that banks do not need to have a monopoly over deposits and the payment systems to carry out their socially useful function of conducting credit analysis and collateral evaluation to extend credit to the economy. 

Unfortunately, EU policymakers have taken the narrative of the banking sector to heart. The ECB and EC have clearly chosen in favour of team banks, by weaving the arguments of the banking sector into their proposals for the design and use of the digital euro. In doing so, they have undermined the merits of the digital euro project. 

The digital euro is a missed opportunity but can still be remedied

To prevent the digital euro from competing with bank deposits, the ECB and EC have had to make the digital euro unattractive enough for people. The digital euro will therefore not be remunerated – it will not bear interest – and there will be a limit on the amount of digital euros that people can hold. The holding limit currently being proposed by the ECB is €3000; it’s worth mentioning that the banks initially pushed for €60. Moreover, the EC has made it clear that people that have existing non-digital bank accounts will only be able to access the digital euro through their banks. 

These limits have seriously watered down the ambition of the digital euro, even as a mere digital means of payment. Imagine a consumer who opens their online banking app and sees two seemingly very similar accounts, one where they can hold unlimited digital bank deposits that are remunerated, and the other where they can hold only €3000 unremunerated digital euros – why would they bother with the latter? They would not even be able to use the digital euros to pay for the security deposit on their new rental flat. 

The current proposal on the digital euro is a missed opportunity. However, it can still be remedied by the EU co-legislators. The European Parliament and European Council can still choose team people by ensuring that the digital euro has very similar benefits to public money (cash) today, that it is usable for people and that people can access it through non-profit/public intermediaries. 

 

(1) Estimate based on extrapolation of available data from The Global Findex Database 2021: https://www.worldbank.org/en/publication/globalfindex

(2) Already in its first progress report, the ECB started to refer to ‘an electronic means of payment for retail payments’ instead of a digital equivalent of euro banknotes: https://www.ecb.europa.eu/paym/digital_euro/investigation/governance/shared/files/ecb.degov220929.en.pdf

(3) As Sereina Grünewald explains in her report ‘A legal framework for the digital euro’, money has both a payment function, in that you can carry out payment transactions with it, and a storage function, in that you can decide to keep it without doing anything with it. 

(4) Despite banks currently earning billions in profit from the interest paid by the ECB bank on the reserves that they keep with the central bank, banks have barely lifted a finger on interest rates on the deposits of their clients.

 

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