Recent progress reports highlight the European Central Bank (ECB)’s commitment to a digital euro, a digital means of payment issued by the Frankfurt-based central bank and accessible to the general public.
The reports document design choices that raise doubts about the objectives of the ECB as well as the proposed means to achieve them. It seems entirely possible that the digital euro will be dead on arrival.
The ECB’s explicit and implicit objectives
The ECB’s progress reports state three main objectives for a digital euro:
- It should preserve European strategic autonomy in the payments sphere by offering an alternative to private initiatives and sovereign projects, such as China’s digital yuan.
- It should help increase competition and contest the dominating position of private payment service providers such as US credit card firms.
- It should serve as a robust monetary anchor that secures public trust in the monetary system even when cash — the traditional link between citizens and the central bank — continues to lose market share as a means of payment.
Attaining these objectives requires an attractive payment instrument and widespread adoption across Europe.
In line with G7 and G20 policy principles, the ECB also wants to make sure that the digital euro does not add further instability to the financial system. The ECB seems to have jumped to the conclusion that this entails ‘banking as usual’. Enter a fourth objective, which the ECB is much less explicit about: do no harm to banks and protect their current business model.
This fourth, implicit objective dominates all others. Key design options favoured by the Governing Council trim the digital euro’s attractiveness rather than increase it. They include holding limits for consumers (a few thousand euros), even lower ones for merchants (zero), and negative interest premia during periods of financial stress. Notwithstanding the goal of securing a robust monetary anchor, the ECB appears to view these features as permanent.
Hurdles for adoption
The ECB wants to outsource deployment of the digital euro to regulated financial intermediaries. This makes sense since the area of retail operations is not among the ECB’s core competences. But it also raises a serious conflict of interest.
Since a substantial share of bank profits originates from offering payment services, it is not clear why banks should have an interest in seeing the digital euro alive and well and compete for a share of their market. To align incentives, the ECB would have to tolerate that digital euro-related bank services such as onboarding or wallet management are as profitable as contemporaneous payment services.
There are more basic hurdles to overcome before the digital euro will be widely adopted. As a survey conducted by the ECB in 2022 showed, users prefer cash payments for privacy reasons and card payments for the convenience they offer (fast and secure). So, convenience and privacy are key for adoption, but along both dimensions the digital euro will likely be perceived as subpar.
The best available private sector solution for retail payments will certainly dominate the digital euro in terms of user convenience. And in terms of privacy vis-à-vis government as well as censorship resistance (can I be sure that the government lets me make payments to whoever I want), many citizens in Europe have limited faith in the ECB.
Those who trust in deposit insurance or do not worry about the difference between public and private money will hesitate to swap their payment instruments of choice with the new ECB one. Everybody else might appreciate that the digital euro will maintain its value under any circumstances, but given its likely low yield, they will probably only seek it during flight-to-safety episodes.
Other robust sources of demand are not evident either. B2B applications are not the focus of the digital euro project, and merchants with a holding limit of zero will barely be drivers of institutional change and will remain captive to private solutions.
Markets seem to doubt the digital euro’s potential, too. This is what a CEPR discussion paper from 2022 suggests. After digital euro news in October 2020, share prices of banks that rely more heavily on deposit funding reacted more negatively than those of banks that rely less on deposits, but this difference started to disappear when plans on holding limits and negative premia were made public. That is, markets appear to view the digital euro in its current mould as a peripheral issue for banks or even as totally irrelevant.
Private versus social benefits
This shows that a successful launch of the digital euro is far from guaranteed. A public relations campaign will not suffice to convince Europeans to use the digital currency. Broad adoption will require an attractive package of yield, convenience and privacy features. But rather than an aggressive marketing approach, the ECB pursues the opposite, because it is held back by its objective to protect banks’ business models.
This is problematic because the case for a digital euro could be quite compelling from a taxpayer and public policy perspective even if it is mixed or even weak from an individual user standpoint.
An effective digital euro could not only help attain the ECB’s first three objectives — European strategic autonomy, increased competition and robust monetary anchoring — but more generally it could help reduce the social costs of liquidity provision, substantially scale down too-big-to-fail problems and the associated bank regulation, and increase transparency about the costs and benefits of liquidity creation.
These potential gains are large and deserve careful scrutiny. Realising them might call for subsidies to foster adoption rather than deterrents and restrictions.
The threat for bank funding
We often hear that the potential gains of a digital euro, even if large, are dwarfed by the costs of the implied ‘disintermediation’ of banks, namely negative effects on credit and growth of the reallocation of funding from bank deposits to digital euros. The ECB’s hesitancy to fully embrace a digital euro could make a lot of sense if these risks loomed large.
We think that they are overemphasised: banks would know many years in advance that the digital euro was coming. They should and would make plans accordingly. The ECB could help by providing banks with a bridge funding facility to alleviate the costs during the transition phase. Yes, the digital euro may imply higher funding costs for banks, but if this were the case it would largely reflect that current deposit rates are low because of deposit insurance and too-big-to-fail policies.
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Eliminating that distortion could lower the dividends paid to banks’ shareholders and still make economic sense.
Historians, economists, commentators and (mostly former) high-ranking central bankers alike have highlighted the stability risks of private money creation and fractional reserve banking in our monetary architecture. The advent of retail central bank digital currencies offers the opportunity to rethink and reevaluate this architecture.
Rather than a rethink, the ECB seems to have opted for the status quo — and for sacrificing the digital euro on the altar of banking as we know it.
Cyril Monnet (above, left) is a professor of economics and Dirk Niepelt is a professor of macroeconomics, both at the University of Bern.
In collaboration with the Centre for Economic Policy Research.
