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ECB starts preparation phase of digital euro

Economic opinion

On 18 October 2023, the ECB reported the results of its investigation phase for the possible introduction of a digital euro (Central Bank Digital Currency or CBDC). From November 2023, a preparation phase will follow, which will last two years. The final decision on whether or not the digital euro will be introduced lies with the European Parliament and the European Council. Consequently, any introduction will not be before 2028. The digital euro would meet a growing need in the pan-European payment system. Indeed, the ECB’s SPACE survey on the payment behavior of Europeans indicates an increasing use of digital options (payment cards) at the expense of physical cash. Therefore, according to the Bank for International Settlements, 94% of the central banks surveyed are examining the development of their own CBDC. Besides convenience for individuals, protection against potential competition from foreign CBDC or private ‘crypto’ assets is also an important motive. Frequently heard concerns are mainly related to privacy and fear of government imposed payment restrictions. To address these fears, the current proposal stipulates that the ECB will not be able to identify individual transactions. Moreover, payment restrictions are also excluded since the ECB, according to its mandate, issues a currency and not vouchers. Moreover, it is important to emphasize that anonymous physical cash will continue to exist as legal tender even after a possible introduction of the digital euro.

On 18 October 2023, the ECB reported the findings of its investigation phase on the possible introduction of a digital euro (Central Bank Digital Currency or CBDC). The next step is the preparation phase, which will take about two years. The final decision on a possible introduction lies with the European Parliament and the European Council. In June 2023, the European Commission started the legislative process with its proposal on the matter. Since further political deliberations will take some time, a possible introduction of the digital euro will probably not be before 2028 at the earliest.

Responding to changing payment behavior

The ECB’s preparations are taking place against the backdrop of a range of financial-technological developments in the payments area. For a general overview of the CBDC concept, see also the KBC Economic Opinions of 22 January 2021 and 4 April 2023.

The latest edition of the ECB’s SPACE survey (Study on the Payment Attitudes of Consumers in the Euro Area) with data through 2022, indicates that a tipping point in the payment behavior of European individuals has been reached since the first survey in 2019. The use of physical cash in retail payments decreased from 72% to 59% of transactions during that period. Expressed in amounts, payment cards at 46% even accounted for a larger share than the 42% of physical cash[1]. In 2019, this was still the other way around: 43% versus 47%. These figures show that while Europeans still attach great importance to cash as a means of payment, the share of cash is nevertheless declining in favor of digital payments.

The ECB is trying to respond to these two trends by exploring a payment option with (digital) cash in an increasingly digital world. It is not alone in this. The Bank for International Settlements (BIS) organised a new edition of its survey of central banks on their activities regarding CBDCs in December 2022. Eighty-six central banks worldwide participated in this survey. They represent 82% of the world’s population and 94% of global GDP. As many as 93% of the central banks surveyed were engaged in CBDCs during 2022. At the time of the survey, in addition to central banks experimenting with or piloting CBDC (including those of Sweden, the U.S. and China), according to the BIS, four smaller central banks had already effectively implemented[2] a retail CBDC fully “live” (the Bahamas, the Eastern Caribbean, Jamaica and Nigeria). That number is likely to grow rapidly.

It is probably only a matter of time before a major central bank will fully adopt a CBDC. The economies of scale of digital instruments (technological, but also the network effects due to the number of users) could greatly and rapidly increase the international use of a CBDC. This has potentially major implications for the international monetary system, specifically for the position of the dominant transaction currency in international trade. For example, China has long been promoting the international use of the renminbi, challenging the position of the US dollar. In that context, there is a danger that a currency area without its own full-fledged CBDC could lose its monetary sovereignty. That could mean, for example, the loss of control over domestic money supply and credit. Such a potential threat emanates not only from a foreign CBDC, but also from private assets. In the BIS survey mentioned, about 60% of the central banks surveyed indicated that they have stepped up their efforts related to a CBDC of their own precisely in response to the rise of so-called ‘crypto-assets’ and ‘stablecoins’.

A digital euro could also address in part the current lack of a pan-European digital payment option for individuals that can be used and accepted anytime, anywhere and by anyone in the euro zone. A digital euro, with legal tender status, could fill that gap, since it is planned that payments can also be made offline. Among other things, such a pan-European payment infrastructure, owned by the EU, is intended to reduce dependence on dominant foreign payment service providers such as Master Card and Visa.

Concerns

In principle, a possible introduction of a digital euro has no downside for private individuals. After all, the CBDC does not replace physical cash and merely provides an additional, non-mandatory, digital payment option. However, the introduction of a CBDC could have implications for financial stability. Indeed, the availability of a digital euro could trigger a flow of private deposits into CBDCs. In theory, this could undermine the traditional role of the banking system. To avoid such ‘bank runs’, there will be an upper limit on possible deposits in digital euro. The relevant ECB simulations suggest that a maximum possible balance of around EUR 3000 per person would not cause a systemic liquidity problem. The exact amount will be determined closer to the time of a possible introduction. To further underscore its character as a means of payment (rather than a savings vehicle), the ECB suggests that the digital euro will not earn interest (i.e., neither a potentially negative interest).

There is also the privacy concern. The ECB’s draft envisions the “highest level of privacy for digital payments”. So that does not guarantee anonymity, but the ECB itself would not have access to payment data that could identify individuals. There will, however, be a trade-off, in all transparency, between privacy and the legal rules related to, for example, fighting money laundering and terrorist financing.

Another fear is that the digital euro would be abused by governments to impose certain payment restrictions with a political agenda (the so-called ‘programmability’). The ECB’s proposal explicitly rules that out. After all, in line with its mandate, the ECB issues a currency and not vouchers. Transparent communication about the nature and purpose of the euro area CBDC remains crucial to promote confidence in a digital euro.

[1]                     The remaining share goes to mobile apps and other payment methods such as bank checks, for example.

 

[2]                     The BIS survey distinguishes between the phases of ‘research and study’, ‘experiments and proof of concept’, ‘development or pilot projects’, and fully ‘live’.

 

Disclaimer:

Any opinion expressed in this KBC Economic Opinions represents the personal opinion by the author(s). Neither the degree to which the hypotheses, risks and forecasts contained in this report reflect market expectations, nor their effective chances of realisation can be guaranteed. Any forecasts are indicative. The information contained in this publication is general in nature and for information purposes only. It may not be considered as investment advice. Sustainability is part of the overall business strategy of KBC Group NV (see https://www.kbc.com/en/corporate-sustainability.html). We take this strategy into account when choosing topics for our publications, but a thorough analysis of economic and financial developments requires discussing a wider variety of topics. This publication cannot be considered as ‘investment research’ as described in the law and regulations concerning the markets for financial instruments. Any transfer, distribution or reproduction in any form or means of information is prohibited without the express prior written consent of KBC Group NV. KBC cannot be held responsible for the accuracy or completeness of this information.

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