In July, the ECB Governing Council confirmed that they are launching a formal investigation into a digital euro, lasting 24 months and engaging relevant stakeholders across Europe. Ongoing innovation brings new challenges and the role of commercial banks could change, but a proactive approach on both sides should ensure that everyone is ready to meet this exciting opportunity.
Earlier this year, KPMG wrote about the possible creation of a digital euro – a Central Bank Digital Currency (CBDC) issued by the ECB. Like other CBDCs, a digital euro would simply be a digital banknote that could be used by individuals to pay businesses or each other, or by financial institutions in the financial markets.
Since then, the digital euro has generated increasing debate. Proponents believe it could offer European citizens the flexibility of a digital currency within the security of an appropriately regulated framework, as well as helping to maintain European influence over the evolution of digitisation. However, it is still unknown how implementing a digital euro could impact the operations of commercial banks in the future.
Banks seeking more information on this issue can turn to the results of the ECB’s Public Consultation on a digital euro, published in April 2021 . These showed that the key features consumers and institutions would value in a digital euro include:
- The preservation of privacy over customer data and transactions (43% of respondents)
- A high level of security (18% of respondents)
- Usability across the Euro area (11% of respondents)
- An absence of additional user costs (9% of respondents)
- The ability to make offline payments (8% of respondents)
These findings informed the decision of the ECB’s Governing Council on 14 July this year to launch a formal investigation into a digital euro . The investigation will last 24 months and will aim to assess key issues such as design and distribution. It will also consider any changes that may be required to the EU’s legislative framework, with the ECB engaging with the European Parliament and other policymakers throughout.
The ECB is not the only central bank interested in CBDCs. Elsewhere in Europe the Bank of England has created a CBDC Taskforce to explore the topic, while the Banque de France made several announcements during the summer of 2021, specifically:
- Plans to test the cross-border settlement of wholesale CBDCs in partnership with the Swiss National Bank, the Bank for International Settlements (BIS) and a consortium of private sector banks and exchanges
- The successful completion, together with the Monetary Authority of Singapore, of simulated cross-border transactions involving multiple CBDCs
- A wire transfer between two individuals in France and Tunisia in commercial bank money, via the transfer of wholesale CBDC between the Banque de France and the Banque Centrale de Tunisie
Further afield, the Federal Reserve in the United States will soon release research examining the costs and benefits of a CBDC, according to Fed Chair Jerome Powell, and China has already launched an e-yuan with ambitious plans for rolling it out. Meanwhile an inter-regional example of collaboration comes from a cross-border CBDC exchange programme led by the BIS and involving Australia, Malaysia, Singapore and South Africa. A recent example of the potential of using digital currencies and distributed ledger technology (DLT) can also be seen in the mBridge project, which is a collaboration between the central banks of Hong Kong (SAR), China, Thailand and the United Arab Emirates (UAE).
So what messages should European banks take away from this accelerating activity? As Fabio Panetta remarked in his speech earlier this year at a Bruegel online seminar, a digital euro “could affect financial intermediaries in several ways”. For example, other financial intermediaries could attract payment activity away from banks, thereby reducing payment-related income and customer information, which can lead to lower profitability. In addition, customers may move deposits from commercial banks to central banks should there be attractive conditions. Though the ECB has committed to designing the digital euro in such a way that will prevent this risk, and has indeed stated that it will need the help of commercial banks to provide front-end services, there are some implications that banks could consider now, which would also be relevant in their general move towards a better digitised environment:
- Customer experiences. The features that consumers value in a digital euro are the same ones they seek from other digital payment mechanisms: the ability to make rapid, low-cost payments, including across borders, with high levels of security and privacy. Banks can prepare for the growth of digital currencies and other digital payments by diversifying end-user solutions.
- Technological considerations. The creation of a digital euro would pose a range of technological challenges and opportunities, most obviously the need to integrate the centralised infrastructure of a CBDC with the systems of commercial banks and create the ability to provide front-end services. Other hurdles could include working with DLT, accommodating any programmable ‘smart contract’ features of a digital euro, and the provision of offline payments.
- Supervisory activities. The ECB is already focussing on certain topics now that will be even more relevant if a CBDC would be issued:
a. Privacy and data protection: A digital euro would call for the segregation of personal information between the settlement system operator and other intermediaries, with multiple privacy standards being applied simultaneously.
b. Anti-money laundering (AML): A digital euro would need to offer a high level of privacy, but without violating the requirements of AML/CFT regulation.
c. Environmental, social and governance (ESG): The environmental and social implications of a digital euro, such as the power consumption of core settlement systems, would need to be considered.
The ECB’s launch of an investigation phase for a digital euro gives European banks a window of opportunity to get up to speed with this fast-evolving topic. Banks should closely monitor the activities of the ECB and national central banks and take a proactive approach to preparing themselves for future developments.