As CBDC research deepens, many banks in Europe are concerned that their customers may withdraw their deposits to hold the digital euro, creating instability in the banking sector. In response to these concerns, in February 2024, ECB Executive Board members Piero Cipollone, Ulrich Bindseil and Jürgen Schaf published the article "Digital Euro: Debunking Banks' Fears About Losing Deposits", in which they argued that these fears are wrong: the digital euro will be designed as a means of payment, not as an investment, And the discussion of the digital euro and banks must take cash into account. The Institute of Financial Technology of Chinese University (WeChat ID: ruc fintech) compiled the core content of the article.
Author | ulrich bindseil、piero cipollone、jürgen schaaf** ecb
Introduction
In October 2023, the ECB's Governing Council released a report outlining the scope and main features of the digital euro. The ECB decided to continue the "preparatory phase" of the digital euro project. The preparatory phase will lay the groundwork for a potential digital euro, which includes finalizing the rulebook and selecting a provider to develop the platform and infrastructure, and will pave the way for a potential decision to issue a digital euro in the future. However, the actual decision on whether to issue a digital euro will be made after the legal framework is in place and all the functional features are clear.
Based on the specifications proposed by the ECB and the European Commission, we can expect the digital euro to be characterized by pan-European use, fiat currency status, and a high degree of privacy. The digital euro will combine all the features of modern digital payment solutions. It will fill a gap that is lacking in electronic payment solutions in Europe, thereby strengthening the monetary sovereignty of the monetary union and the resilience of the payment system.
In order to protect the economic function of commercial banks, the digital euro held by individuals will be restricted. Merchants will be able to receive and process digital euros, but will not be able to hold them at all, a principle that aims to protect the corporate deposit base of the banking system. In addition, holding digital euros does not accrue interest. Users will be able to seamlessly link their digital euro accounts to their banks' payment accounts, enabling a "reverse waterfall" mechanism. This eliminates the need to pre-fund the Digital Euro account for ** payments, as any shortfall can be immediately covered from the linked business bank account as long as there are enough funds available.
Addressing concerns about bank disintermediation
From the outset, questions about bank funding risk have been at the center of discussions about central bank digital currencies (CBDCs). Theoretically, the CBDC could affect financial institutions, as depositors may choose to transfer funds from bank deposits to the central bank in exchange for CBDC. This could reduce the ability of the traditional banking system to provide credit. However, central banks have analysed the issue and devised ways to deal with such risks in advance. In the case of the digital euro, the combination of reverse waterfalls, holding limits, and no remuneration will significantly reduce the incentive to keep a large amount of money in a digital euro wallet. Users will rely on the digital euro as a means of payment rather than using it for investment and savings. In addition, banks can always offer higher interest rates to retain deposits.
But despite the explicit inclusion of mitigation measures in the CBDC design, banking associations, bank-funded think tanks, and academics continue to publish research highlighting the potential of CBDCs to eliminate financial intermediaries in transactions (known as bank disintermediation) and the associated risks. Given the persistence of such criticisms, it is worth taking a closer look at these arguments.
Some critics say the digital euro could exacerbate the crisis by accelerating a bank run in the midst of a severe banking crisis. However, this is not quite plausible for the following reasons:
Due to the restrictions on digital euro holdings, customers cannot withdraw unlimited amounts in times of crisis. And the ability of customers to withdraw unlimited amounts of cash will pose an even greater threat to banks. Indeed, in a crisis of this magnitude, the negative impact of holding cash for security reasons as a short-term store of value will also become less important.
Even in a severe banking crisis, many banks remain considered safe (also because central banks act as system-wide lenders of last resort). For example, during the 2008 financial crisis and the recent crisis at regional banks in the United States, many banks benefited from the inflow of money into safer banks.
In recent decades, bank runs have typically been triggered not by large numbers of retail customers withdrawing small deposits, but rather by events in the wholesale market or withdrawals of large amounts of individual amounts that exceed the threshold covered by the Deposit Guarantee Program.
Other critics say the CBDC's attractiveness as safe central bank funding could cause banks to lose deposits as long-term refinancing**. This can put pressure on loans for companies and private households. The German Banking Association said that a large amount of central bank funds could be withdrawn from the banking system, which would limit the ability of commercial banks to refinance customer deposits. However, the combination of holding restrictions, no compensation, reverse waterfall, and the fact that companies do not hold digital euros means that the overall level of digital euro holdings will remain fairly low.
A comprehensive analysis of digital currencies must take cash into account
For banks, the most important thing is the total amount of central bank money in circulation. Focusing solely on the digital euro and ignoring the paper money in circulation is misleading, as they affect the economic financial accounts in the same way. During a period of financial stress and low interest rates, the demand for euro banknotes increased by banks, but this was not considered an issue at the time. Between 2007 and 2021, euro banknotes in circulation increased from €628 billion to €1,572 billion, far exceeding the number expected to be issued in the form of digital euros.
The reduction in the use of paper money for everyday transactions will also ultimately reduce the structural demand for paper money. The significance of being a "store of value" is that it should be spent, but not immediately. In addition, the usefulness of a store of value depends on how easily the money ends up. Therefore, the reduction in the use of paper money may also reduce its attractiveness as a means of preserving value in the long run.
In fact, the nominal value of euro banknotes in circulation in 2023 fell for the first time since 2002, at around €5 billion. Although only 20% of the demand for banknotes can be attributed to domestic payments. This trend reversal may largely reflect rising interest rates and the trend towards digitization of payments.
Overall, digitalization could lead to a slowdown, or even a decline, in the real growth of money in circulation by central banks. From this point of view, the constant complaints about the digital euro in the study of the banking system do not take into account the right variables, i.e. do not take into account the cash in circulation, nor do they incorporate the blueprint of the digital euro, this kind of research is outdated.
Conclusion
As the ECB continues its work on the development of a digital euro, design options will be refined to address potential risks and optimize returns. The ECB has come up with innovative design features that will limit the circulation of the digital euro while providing benefits to users. By proposing measures such as holding restrictions, access restrictions, no interest rates, and reverse waterfalls, concerns about bank financing have been taken seriously. Holding limits will be calibrated based on a comprehensive analysis that takes into account all relevant factors.
In terms of the interaction between central bank money and commercial bank financing, what really matters is the total amount of money in circulation by the central bank. As the use of banknotes decreases, the nominal growth in cash flow may decrease or even decline. This can lead to a decline in central bank currency in circulation relative to GDP.
In addition, new players may pose a greater risk to bank financing than CBDCs. Stablecoin issuers, e-money institutions, and other narrow banking institutions, some of which are sponsored by big tech companies with large customer bases, don't care about the role of banks in the economy. These institutions have no apparent incentive to limit the use of their stablecoins or the services they provide, resulting in greater impact.
When banks' research ignores the design features of the digital euro, they are wrong. In doing so, they ignore many other challenges that need to be addressed to ensure stable funding through deposits. Banks need to offer attractive products and services that incentivize customers to deposit their deposits in the bank, rather than having customers divert their funds to new, powerful private competitors.
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end compiled by Sun Yi.
Edited by Ma Jijuan.
Editor-in-charge: Xu Hecong, Sun Yi.
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