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Banks ‘barking up wrong tree’ over digital euro deposit flight fears: ECB blogpost

Euro notes: the issuance of CBDCs, such as a potential digital euro, has raised concerns that people could shift money away from conventional bank accounts | Credit: Maria_Domnina (Pixabay)

Banks have been accused of ‘barking up the wrong tree’ if they believe that a eurozone central bank digital currency (CBDC) would cause people to withdraw significant amounts of money from conventional bank accounts to hold digital euro.

‘Many banks worry their customers might withdraw deposits to hold digital euro instead,’ three senior European Central Bank (ECB) figures acknowledge in a co-authored blogpost published on the Frankfurt-headquartered authority’s website this week (19 February). ‘These fears are misplaced.’

Executive Board member Piero Cipollone, Market Infrastructure & Payments (MIP) director-general Ulrich Bindseil and MIP adviser Jürgen Schaaf aim in their article – titled ‘Digital euro: Debunking banks’ fears about losing deposits’ – to address what they describe as ‘persistent criticism’ on the topic.

‘Despite the explicit inclusion of mitigation measures in CBDC design, banking associations, bank-sponsored think-tanks and scholars have continued to publish studies emphasising the risks associated with eliminating financial intermediaries from transactions ‒ known as bank disintermediation ‒ through the potential issuance of CBDCs in general and of a digital euro in particular,’ they write.

‘Banks are barking up the wrong tree when they rely on studies that overlook the outlined design features of a digital euro,’ they contend. ‘In doing so, they ignore the many other challenges they need to address to ensure stable funding through deposits. Banks need to offer attractive products and services that incentivise customers to hold their deposits with them instead of migrating to new and powerful private competitors.’

RELATED ARTICLE ECB kicks off 2024 with hunt for digital euro ‘components and related services’ providers – a news story (4 January 2024) on the ECB issuing five calls for applications – carrying a total estimated spend of €432.1m (about £373m) and a potential maximum spend of more than €1bn (more than £862m) – to set up framework agreements with potential providers of digital euro ‘components and related services’

‘Calibrated’ holding limits

The ECB entered a ‘preparation phase’ for a potential digital euro on 1 November 2023 that will initially run for two years. A decision on whether to issue a digital euro will be taken at a later stage, but not before the legal framework is in place and ‘all functional features’ have been specified.

The Frankfurt-headquartered authority has said that it has ‘designed a digital euro that would be widely accessible to citizens and businesses through distribution by supervised intermediaries, such as banks’.

In their blogpost the ECB trio explain that ‘to preserve the economic function of commercial banks, individual digital euro holdings would be limited’ and that ‘holding limits would be calibrated based on a comprehensive analysis considering all relevant factors’. A limit of €3,000 (about £2,560/$3,246) per person has been mooted.

‘Merchants would be able to receive and process digital euro, but would not be able to hold them at all ‒ protecting the corporate deposit base of the banking system,’ they also explain.

‘Digital euro holdings would not accrue interest,’ they continue. ‘Users would be able to seamlessly link their digital euro account to a payment account with their bank, enabling a “reverse waterfall” mechanism. This eliminates the need to pre-fund the digital euro account for online payments, as any shortfall would be covered instantly from the linked commercial bank account, provided it has sufficient funds available.’

RELATED ARTICLE European Central Bank gives nod to digital euro ‘preparation phase’ – our news story (18 October 2023) on the Governing Council’s thumbs-up to move to the next stage of the ECB’s journey towards a potential eurozone CBDC

Bank run acceleration threat ‘not very plausible’

Cipollone – who replaced Fabio Panetta on the ECB’s Executive Board in November 2023 – Bindseil and Schaaf note that questions about the risk to bank funding have been ‘at the centre of discussions about CBDCs from the outset’. In theory, CBDCs could affect financial institutions, as depositors might choose to move money from bank deposits to the central bank. This could reduce the ability of the traditional banking system to provide credit, they acknowledge.

‘However, central banks have analysed this issue and devised ways of tackling such risks upfront,’ they state. ‘In the case of a digital euro, the combination of the reverse waterfall, a holding limit and no remuneration would strongly reduce incentives to keep large amounts of money in a digital euro wallet. Users would rely on digital euro as a means of payment rather than use it for investment, particularly in view of the tendency of money holders to consolidate their liquidity pool. Moreover, banks could always offer higher remuneration to retain deposits.’

They continue by stating that ‘some critics say that in an acute economy-wide banking crisis, a digital euro could accelerate bank runs, which could exacerbate the crisis’. But they argue that this is ‘not very plausible’ for reasons including that since a limit would be applied to digital euro holdings, customers’ ability to withdraw unlimited amounts of cash ‘would pose much more of a threat’ to banks; and that, ‘even in severe banking crises, many banks are still considered safe’.

‘In recent decades bank runs have not generally been triggered by large numbers of retail customers withdrawing small deposits, but by incidents in the wholesale market or the withdrawal of very large individual amounts above the thresholds covered by deposit guarantee schemes,’ they argue.

‘Other critics say that the attractiveness of safe central bank money could lead to banks losing deposits as a source of refinancing in the long term,’ they add. ‘This could put a strain on lending to companies and private households. According to the Association of German Banks, substantial quantities of central bank money could be withdrawn from the banking system, which would restrict the ability of commercial banks to refinance against customer deposits. However, the combination of a holding limit, no remuneration, the reverse waterfall and the absence of corporate holdings of digital euro would mean that overall levels of digital euro holdings would remain rather low.’

RELATED ARTICLE UK authorities set out next steps towards potential digital pound – a news story (26 January 2024) on the Bank of England (BoE) and HM Treasury (HMT)’s response to a CBDC consultation

Global topic of debate

A CBDC’s potential impact on bank deposits is also a topic of debate in other jurisdictions exploring the possibility of launching a CBDC, for example Canada and the UK.

Bank of Canada earlier this month published a staff working paper, ‘Central Bank Digital Currency and Banking Choices’, stating that a non-interest-bearing CBDC ‘that does not provide complementary financial products can substantially crowd out bank deposits only if it provides an extensive service network’. The authors state that ‘imposing a large limit on CBDC holding would effectively mitigate this crowding out.’

UK authorities last month published proposed next steps towards a potential digital pound, reaffirming a plan to ‘proceed at this stage with a proposed holding limit in the range of £10,000 (about €11,720/$12,682) to £20,000 (about €23,440/$25,364), at least during [an] introductory period’. Corporates would also be limited in their holdings but the limit would be significantly higher.

De Nederlandsche Bank (Netherlands Bank) – which is a member of the Eurosystem, so therefore falling under the umbrella of the ECB’s digital euro project – this month published a working paper, ‘Managing the transition to central bank digital currency’ studying a potential CBDC’s macroeconomic effects in what is described as a ‘transition’ to a ‘new equilibrium – that is from the moment of the initial launch up to the longer run when it is firmly established as a payment instrument’.

The Dutch central bank paper’s authors assess how different policies would reduce ‘volatility during the transition’, considering instruments: ‘soft’ and ‘hard’ holding limits; a ‘two-tiered’ CBDC remuneration scheme that penalises ‘excessive’ holdings of CBDC by applying a negative interest rate to CBDC holdings above a certain limit; and third, restrictions on non-residents’ CBDC holdings that either preclude non-residents to hold CBDC or result in higher cross-border transaction costs in CBDC for non-residents. In addition, the authors also investigate whether active central-bank balance-sheet policies, where the central bank purchases private-sector assets to balance CBDC issuance, are effective in smoothing the transition. ‘We find that binding caps are most effective in reducing disintermediation and output losses in the transition and in minimising international spillovers,’ the authors state. ‘Their optimal level — i.e. minimising welfare losses — is around 40 per cent of steady-state CBDC demand.’

RELATED ARTICLE Think you know CBDCs? An A(CID) to Z(KP) test – a feature article (26 June 2023) focused on some of the many technology considerations involved with CBDCs (the article is based on a Bank of England ‘Digital pound: technology working paper’)

‘New players might pose a greater risk’

In a section of their article sub-titled ‘comprehensive analysis must include banknotes’, Cipollone, Bindseil and Schaaf argue that ‘what matters most for banks is the total amount of central bank money in circulation’ and that ‘focusing on digital euro alone ignores banknotes in circulation’.

‘Digitalisation in general is likely to lead to lower real growth in central bank money in circulation, or even to a decline,’ they state. ‘From this perspective, the persistent complaints regarding future volumes of digital euro in studies sponsored by the banking system are not looking at the right variable (which is central bank money in circulation) and are outdated (since they ignore the digital euro blueprint).’

The trio conclude by stating that ‘new players might pose a greater risk to bank funding’ than CBDCs. ‘Stablecoins, e-money institutions and other narrow bank constructs, some sponsored by big tech companies with huge customer bases, do not care about the role of banks in the economy,’ they state. ‘Non-banks have no obvious incentive to limit the use of their stablecoins or the services they offer, and the use of stablecoins could become significant.’

The ECB is currently growing its digital euro team, recently posting adverts for a head of ‘product proposition’ division; rulebook development manager ‘in charge of developing the rules to standardise digital euro payments throughout the euro area’; and ‘head of positioning and outreach division’, which will define the digital euro’s branding, positioning and communications strategy. The latter role’s job description makes reference to the overall objective ‘being to foster the public’s understanding of and trust in the digital euro’, with the role including responsibility for ‘manag[ing] the budget for both human resources and external consultancy.’