Effects of a digital euro on financial stability and consumer welfare
Effects of a digital euro on financial stability and consumer welfare
BACKGROUND: THE REASONING BEHIND A DIGITAL EURO CURRENCY
In June 2023, the European Commission presented its legislative proposal for a digital euro, following the European Central Bank’s decision to move into the preparation phase of the project. The digital euro would be a retail central bank digital currency (CBDC), accessible to citizens across the euro area with legal tender status, like cash.
Its objectives include ensuring the euro remains a stable monetary anchor in a society with declining cash use, promoting innovation and competition in payments, supporting financial inclusion, and strengthening EU monetary sovereignty.
However, many design features of the digital euro remain undefined, and uncertainty about its broader implications is high. Copenhagen Economics, on behalf of the European Banking Federation, has analysed the potential impact on financial stability, consumer welfare, and innovation.
SIGNIFICANT RISKS TO THE BANKING SECTOR AND LIMITED BENEFIT FOR CONSUMERS
Our study shows that the introduction of a digital euro could trigger substantial withdrawal of money from commercial banks by individuals and businesses, raising bank funding costs and potentially amplifying bank runs in times of stress in its current shape and design.
With a holding limit of €3,000 per person, deposit outflows could amount to €739 billion (10% of household deposits), with smaller banks particularly exposed. This could increase lending costs, reduce credit supply, and ultimately weigh on investment and GDP.
The case for significant benefits to competition, consumer welfare, or financial inclusion appears limited, as many of the policy objectives are already being addressed by existing EU legislation and market-driven innovation. Moreover, the digital euro will entail substantial launch and compliance costs for banks, payment providers, and merchants, many of which are likely to be passed on to consumers.
DESIGN, IMPLEMENTATION, AND HOLDING LIMITS ARE ESSENTIAL
Our key conclusion is that careful design choices – especially around holding limits and the business model – are critical if a digital euro is to be implemented. Lower holding limits, possibly even zero, would significantly mitigate risks to financial stability while still enabling use of the digital euro as a means of payment.
In brief
A digital euro with a EUR 3,000 holding limit could draw up to EUR 739 billion out of euro area bank deposits, 10 per cent of the household deposit base, with the sharpest effects falling on smaller banks, according to this analysis based on the December 2023 state of affairs.
EUR 739 bn.Potential deposit outflow at a EUR 3,000 holding limit, equal to 10 per cent of the total household deposit base and 3 per cent of total bank liabilities. At a EUR 500 limit the outflow falls to EUR 139 billion, 81 per cent lower.
7% of liabilitiesDeposit outflow across the smaller banks in the sample, more than twice the 3 per cent aggregate. For the most affected banks, outflows could reach 20 per cent of the deposit base.
EUR 681 bn.The additional funding banks would need in a severe scenario of a EUR 3,000 limit and full uptake, implying roughly a 20 per cent expansion of the bank-issued debt securities market and costing banks upwards of EUR 20.4 billion annually.
300 basis pointsIncrease in incremental lending costs per euro refinanced from alternative sources under full uptake, reducing net interest income by 7 per cent across the euro area and 13 per cent for the smaller banks in the sample.
0.12-0.34%Estimated permanent reduction in GDP arising from higher borrowing costs and reduced access to credit.
Commissioned by the European Banking Federation. Authors: Helge Sigurd Næss-Schmidt, Charlotta Zienau, Rodrigo Cipriano, and Jens Brink. Published December 2023. Euro area.
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About this analysis
Copenhagen Economics evaluated the implications of establishing a digital euro, quantitatively and qualitatively, following the European Commission’s June 2023 legislative proposal and the ECB’s move to the preparation phase in October 2023. The study covers the design features and objectives of the digital euro, its effects on financial stability through deposit outflows and bank funding costs, and its effects on consumer welfare. Financial stability effects are modelled across scenarios spanning holding limits of EUR 500, 1,000, 2,000, and 3,000, different macroeconomic environments of stress and stability, and varying funding compositions across the banking sector, using a bank-level sample that distinguishes smaller institutions from the aggregate.
The authors note significant uncertainty at the time of writing, for two reasons they state explicitly: many of the digital euro’s design features and their practical implementation were still being defined, and few analyses existed that attempt to quantify its effects. The holding limit, the single most important parameter in the modelling, was not set in the Commission proposal and was left to the ECB. The study addresses three of the four stated policy objectives, treating strategic autonomy and monetary sovereignty as outside its scope, and notes that focusing on financial stability does not diminish other anticipated impacts on banks. The 300 basis point funding spread is drawn from BIS parameter estimates rather than derived here.