The digital euro – next generation banking for the eurozone?

May 2024

A lot has happened in the last years since our last article – many central banks – responding to accelerating digital payments, the growth of cryptocurrencies, and the actions of their peers – have moved forwards with their plans for digital currencies. The European Central Bank (ECB) is no exception, with plans for a digital euro having come a long way since its ‘investigation phase’ was announced in October 2021.

That first phase of the digital euro project is now concluded and a two-year ‘preparation phase’ is underway. This will comprise activities such as finalising the rulebook, testing concepts, searching for service providers, and engaging with stakeholders – these include not only the general public, the ones who will use the digital euro, but equally as importantly the banks. After all, banks will be the key distributors of the digital euro to the public and therefore will be key to ensuring a smooth uptake of this new technology.

Recent months have seen a flurry of publications on the digital euro from European authorities – even if some may be somewhat delayed due to the upcoming elections in June 2024. These include the Commission’s June 2023 legislative proposals for a digital euro legal framework, a February 2024 ECB blog on “Debunking banks’ fears about losing deposits”, and a March 2024 presentation by ECB Executive Board Member Piero Cipollone entitled “Digital euro: the future of money“. These all complement the Eurosystem’s retail payment strategy, first developed in 2019, expanded in 2020, and further developed in November 2023.

All these developments mean that the anticipated high-level design features of a future digital euro are rapidly coming into focus. These are expected to include:

• No-cost usage for basic consumer transactions
• Available for any digital payment in the euro area (e.g., online, in store, person-to-person)
• The strongest level of privacy permitted by regulation
• Intermediation via banks and other payment service providers
• Compensation for intermediaries via merchant fees
• Financial inclusion for the unbanked via public entity intermediation
• Holding limits for individual users, with no interest or other remuneration
• Available for offline transactions

Perhaps most importantly, the digital euro is expected to strengthen the strategic autonomy and monetary sovereignty of the euro area. For the eurozone, it is seen as a piece of critical infrastructure for Europe, paving the way for a payment solution in Europe that is currently reliant on foreign technology and companies.

A decision to issue the digital euro could theoretically be taken as soon as 2025, even if development would probably take years. But serious preparations and strategy developments are already underway in the payment space – commercial banks are increasingly conscious that the profound effects the digital euro will have on their business and operating models in areas such as liquidity, privacy and interoperability, to name just a few. And yet, despite recent publications, many practical questions about the digital euro remain unanswered. At present, commercial banks’ potential concerns about the concept include:

• Deposits: Banks are generally fearful that the introduction of a digital euro could encourage customers to move away from conventional deposits at commercial banks – what impact might it have on banks’ customer relationships and funding strategies?
• Costs: What might it cost commercial banks to develop digital euro interfaces for customers? Would they use existing bank systems or use other private wallet initiatives? Might the industry need to contribute to the potentially enormous cost of developing the digital euro’s new ‘payment rails’?
• Revenues: To what extent will banks be able to offset the costs of providing customers with ‘free’ digital euro services by charging merchant fees? Could commercial banks lose existing or potential customers and their associated revenue streams altogether? Perhaps there are new value-added services – like micro payments, split payments, billing, receipts admin, cross border payments, subsidiary, programmable or conditional payments?
• Competition: What might be the impact of Fintech innovations leveraging the digital euro’s payment rails? Could new entrants use this infrastructure to outcompete banks or replace them altogether? From another angle, could the digital euro be seen as a win for banks? This could be an opportunity to outsource payments, reduce the maintenance cost of legacy systems, or even get rid of such legacy systems altogether. Perhaps there could be more collaborations with private initiatives from commercial banks using intermediary apps.
• Talent: Will banks be able to attract and retain staff with the skills needed to build and operate digital euro interfaces, given the novel technologies underpinning digital currencies?

For banks, there are also uncertainties around the potential commercial upsides of a digital euro – such as using a strong digital euro proposition to cross-sell, up-sell, or even acquire new customers from underserved social groups. In addition, it’s unclear how banks should prioritise planning for a digital euro against other major initiatives such as DORA or instant payments.

In short, there is some uncertainty for banks in exactly how to frame their decision-making around the digital euro – a concept that’s unique, slow moving, hard to quantify, and yet with potentially huge long-term effects. For now, there appear to be risks associated both with acting too slowly (ceding competitive advantage) and too quickly (wasting resources and attention).

There are no easy answers to these questions. Even so, strategic planning is vital. In our view, commercial banks should be modelling potential scenarios, together with their possible implications and practical responses. However, we believe that the digital euro rulebook already provides a good direction of travel for banks and should form the basis of strategies going forward.

More specifically, we believe that banks should:

• Assess the greatest potential areas of disruption to their current business and operating models, including areas such as funding strategies, IT front and back-end systems (including interfaces), payment strategies, transaction management, investment strategies, and the need for new external partnerships.
• Assess the potential implications for customer and product propositions - including deposits, digital wallets, and digital assets - and the potential impact on current and future revenue streams.

In summary, while significant uncertainties remain, including uncertainty over the eventual traction of the digital euro in terms of reach, or whether it will even be possible to build a sovereign infrastructure to support the digital euro, clarity around the actual features of a future digital euro is increasing fast. Many banks are already actively considering the possible impacts of a digital euro on their strategies and operations. Other institutions should do the same if they want to mitigate the potential risks – and capitalise on possible opportunities.