There are two constituencies, united in their suspicion of central bank digital currency (CBDC), who are working to stop a digital euro. One group is working from without, the other from within. On the one hand there are the conspiracy theorists who begin with legitimate concerns about privacy and quickly shift to a broad agenda involving (as far as I can tell) Bill Gates, the World Economic Forum and black helicopters. Central banks, normally used to deploying technical or economic arguments, find it difficult to deal with them. On the other hand there are the commercial banks, and they are far more likely to succeed in derailing the digital euro.
In a paper for the Centre for Economic Policy Research (CEPR), Cyril Monnet and Dirk Niepelt identify an implicit and unspoken objective for the digital euro, which is to do no harm to banks and protect their business model. As they point out, this objective dominates all others and means that requirements favoured by the Governing Council — which include holding limits for consumers (a few thousand euros), even lower ones for merchants (zero) and negative interest rates during periods of financial stress — make the digital euro really rather unattrative. The ECB appears to view these features as permanent, which means that the digital euro will never be anything more than a footnote.
It is easy to understand the opposition from the legacy payments world, because there is no getting around the fundamental dynamic: a useful, functioning, well-designed digital currency will eat into bank profits. There it is. Black and white. A recent paper from the Bank of Canada on “Central Bank Digital Currency and Banking Choices” looks into the issue of CBDC substitution for bank deposits and, taking into account the key fact that commercial banks provide financial products that are complementary to their deposits and cannot be provided by a central bank, through some detailed modelling find that
First, we find that the impact of a CBDC is much lower after taking into account that households enjoy the complementarity between deposits and other financial products within the same bank, which gives banks a competitive advantage over the CBDC.
Second, the impact of a CBDC depends crucially on its service location network. A CBDC that has no service location can barely gain any traction. A CBDC that uses Canada Post offices as service locations would lead to a take-up that is similar to the market share of cash and benefit rural households more than a CBDC that uses bank branches as service locations.
Third, banks with larger market shares tend to respond more to the CBDC and hence retain more deposits.
In conclusion they find that the substitution ranges from 1% in some cases to more than a third in other cases, with the most likely case being a 12% loss with the reduction skewed towards the smaller banks.
I tend to think that the substitution would be limited, because that is what has been observed when consumers have the option of fariyl frictionaless shifting to CBDC (eg, in China).
At a macro level, it is reasonable to think that the goal of digital currency policy should be to do the right thing for society as a whole and not to maximise the revenues of commercial banks at the expense of all other stakeholders. So, why would it benefit society? Well, remember the crucial distinction between electronic money of the kind we have now and the electronic cash of the future, of which a digital euro should be an exemplar: Electronic money moves between accounts and through banking networks (eg, FedNow) whereas electronic cash (eg, the currently non-existent FedCoin) moves between devices and not through accounts, banks, banking networks or indeed any other intermediary at all. Since there is no clearing or settlement (the money is the message, so to speak) this will of course be much less expensive for users and much less profitable for intermediaries.
It is not all about transaction costs though. There are other benefits, of course. Back at the dawn of central bank digital currency, the Bank of England Staff Working Paper No. 605 says (amongst other things) that
we find that CBDC issuance of 30% of GDP, against government bonds, could permanently raise GDP by as much as 3%, due to reductions in real interest rates, distortionary taxes, and monetary transaction costs. Countercyclical CBDC price or quantity rules, as a second monetary policy instrument, could substantially improve the central bank’s ability to stabilise the business cycle.
GDP growth aside, the Bank was also interested in the fact that cash has no Application Programming Interface (API). Writing in the Bank of England’s “Bank Underground” blog, Simon Scorer from the Digital Currencies Division made a number of very interesting points about the requirement for some form of digital Sterling. He remarked on the transition from dumb money to smart money, and the consequent potential for the implementation of digital fiat to become a platform for innovation (which I have always seen as being one of the most important reasons for driving forward with digital currency), saying that “other possible areas of innovation relate to the potential programmability of payment”.
(Programmability is actual rather complicated, so let’s not get sidetracked on it here.)
If the requirements for digital currency are reset in a somewhat utilitarian context then they would point toward a digital currency that is based on unintermediated device-to-device value transfers, pseudonymous digital wallets and permissionless innovation. In such an environment, value transfers between wallets would be instant and free.
Does this mean that there would be nothing for banks to do in such as digital euro world? No, of course not. Even if digital euros were the only currency on Earth, I would still need to borrow some of them from Barclays in order to buy a new Jaguar.
In fact, I might argue that removing the narcotics of interchange and other transaction fees from banks might well wake them into significant innovation in artifical intelligence and financial health, in digital identity and reputation protection, in custodial wallet provision and management.
Marshall McLuhan famously said, with a towering prescience that we have yet to fully appreciate, the medium is the message and predicted the “global village” that gave us Wikipedia and social media, online banking and Pornhub. Well, I’m saying that the money is the message and there is nothing that banks can, or should
Snippings 