Insight: Exploring the potential for a digital euro

Barry Rodrigues,
14 Jun 2023

The European payments industry has undergone significant changes in recent years, driven by advances in digital technology, the emergence of new payment providers and increasing consumer demand for faster, more convenient, and more secure payment options. In response, European authorities and financial institutions have been working to create an environment that fosters innovation in the payments sector, while also striving to ensure the safety and stability of the financial system.

While conversations at the beginning of the year indicated that a digital currency could soon be on its way, recent reports have indicated a slowing down in the creation of a digital euro by the European Central Bank (ECB).

A recent paper from the European Parliament warns about the risks associated with a digital euro in terms of market impact, the implications for banks, privacy, design and technical issues, as well as the impact for monetary policy, financial stability, financial inclusion and more.

With hesitations at the forefront of decision-makers’ minds, it’s important to be aware of the challenges ahead and how banks can best prepare.

The current landscape

Today, about 85 central banks worldwide are engaged in projects to create digital currencies, according to figures from the Bank for International Settlements. Central banks such as the Central Bank of The Bahamas, the Eastern Caribbean Central Bank, the Central Bank of Nigeria, and the Bank of Jamaica have taken a lead in launching Central Bank Digital Currencies (CBDCs) in their domestic markets.

Meanwhile, the Monetary Authority of Singapore and the Fed’s New York Innovation Center have teamed up to explore the use of wholesale CBDCs for cross-border payments. Their research has highlighted key opportunities for central bank innovation to play an important role in easing wholesale payment flows globally and improving settlement outcomes.

In Europe, the ECB will be actively monitoring the efforts undertaken by central banks worldwide around the potential issuance of CBDCs, aligning with the approaches adopted by other significant central banks.

Launching a digital euro would put the ECB in a new position: that of offering a new payment instrument in competition with banks and other payment service providers (PSPs). Banks will need to prove to the European Parliament that there is a market niche for a digital euro, or whether one would have a good chance of establishing itself in today’s highly competitive, innovative, and fast-moving payment industry.

The challenges faced and how banks can overcome them

The introduction of CBDCs and associated digital wallets is generally expected to have a significant impact on the banking industry; traditional banks rely on various revenue sources, such as deposits, lending, and payment services to generate profits. However, the issuance of CBDCs could disrupt these business models in several ways.

Finastra’s Barry Rodrigues

Firstly, CBDCs would allow consumers to hold digital currencies directly with the central bank, potentially leading to a reduction in customer deposits for traditional banks. This could result in a decline in their funding sources and account fees.

Secondly, CBDCs’ central digital wallets offering better services and lower fees could erode customer loyalty towards incumbent banks and fintechs, shifting trust towards the central bank.

However, it’s not all doom and gloom, as CBDCs also present new opportunities for banks and fintechs. They can explore partnerships with central banks and other stakeholders in the CBDC ecosystem to offer innovative services.

CBDCs may also facilitate financial inclusion, allowing the unbanked and underbanked populations to access financial services more easily.

Nevertheless, the introduction of CBDCs and digital wallets requires banks and fintechs to innovate and adapt their business models to remain competitive. Providing a seamless user experience will be crucial for banks to attract and retain customers, as technology and UX become the main differentiators in the digital banking landscape.

To prepare for the impact of CBDCs, banks can explore new ways to offer additional value to customers; they can leverage their reputation, reliability, and expertise to manage risks associated with new services like peer-to-peer (P2P) lending.

Design thinking and a user-centric approach, combined with emerging technologies such as AI, Big Data and the metaverse, will be instrumental in enhancing digital offerings and delivering personalised and valuable services to customers.

Open Banking and embedded finance will also create synergies that enhance the overall customer experience. Adapting their digital product UX and embracing these technological trends will help banks navigate the changing financial landscape and thrive in the era of CBDCs.

Crucial support from fintechs

Fintech companies play a valuable role in facilitating the adoption and integration of CBDCs by providing expertise, technology, and support to central banks and other stakeholders. This includes working together to develop and implement technical standards and protocols for using CBDCs, helping to ensure that the different systems and platforms used by fintechs and central banks can inter-operate smoothly and efficiently.

Additionally, fintechs can educate the public about the benefits of CBDCs and how to use them, which helps to increase their adoption and integration into the broader economy.

Fintech companies can also support the seamless integration of CBDCs with existing payment systems and infrastructure. This could include developing APIs and other technical solutions to enable the smooth flow of information and transactions between CBDCs and other payment systems.

What can be expected in the future?

CBDCs have the potential to bring many benefits, including greater financial inclusion, faster and cheaper cross-border payments, and enhanced security and resilience.

The design of CBDCs is still in its infancy, with several experiments ongoing and various approaches being studied. Several technical, economic, legal, and governance challenges must be addressed before any CBDC is fully launched. To do this right, Europe’s digital currency must be widely available and easy to use, while simultaneously adhering to a regulatory framework.

The jury is still out on whether a digital euro can go ahead, so industry players will be paying close attention to developments and conversations over the next few years.

For Europe to benefit from CBDCs, the ECB must show that the opportunities of launching a digital euro outweigh the risks and uncertainties.

Barry Rodrigues is executive vice president, payments at Finastra