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Bi-Monthly June 2024

Unlocking the Digital Euro: Impacts and Preparations for the Financial Sector

Almost 13 billion Germans have stuffed away between sofa cushions. No, not euros, but deutsche marks, according to 2023 data of the Deutsche Bundesbank, Germany’s central bank. Germans might hold on to their old currency for sentimental reasons, but they still carry on average €100 in their wallet, much more than their counterparts in many other western nations. Germans love cash for the security and control it provides, knowing only they are aware of their spending habits. The thought of a large financial institution knowing everything about them based on their financial transactions doesn’t sit well with many Germans. This preference has kept cash as the most frequently used day-to-day payment method.

However, there seems to be an interesting twist to this story. While digital payment adoption remains slow, Germans appear more open to sophisticated digital payment methods that respect their privacy. According to a recent Deutsche Bundesbank survey, 50% of Germans can imagine using the digital euro, a digital version of the euro with similar characteristics to cash. Over 75% of respondents emphasised the importance of privacy in the digital euro, with two-thirds highlighting the significance of an offline version offering privacy akin to cash.

Even though the digital euro is driven by the advances of Distributed Ledger Technologies (DLT) such as blockchain, it is not a cryptocurrency. Cryptocurrencies can be issued by anyone on the internet and often experience significant value fluctuations. For example, Bitcoin's value surged from about $30,000 in mid-2021 to nearly $70,000 by the end of the year, then dropped to around $35,000 in early 2022. The digital euro, issued by the European Central Bank (ECB), is stable, with a 1:1 exchange rate to physical euros. It functions like digital cash, allowing customers to make payments to businesses across the euro area or among friends without third-party facilitation.

The new currency is still in the preparation phase and being actively shaped. The goal for the CBC is clear: it will be a secure, fast, and innovative payment method for European consumers, blending the benefits of traditional digital payments with enhanced privacy. Its planned offline version ensures a level of privacy comparable to physical cash, while the online version stores significantly less data than conventional digital payments.This feature likely appeals to German consumers, especially since the digital euro is not intended to replace traditional cash. For readers who want to learn more about the offline version, the recent ECB’s state of play sheds more light on it: read more

The Eurosystem is experimenting with different technologies – both centralised and decentralised – in the development of a digital euro, including DLT. Prof. Dr. Joachim Wuermling, former board member of Deutsche Bundesbank, sees significant potential in B2B contexts if the ECB decides to harness the full potential of the DLT. For instance, in international trade, the digital euro could streamline and reduce the cost of trade finance by enabling automatic compensation for goods and services through digital triggers. Wuermling also identifies interesting use cases in retail and the public sector in his recent blog article for the European School of Management and Technology: read more

The ECB plans to launch the digital euro in 2028, with a final decision expected in 2025 or 2026. This timeline allows financial institutions and fintechs ample time to strategise for the new digital currency. Two major risks for financial institutions are associated with the digital euro: it could disrupt existing business models and profitability, and retail deposits might decrease as savers transfer funds to digital wallets. The ECB proposes an intermediate model to mitigate competitive distortions and financial stability risks, with a potential holding limit of €3,000 per customer to limit large deposit withdrawals. However, the impact on banks' loan issuance capabilities remains uncertain.

Preparing for the Digital Euro: Strategies for Banks and Fintechs

Scenario-Based Analysis: Financial institutions should begin with a scenario-based preliminary analysis to assess the implementation costs, opportunities, and risks associated with the digital euro. This involves evaluating various scenarios and their potential impacts on existing business models and operations.

Holistic Payments Strategy: Developing a holistic payments strategy is crucial. This includes redefining the role of digital banking apps, enhancing user experience, and integrating the digital euro into existing payment ecosystems. By positioning their apps as central to digital euro transactions, banks can maintain customer engagement and loyalty.

Innovative Value-Added Services: Banks and fintechs should explore how the digital euro can serve as a catalyst for innovative value-added services. This could involve offering new financial products, personalised financial advice, or integrating with smart contracts for automated payments in various sectors such as retail and supply chain.

Regulatory Readiness: Staying ahead of regulatory developments is essential. Financial institutions must ensure compliance with emerging regulations related to the digital euro. This includes understanding data privacy requirements, transaction monitoring, and reporting obligations.

Collaboration Opportunities: Traditional financial institutions can benefit significantly from collaborating with dynamic fintechs. Fintechs offer agility and technological infrastructure, while banks provide regulatory expertise and customer trust. Such collaborations can lead to the development of robust digital euro solutions that are secure, efficient, and user-friendly.

Customer Education and Engagement: Educating customers about the benefits and functionalities of the digital euro will be key to its adoption. Financial institutions should invest in marketing and educational campaigns to inform customers about how to use the digital euro, its security features, and the privacy it offers compared to other digital payment methods.

Infrastructure Investment: Investing in technological infrastructure to support digital euro transactions is critical. This includes upgrading payment systems, enhancing cybersecurity measures, and ensuring interoperability with existing digital payment platforms.

By preparing now, the financial sector can ensure a smooth transition and capitalise on the digital euro's benefits, aligning with consumer expectations and technological advancements.

Author: Günther Petelin, Senior Advisor BFI

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