Digital euro could stress smaller banks

The association describes the conceivable consequences of the 3000 euro scenario as “devastating”. In the BVR stress scenario, all customers would convert 3,000 euros into digital currency. As a result, the institutions concerned would either have to obtain liquidity elsewhere on less favorable terms – for example by offering higher interest rates on deposits – or limit lending in order to achieve the prescribed liquidity cushion again.

From the point of view of the association, this would have consequences for the economy, because interest rates on bank loans could then rise. Smaller companies in particular would be affected, as they would not be able to easily switch to financing via the bond market.

The calculations by the BVR represent the first concrete impact assessment of the possible consequences of a digital euro for the banking system. They fuel the debate as to the extent to which digital central bank currencies can pose a threat to the stability of the financial system.

The background: as long as customer funds are normally in the account, they are considered liquidity for the bank. Legally, bank deposits are loans from customers to their bank. However, if customers convert their credit into digital euros, they become a customer claim against the European Central Bank.

The study is also criticized

There are experts who wish to remain anonymous who consider the BVR scenario to be exaggerated. The association itself also admits that the 3000 euro scenario is an “extreme scenario”. “It assumes that all active private customers really have bank balances of at least 3,000 euros,” said BVR chief economist Andras Bley of the Handelsblatt. However, this is by no means the case with every customer, so the calculated outflows are likely to be too high.

The study also assumes that all active customers actually convert bank balances of 3,000 euros. Critics doubt that all customers are really interested in the digital euro. Studies by the ECB also suggest that customers would probably not fill up their “purse” for the digital euro permanently, but would rather top it up at the beginning of the month and then use it up.

But despite all the criticism, there is a widespread fear among experts that customers will withdraw their trust from financial institutions in times of crisis and would rather entrust their money to a central bank like the ECB.

This is also the conclusion of studies, such as a study by the Center for Economic Policy Research (CEPR) from 2021. Central banks are aware of the danger. Therefore, they are likely to introduce caps per customer for their digital currencies.

“We will ensure that a digital euro does not pose any risks to financial stability. In its design, it will be possible to set a cap on holding digital euros, although no decision has yet been made on the exact amount,” ECB Director Fabio Panetta said in a recent interview with Handelsblatt. “We want the digital euro to be a means of payment and not a form of investment.”

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In the past, however, Panetta had repeatedly brought a sum of 3,000 euros per customer into play. In its first publication, the ECB divided the banknotes in circulation by the number of EU residents. With 3000 euros, the ECB would be much more conservative than the Bank of England. Their Deputy Governor Jon Cunliffe spoke out in early February for a cap of £20,000 per person. However, nothing has been finally decided in Great Britain either.

“Many details are still missing about how the digital euro will be designed. But the study shows that it would be important to carry out comprehensive impact analyzes in advance, taking into account the different business models of the banks and different regions,” BVR chief economist Andreas Bley told the Handelsblatt. An average view hides the fact that the digital euro can have very different effects on individual institutes.

It can even hit highly liquid institutions

Because the BVR investigation also had surprises. “The analysis shows that, depending on the design, even banks with very ample liquidity cushions can feel the strong effects of the digital euro,” explained Bley. The customer structure of the institutes plays an important role, i.e. the question of how many private customer deposits a bank has.

The deputy general manager of the Association of German Banks, Henriette Peucker, recently criticized the fact that the ECB had so far not carried out a detailed impact assessment on the issue of possible deposit outflows and had not examined which upper limits would have which effects.

The BdB, which is fundamentally in favor of a digital euro, is in favor of “very clear upper limits” in the debate in order to ban outflows of deposits and the risk of a digital bank run. The BdB did not name a specific sum in its recently published position paper. The cooperative banks are more specific. “We are in favor of a digital euro that can be used as a kind of digital wallet. 500 euros are enough for that,” said Bley.

The BVR investigation is part of a presentation by the German banking industry, i.e. the umbrella organization of all German banking associations, which was presented to the ECB at the end of January. The central bank did not want to comment on the results of the study when asked because they were not public.

In autumn 2021, the ECB launched a two-year investigation phase to determine the core characteristics of a digital euro. This October, the decision is to be made as to whether a digital euro should be developed at all. It would probably be another three years before it would be available. The EU Commission is expected to present a legislative proposal this spring, which will then be discussed by the member states and the EU Parliament.

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