Fabio Panetta: The cost of not issuing a digital euro
Central bank: ecb | Type: speech | Date: 2023-11-23

## The cost of not issuing a digital euroSpeech by Fabio Panetta Governor of Banca d'ItaliaCEPR-ECB Conference The macroeconomic implications of central bank digital currenciesFrankfurt am Main, 23 November 2023It is a pleasure to be with you today to discuss the implications of central bank digital currencies (CBDCs) from a macroeconomic and policy perspective.I am sure there will be a lot of discussion at the conference about what we can expect if CBDCs are issued.

So let me focus on the counterfactual - the consequences of not issuing CBDCs - using the digital euro as a case study.

Therefore today I will highlight the costs of not issuing a digital euro. 1Throughout

history,

monetary

transformations

have

been

the

result

of

a

dynamic interplay between technological progress, changing human preferences and institutional evolution.In

the

early

Renaissance,

commerce

and

financial

innovation

flourished

in

the

Italian city-states.

The

introduction

of

letters

of

exchange

and

correspondent

banking

freed merchants

from

the

perils

of

transporting

cumbersome

gold

and

silver

coins

and promoted secure methods of payment which, in turn, facilitated international trade.

The substantial wealth of the Italian city-states could then be used as the foundation for the splendour of the Italian Renaissance. 2Today, we are once again at a pivotal point in the evolution of money.

The economic landscape is changing in unprecedented ways.

Digital innovation has ushered in a new age with the potential to unlock enormous opportunities.

These changes inevitably affect payments and money, which are becoming as digital as our economies.Central banks around the world are preparing for this new digital era, recognising both the opportunities and the challenges it brings.

They are actively exploring the potential1 This

counterfactual

approach

was

famously

employed

in

the

Cecchini

report,

which

made

the

case for the Single Market by assessing the 'cost of non-Europe', defined as the untapped potential of the European internal market due to its incomplete integration.

See Cecchini, P., Catinat, M., Jacquemin, A. (1988). 'The Benefits of a Single Market', Wildwood House.2 Ferguson, N. (2009), 'The Ascent of Money: A Financial History of the World', 10th Anniversary Edition.of

issuing

a

digital

payment

instrument

alongside

cash

as

a

logical

next

step

in

the evolution of central bank money.

According to a BIS survey 3 , in 2022, out of a pool of 86 surveyed central banks, 80 (or 93 per cent) engaged in some form of CBDC work, ranging from research and proof of concept to pilots and also live CBDCs.

The European Central Bank is one of these, as the Governing Council of the ECB has recently decided to launch the preparation phase of the digital euro project. 4Central banks have long provided reliable means of payment as a public good and an anchor of stability for the financial and monetary system.

Why should they not do the same in the digital age and be the only ones not to offer a digital version of their product?But

there

are

sceptics

today

who

claim

that

issuing

CBDCs

would

be

fruitless.

Some believe that a digital euro may not be successful enough ; many ask what specific benefits it could offer that existing payment methods do not already provide.

At the same time, others fear that a digital euro could be too successful and create instability by potentially challenging traditional bank deposits.These opposing concerns deserve close attention, and clear responses.A digital euro would be a digital form of cash that could be used for all digital payments throughout the euro area, free of charge, both online and offline.

It

would

offer

the highest level of privacy by default and allow users to settle payments instantly in central bank money.

It could be used for person-to-person (P2P), point-of-sale, e-commerce and government payments.

No existing digital payment instrument offers all these features.The digital euro would fill this gap.

And its design features would prevent its introduction from

triggering

financial

tensions

and

provide

appropriate

incentives

for

all

parties involved.

It would contribute to financial inclusion while fostering integration, innovation and resilience in the European payments market.But above all, the concerns that are sometimes expressed also tend to overlook a crucial consideration.Assessing the prospective advantages and disadvantages of CBDCs on the assumption that the payments landscape will not change in the future can be misleading.

To do so would be to ignore the fact that our 21 st century economies are in a state of flux, as evidenced by the multiple technological shocks hitting many sectors of the economy - think of the rise of generative artificial intelligence, to take one recent example.

And the financial services sector is certainly not exempt from the inexorable progress of the digital revolution.

The use of cash is expected to continue to decline, while large technology companies have already begun to expand into the payments market and are increasingly setting their sights on other financial services, thanks to their very large customer base and global operations.

It is against this backdrop that we need to assess the merits of a digital euro.3 Kosse, A., & Mattei, I. (2023).

Making headway-Results of the 2022 BIS survey on central bank digital currencies and crypto.

BIS Papers.4 I will first examine the most important current shortcomings of the European digital payments market and the risk that these shortcomings will be exacerbated by the quest for dominance of technology platforms in a counterfactual scenario where a digital euro is not issued.

I will then argue that the digital euro would offer clear advantages in ensuring a

competitive,

innovative,

open

and

secure

digital

payment

system,

while

maintaining the highest standards of privacy protection.

I will also discuss how potential risks to the financial sector can be effectively mitigated through the careful design of safeguards.

## The counterfactual: technology firms' quest for dominanceThe

rapid

digitisation

of

payments

is

a

prevailing

trend

that

was

accelerated

by

the Covid-19 pandemic.

The share of payments made via mobile applications and the share of consumer online payments tripled in the euro area between 2019 and 2022. 5Consumers are clearly embracing the efficiency and convenience of digital payments.

However, this transformation is associated with a number of challenges for the European payments market.While pan-European credit transfers and direct debits work thanks to European payment schemes and infrastructures, 6

this

is

not

the

case

for

cards

and

certain

types

of

online payments - whose use is growing disproportionately.

This means that, as digitalisation progresses, pan-European payments are in the hands of international players, increasing our dependence on the payment rails they provide.A handful of international companies dominate domestic and cross-border card and online payments.

International

card

schemes

operate

payment

networks

that

are

exclusively compatible with their point-of-sale terminals.

This situation raises barriers to entry and expansion and discourages potential competitors from setting up new payment networks.The situation remains largely unchanged despite regulatory initiative and competition law

enforcement. 7

The

decision

of

European

banks

to

abandon

their

plans

for

a continent-wide card scheme is a stark illustration of the dominant position held by these firms. 8

It

is

also

striking that the average cost of card payments in the EU has been reported to be higher now than in 2015, when the Interchange Fee Regulation came into force. 9

And the scheme fees applied by international card schemes almost doubled between 2016 and 2021 in the EU. 105 .6 SEPA payment instruments - which are the result of a public-private partnership.

See Fabio Panetta's speech at the European Payments Council: sp220616~9f8d1e277b.en.html.7 .8 Rising

from

around

0.08

per

cent

to

0.15

per

cent.

See

 uploads/CMSPI-Zephyre-Scheme-Fee-Study-V3-1.pdf.As a result, and given the difficulty of using cash in e-commerce, consumers are faced with prevailing payment solutions that work well, but may not be sufficiently tailored to their needs and preferences in terms, for example, of privacy 11

and pan-European reach.

This situation leads to unnecessary complexity and costs, as consumers are forced to rely on a variety of payment methods depending on the specific transaction and counterpart involved.

Surveys

show

that

consumers

value

the

possibility

of

benefiting

from

a universally accepted payment method across online and physical stores in Europe. 12In essence, the current state of digital payment markets already justifies the introduction of a truly public and openly accessible payment solution to safeguard competition, better meet user needs and preserve European autonomy.

This is likely to become even more critical in the future, as further expansion of large technology companies into payments would make the concerns I have outlined even stronger and more pressing.Three challenges deserve careful consideration.The

first

is

the

drive

for

dominance

of

technology

platforms.

These

companies

are increasingly entering the financial sector and reshaping financial markets.

The logic of platforms revolves around bundling various activities, including financial ones, with the aim of expanding their customer base and enhancing network effects.

By creating closed ecosystems, or 'walled gardens', they reduce competition. 13This is not far-fetched fiction.

Concerns about platforms favouring their own products have already been at the forefront of antitrust cases.

In as far back as 2010, the landmark European antitrust case known as the 'browser wars' exposed the ability of companies to restrict competition.

More recently, the European Commission took issue with Apple's decision to prevent app developers of rival mobile payment wallets from accessing the necessary hardware and software on its devices.

This was done to favour its own solution, Apple Pay. 14It is inevitable that technology platforms, armed with their large customer base and big data processing capabilities, will expand their reach into financial services to attract new customers - at the risk of reducing competition.

In China, big tech companies such as11 Payment data are often used for purposes other than those strictly related to payment execution.

For example, payment providers may work with private credit scoring companies that inform landlords, creditors and service providers about the individual trust score of their prospective clients.

Data obtained from the payment process are also used by merchants in tailoring their offering, using profiling techniques to understand a payer' s spending capacity or their preferences to increase the effectiveness of certain marketing campaigns. techdispatch-22021-card-based-payments\_en.12 See and By

adopting

the

commercial

practices

of

bundling

and

price

discrimination,

suppliers

can

replicate monopoly pricing and extract consumer surplus from their customers.

See Adams, W. and Yellen, J., 'Commodity bundling and the burden of monopoly', The Quarterly Journal of Economics, Vol. 90, No. 3 (August 1976).

See also Jullien, B. and Sand-Zantman, W., 'The Economics of Platforms: A Theory Guide for Competition Policy' (July 2020).

CEPR Discussion Paper No. DP15071; Brunnermeier and Payne, 2022 and Tencent have overtaken the digital payment and e-commerce sectors, and are expanding into financial intermediation. 15

As a result, between 2020 and 2021, big tech credit in China grew at an average annual rate of 37 per cent, outpacing the growth rate of bank credit by more than 20 percentage points. 16Western technology companies are also increasingly challenging financial institutions, seeking to compete with traditional banks as financial service providers. 17

In the United States, Apple's new savings account, linked to its payment solutions, offers interest at more than 10 times the national average rate, 18

and has attracted more than 10 billion dollars in user deposits since its launch in April. 19

And X (formerly Twitter) is reportedly planning

to

offer

a

full

range

of

payment

and

financial

services. 20 Amazon

offers buy-now-pay-later services to its customers worldwide.This

brings

us

to

the

second

concern

about

the

dominance

of

technology

platforms, that

of

privacy.

Through

their

involvement

in

payments,

large

technology

companies have

access

to

extensive

customer

information

-

including

income,

preferences

and demand patterns.

This information is key to their business model, whether it is based on

advertisement

revenue,

sales

of

technology-intensive

products

and

services

or e-commerce.

Their quest for data will only increase with the development of artificial intelligence and big data techniques.Market forces alone will not satisfy the demand for digital money with socially desirable levels

of

privacy.

As

I

have

mentioned

above,

extensive

use

of

payment

data

allows big tech companies to price discriminate between customers, cross-sell products and increase margins on their advertisement and commercial services. 21Even if most consumers do not perceive these indirect costs, many have become highly sensitive to the use of their personal data derived from digital payments, as shown by the

results

of

the

Eurosystem's

public

consultation

on

a

digital

euro. 22 They

are

also15 ;

Ant Financial's Yu'e Bao is China's largest money market fund and one of the largest worldwide, providing on-demand redemptions and close substitutes for bank deposits at higher returns than bank deposits; see also pandp.20191012.16 ; the share of online payments in consumers' non-recurring payments increased from 6 per cent in 2019 to 17 per cent in 2022.

Mobile phone app payments increased in P2P payments.

The share of payments using mobile apps increased threefold between 2019 and 2022.18 .21 h t t p s : / / w w w . e c b . e u r o p a . e u / p u b / p d f / s c p w p s / e c b . w p 2 6 6 2 ~ f a 8 4 2 9 a 9 6 7 . en.pdf?4f8b773dd930231c86ed40bb29ff9eca .22 euro~539fa8cd8d.en.pdf.aware that, in the absence of a digital form of cash, they do not have an attractive and convenient alternative that meets their desired level of privacy.The third concern about the rise of technology platforms is that they may start issuing their own digital payment instruments, posing risks to the functioning of the payment system, monetary sovereignty and financial stability.This is a real possibility, as illustrated by the decision of PayPal - a big-tech-like company with a user base of 450 million - to launch its own dollar-denominated stablecoin.

Big Tech issuance of their own currencies will be focused on maximising profits rather than taking responsibility for monetary and financial stability.

Depending on the scale of adoption, stablecoins may lead to the fragmentation of the payment system, as they are structured as 'closed-loop solutions' that restrict payments to users who adopt a particular payment tool.

And, as I have stressed in the past, 23

Big Tech would not be concerned about avoiding disruptions to financial intermediation, preventing excessive outflows of bank deposits and ensuring a balanced compensation model, as instead a central bank would be.

On the contrary, they would deliberately seek to change the market structure to their advantage.In other words, without policy intervention, the growing role of technology platforms in payments and financial services could have a strong negative impact on the financial sector, disrupting the prevailing financial intermediation process.

## Digital Euro: Forging a sustainable digital futureRegulatory

measures

can

go

a

long

way

towards

countering

the

negative

effects and

preserving

the

integrity

of

the

digital

payment

system, 24 although

tackling

the anti-competitive practices in the payment landscape is a highly complex task.

It requires a

fresh

look

at

the

existing

toolkit

and

enhanced

international

cooperation given the global nature of the phenomenon. 25But it is important to recognise that regulation alone cannot replace the essential role of public money and the confidence it inspires. 26Consider, for example, the introduction of euro banknotes in 2002, when people started counting, paying, contracting, and setting prices in euros.

Without the introduction of paper

banknotes,

the

euro

might

have

been

perceived

as

a

mere

pegging

of

earlier currencies to a synthetic unit of account, rather than as a fully-fledged currency, backed by strong trust, which is the foundation of Economic and Monetary Union.23 Brunnermeier and Landau, 2022.Similarly, without the European Central Bank issuing digital money - that would provide a common unit of account and a convertibility anchor underpinning the various forms of private digital money - consumers could lose sight of a visible symbol linking money to the State.

This could undermine trust in money and ultimately monetary sovereignty.Moreover,

it

remains

unclear

to

me

why

central

banks,

charged

with

fulfilling

their mandates, should stand idly by in the face of digitalisation.

The changes affecting money and payments are at the core of central banks' responsibilities.

In today's technological landscape, central banks cannot confine themselves to merely providing paper money.

They have a responsibility to satisfy

people's

needs,

which

increasingly

favour

digital payments over physical cash.Issuing a digital euro as a form of digital cash would ensure that public money remains an option available to all, providing a convenient payment instrument with a pan-European reach.

And it would provide an alternative payment network to those operated by the dominant card and online payment solution providers, making it easier and cheaper for supervised intermediaries to offer new, pan-European services.The benefits of a digital euro would be amplified in the context of the potential disruption caused by a handful of large technology companies seeking to dominate the payments market.

It would play a key role in fostering competition, protecting privacy and enhancing stability.Let me start with competition.

A digital euro would be driven by public interest, promoting open standards to create a network that benefits everyone, rather than serving private interests by creating 'walled gardens'.

A digital euro would avoid the creation of closed loops,

and

instead

offer

all

payment

service

providers

(PSPs)

an

open

platform

for innovation, immediately scalable at European level.

Nowadays, the novel and advanced payment

solutions

available

in

many

European

countries

encounter

challenges

in achieving a pan-European dimension, with direct costs for European citizens who cannot fully harness their benefits.Unlike digital platforms and e-payment solutions such as PayPal, a digital euro would allow

banks

to

maintain

their

customer

relationships,

thereby

stimulating

innovation within banks.Finally,

the

reduction

of

market

power

would

ultimately

lead

to

lower

charges

for merchants and consumers.

A digital euro would ensure that, as the use of cash declines and private companies offering digital payment options gain a larger market share, the benefits do not accrue exclusively to these private companies, but also to consumers and merchants.

In addition, it

safeguards

the

role

of

central

bank

money,

preserving seigniorage - the profit made by the State as the issuer of the currency - for the benefit of taxpayers.The second advantage of a digital euro is its ability to preserve privacy in digital payments.

In

this

respect,

it

has

a

notable

advantage

due

to

the

absence

of

profit-maximising incentives on the part of its issuer, the ECB.In

addition,

a

specific

legal

framework

would

establish

strict

privacy

requirements: for example, the legislative framework proposed by the European Commission would ensure that the ECB has no access to users' personal data.

Furthermore, offline payments would also offer enhanced privacy, as they would not require any third-party validation, relying only on the direct transfer from payer to payee.The third benefit of a digital euro is its potential to contribute to long-term stability.

Unlike the potentially disruptive changes expected from large technology firms vying for dominance in digital payments (and, potentially and more broadly in financial services, at a later stage), the issuance of a digital euro will not cause instability in the financial system.

On

the

contrary,

it

would

maintain

healthy

competition

in

digital

payments, thereby promoting the overall resilience of the financial sector.Crucially, its design features would allow the ECB to maintain a balance between private money, such as commercial bank deposits, and central bank money.

Features such as holding limits can be calibrated to avoid any undesirable consequences for monetary policy, financial stability and the allocation of credit to the real economy. 27In all likelihood, the process of digital euro adoption would unfold gradually, as is often the case for new payment methods, reducing the risks of cliff-edge effects on bank deposits.

However, to manage the transition well and to mitigate the risk of tensions along the way, the holding limit could be initially set below the intended steady-state level and gradually increased towards it.

Ultimately, the limit should neither be so restrictive as to hamper the convenience of the digital euro as a means of payment, 28

nor so lax as to ignore the risk of excessive deposit outflows. 29The holding limit will be chosen on the basis of thorough empirical analysis, using models to simulate its effects and alternative transition strategies.

Appropriate calibration will also need to ensure robustness to differences between banking markets and supervised intermediaries.And when it comes to the impact of a digital euro on run risks, it is important to remember that depositors do not need digital central bank money to run from a bank.

They can already do so by withdrawing cash or digitally, by moving deposits to an account held with another intermediary.

In fact, CBDCs could even help mitigate run risks.

A digital27 Adalid,

R.

et

al.

(2022),

' Central

bank

digital

currency

and

bank

intermediation:

Exploring

different approaches for assessing the effects of a digital euro on euro area banks ', Occasional Paper Series , No 293, ECB, May; Meller, B. and Soons, O. (2023), ' Know your (holding) limits: CBDC, financial stability and central bank reliance', Occasional Paper Series , No 326, ECB, August; Bindseil, U., Panetta, F. and Terol, I. (2021), 'Central Bank Digital Currency: functional scope, pricing and controls', Occasional Paper Series , No 286, ECB, December.28 Linking a digital euro wallet with a commercial bank account could reduce the impact of the holding limit on convenience.

First, it would always be possible to receive a payment, even if the amount to be received raises the digital euro balance above the holding limit.

The excess amount would be transferred automatically

to

the

linked

commercial

bank

account

(waterfall

functionality).

Second,

if

there

are insufficient funds in the digital euro account when making a payment, the shortfall could be transferred immediately from the linked commercial bank account (reverse waterfall functionality).29 Assenmacher et.al., forthcoming, 'Managing the transition to central bank digital currency'.euro could provide real-time information on outflows of bank deposits, allowing for a quicker response to incipient runs, which, in turn, would help stabilise expectations by increasing depositors' confidence. 30

## ConclusionsLet me conclude.I know that the aspects I have raised are difficult to model, but I am also convinced that they are crucial and must be taken into account when analysing the effects of a CBDC on welfare, economic growth and risks.Central banks have a mandate to ensure stability - both monetary and financial - and are therefore naturally inclined to be prudent.But prudence should not mean inaction.

The cost of not issuing a digital euro could be significant.Central bank digital currencies would bring considerable benefits to digital payments.

As the large technology companies further expand into digital finance, the availability of

digital

central

bank

money,

together

with

effective

regulation,

would

become necessary to ensure competition, privacy and the smooth functioning of payments and the financial intermediation process.As

forward-looking

policymakers,

the

central

banks

of

the

Eurosystem

are

preparing - including through the possible issuance of a digital euro - to address the risks that the digital revolution poses to monetary and financial stability.

Carrying out this complex transition phase to the benefit of the well-being of everyone is the ultimate goal.Thank you for your attention.30 Keister,

T.

and

Monnet,

C.

(2020),

'Central

Bank

Digital

Currency:

Stability

and

Information',

Rutgers University and University of Bern, mimeo.