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The digital euro - an opportunity for Europe
Autumn meeting of the Wildbader Kreis

06.11.2023 I Darmstadt I Joachim Nagel

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1 Introduction

2 Digital transition in the payments space
3 Protecting privacy

4 European sovereignty in payments

5 Potential risks posed by the digital euro

6 Closing remarks

1 Introduction

Ladies and gentlemen,

I am delighted to be joining you today as a guest speaker at this year's Wildbader
Kreis autumn meeting. Thank you very much for inviting me.

Savings banks are an integral component of the German financial industry. Last year,
savings banks accounted for 15% of the aggregated total assets of all banks
domiciled in Germany. And the share is far larger - twice as large, to be precise - if
we're looking at loans to households and non-financial corporations. The savings
banks group, then, has an important role to play in tackling the challenges that the
future brings with it.

One of these is a growing customer preference to bank digitally. The coronavirus
pandemic added to this trend. The savings banks group has likewise embarked on a
mission to make its business more digital in response.

And digital transformation is what I want to talk about in my speech today, too.
Over the past half-century, the financial industry has been at the vanguard where
this global megatrend is concerned. There's one example I dare say we're all familiar
with: ATMs (Automatic Teller Machine). Because, in many ways, the

ATM (Automated Teller Machine) has been a trailblazer in terms of cutting-edge
digital technology. The accelerometers, biometric scanners and micro-cameras built
into our smartphones today were road-tested in ATMs (Automatic Teller Machine)
years earlier.[1]

The ATM (Automated Teller Machine) was also lauded by former US (United States)
Federal Reserve chief Paul Volcker. In 2009, Volcker apparently declared that "the
ATM (Automated Teller Machine) has been the only useful innovation in banking for
the past 20 years" [2] Volcker was of course exaggerating for ironic effect there. He
was actually talking about the numerous innovations in the securitisation market
that contributed to the 2008 financial crisis. Back then, we central bankers, too, had
years' worth of homework to do with respect to financial stability and banking
supervision so as to make sure that the ATM (Automated Teller Machine) didn't
actually end up being chalked up as the only useful piece of financial innovation. I
think we did well.

Nowadays, in the age of the smartphone, the digital transition means that cash as a
means of payment, and thus ATMs (Automatic Teller Machine), too, are gradually
being used less and less. That's true even though cash still ranks as the most
frequently used means of payment in Germany.[3]

So far, though, banknotes and coins have been the only way for individuals to pay
with central bank-issued currency. This is one reason why around 90% of central
banks around the world are currently working on projects concerning central bank
digital currency, or CBDC (Central Bank Digital Currency) for short.[4] The
Eurosystem is among their number. The digital euro is meant to complement cash:
the idea is that it will act as the mirror image of cash in the digital world. But it is
also meeting with some degree of scepticism. I'd like to use my speech to dispel
some of that.

I'm going to take a closer look at three key reasons for introducing a digital euro:
the digital transition in the payments space, the protection of privacy, and
sovereignty in payments. I will then spend a bit of time outlining some of the risks
that the introduction of CBDC (Central Bank Digital Currency) could bring with it and
explain how we intend to address those risks.

2 Digital transition in the payments space

The first reason why I believe we need a digital euro is the increasing digitalisation
of payment processes. The digital transformation is generally reducing the
importance of cash. State-of-the-art digital payment solutions are quick and
convenient.

According to a recent Bundesbank survey, it takes less time to make a payment
using a smartphone, smartwatch or PIN (Personliche Identifikationsnummer)-free
card transaction than it does to pay using cash.[5] More and more purchases are
being settled by cashless means, be it through card or smartphone payments in
brick-and-mortar shops or transactions when people shop online.

Another Bundesbank payment behaviour study shows that the proportion of day-to-
day payments settled in cash in Germany fell from 74% in 2017 to 58% in 2021.[6]
It's a similar story if we look at shares of turnover: here we see a drop from 48% in
2017 to 30% in 2021. On top of this, online sales have seen outsized growth over
the past few years. This is depressing the percentage of transactions settled in cash
further still.

But what does an increase in cashless payments mean from an economic
perspective? It means more than just switching from one payment method to
another. Cashless payments are, after all, settled in private (commercial bank)
money. And the flipside to this is that central bank-issued money is being used less
and less in payments.

True, the functions that we are used to seeing from our monetary system can
presumably be ensured even in a world dominated by private commercial bank
money. After all, central bank-issued currency would also have a role to play there,
in the form of central bank reserves, as would public regulation. Nevertheless, as
things stand today, a monetary system in which central bank-issued currency is no
longer widely used would be a significant step into the unknown.

The economists Markus Brunnermeier and Jean-Pierre Landau sum it up ina
nutshell: "Because there is no precedent in modern history without public money, it
would be dangerous to base public policy on that assumption. In such an
environment, what would determine perceived safety for the public is unknown." [7]

Furthermore, many people still appreciate what cash has to offer. According to
Bundesbank surveys, the main advantages of cash payments include the anonymity
of the payment process, the good overview they provide of one's spending, and
direct settlement.[8] These are benefits we will still be able to enjoy in the future
because cash will continue to be a key service provided by the central bank.

By contrast, the digital euro - being the digital equivalent of cash - would give
people more choice in how they pay in the digital sphere. In my view, this would
reduce uncertainties as the way we pay becomes increasingly digital.

3 Protecting privacy

But going digital poses risks in another important area, too - namely the protection
of users' privacy. This ties in closely with the question of data protection. And as far
as the digital euro is concerned, what concerns people most is the disclosure of their
personal information.

The Eurosystem invited people in the euro area to name the features they would
particularly like a digital euro to have. Their feedback was clear: most respondents
consider privacy the most important factor when paying with a digital euro.[9] The
percentage of respondents who regard privacy as the key characteristic is highest in
Germany.

That is something I also hear during personal conversations. People often share their
concerns that the introduction of the digital euro will lead to significant rollbacks in
privacy in the payments space. If anything, the opposite would actually be the case.
You see, strong economies of scale and network effects are a hallmark of digital
payment processes. And these effects work to the advantage of global payment
service providers, enabling them to dominate the market.

But if we allow ourselves to become reliant on worldwide payment platforms, it isn't
always clear what will happen to our payment data further down the line. What
many people aren't aware of is that if you lift the veil on many a state-of-the-art
payment solution, you'll find reams upon reams of external service providers. At
each of these steps, data can be collected and leveraged for commercial purposes.

The digital euro, on the other hand, would guarantee the highest-possible levels of
privacy in the digital space. Customers would have more control over the personal
data made available to service providers offering digital euro services. The
Eurosystem would not have access to their personal information. [10] It would
merely be ensured that public policy objectives, such as combating money
laundering and terrorist financing, can be safeguarded.

4 European sovereignty in payments

The question of European payment infrastructures brings me to my next point,
which has a geopolitical dimension: namely Europe's sovereignty in payments. You
see, the dominance of non-European payment solutions within the European
payments environment might not just be to the detriment of data protection.
Russia's attack on Ukraine in February 2022 was a stark reminder for us here in
Germany of the risks emanating from unilateral dependencies in the energy sector.
Nowadays, though, payments are another key component of national sovereignty in
the fields of economic and security policy.[11]

And yet, 25 years on from the introduction of the euro, the euro area still doesn't
have a cross-border single European solution for digital payments. There's a risk that
traditional cashless payment solutions from private European payment service
providers won't keep up with customer needs. Some Member States have
undeniably rolled out successful innovations in the area of payments - including the
online payment system iDEAL in the Netherlands and the Bizum wallet in Spain, for
instance. However, the reach of such payment solutions is usually limited to national
borders.

Not just that: many national payment procedures have not even managed to carve
out a significant share of their own domestic markets. One of these, I'm sorry to say,
is the German bank-owned payment provider paydirekt, with its payment procedure
giropay.[12] Against this backdrop, the banking industry has recognised the need for
a European solution: back in 2020, a number of euro area banks established the
European Payments Initiative (or EPI (European Payments Initiative) for short). The
aim of the EPI (European Payments Initiative) is to develop a cross-border European
payment solution with a view to making Europe more independent of global
payment providers.

But the digital euro could also make a valuable contribution in this context. It would
give people a standardised digital means of payment that would work in day-to-day
transactions throughout the euro area: at the point of sale, online, and also
between individuals. The digital euro would run on European infrastructures and
add further to Europe's sovereignty in payments.

But sovereignty isn't the same thing as provision by the public sector. Rather, the
digital euro could and should also help private payment solutions become more
resilient and innovative and, at the same time, achieve greater pan-European
acceptance. So it's not a matter of crowding private initiatives out of the payments
space. Quite the opposite; it's about promoting innovation and advances in
productivity together with the banking sector.

5 Potential risks posed by the digital euro

You can probably guess from what I've just said that the introduction of the digital
euro also harbours some risks that warrant consideration. These concern the
stability of the financial system, to name just one example. After all, the digital
euro's availability could create incentives for enterprises and households to shift
deposits out of the banking sector into digital euro. Periods of heightened
uncertainty could see abrupt and substantial outflows that would pose risks to
financial stability.

But even if people only gradually move large volumes of bank deposits into digital
euro, this could still have a detrimental effect on the situation in the banking sector.

That's a scenario experts call "structural disintermediation". Without deposits, banks
would be deprived of an important source of funding, leaving them much more

reliant on bonds or central bank loans than they are at present.

It is difficult to say exactly how that kind of disintermediation would impact on the
flow of credit to the economy. The Eurosystem is firmly committed to preventing this
scenario from happening. To avoid that, there are plans to set a holding limit for
digital euro. The Governor of the Banca d'Italia, Fabio Panetta, formerly a member
of the ECB (European Central Bank) Executive Board, said: "What we want to offer is
a means of payment, not a form of investment."[13] A limit of €3,000 is being
discussed, but the Eurosystem has not taken any decisions on this yet. The exact
amount would only be set by the Eurosystem shortly before the digital euro is
issued.

More broadly, too, we want to avoid the central bank's footprint in the financial
system growing too large. The Eurosystem should not become a commercial bank
for the people of Europe, hence our plan to issue digital euro, but not distribute it.
This would mean that banks, savings banks and payment service providers would
continue to be the face to the customer, as has been the case to date. You see,
we're not looking to replace commercial banks. Our aim is to preserve the long-term
anchor role of central bank-issued currency in the digital world as well.

6 Closing remarks

The Eurosystem is embarking on a new phase in the digital euro project this month:

the preparation phase. This does not yet mean that the digital euro will be

introduced - I would expect that to happen in four to five years' time at the earliest.

Many members of the general public still don't have much of a tangible idea of

what the digital euro project is about. Our work to convince and gain the trust of

the public is cut out for us. But that is not unusual when it comes to technical

innovations. Even after the ATM (Automated Teller Machine) was invented, bank

customers still needed some time to shake off their reservations.[14]

I am firmly convinced that the digital euro will be a success.

Footnotes:

. Shepherd-Barron, J., Meet the true star of financial innovation - the humble

ATM (Automated Teller Machine), Financial times, issue dated 22 June 2017.

. Volcker praises the ATM (Automated Teller Machine), blasts finance execs,

experts. Wall Street Journal, issue dated 8 December 2009.

3. Deutsche Bundesbank (2022), Payment behaviour in Germany in 2021, p. 3.

. Bank for International Settlements (2023), BIS (Bank of International Settlement)

Annual Economic Report 2022, p. 102.

. Deutsche Bundesbank, Schnelles Bezahlen mit Bargeld und kontaktlosen

Zahlungsmitteln méglich, press release, 10 January 2023.

. Deutsche Bundesbank (2022), Payment behaviour in Germany in 2021, p. 26.
. Brunnermeier, M. K. and J. P. Landau (2022), The digital euro: policy implications

and perspectives. Study requested by the European Parliament's committee on
Economic and Monetary Affairs.

8. Deutsche Bundesbank, Payment behaviour in Germany in 2021, p. 12.

9. European Central Bank (2021), Eurosystem report on the public consultation on

a digital euro, April 2021, p. 11.

. European Central Bank, A stocktake on the digital euro: Summary report on the

investigation phase and outlook on the next phase, 18 October 2023, p. 37.

. Balz, B. (2021), Digital payments and European sovereignty,

SUERF (Société Universitaire Européenne de Recherches Financiéres) Policy Brief,
No 146, August 2021.

. Atzler, E., Onlineshopping: Erstmals ist Paypal beliebter als der Kauf auf

Rechnung, Handelsblatt, 11 May 2023.

. Panetta, F., interview with the Financial Times, conducted by Martin Arnold on

14 June 2021.

14. So funktionierte Deutschlands erster Geldautomat, Frankfurter Allgemeine
Zeitung, 25 May 2018.