SPEECH

Modernising finance: the role of central bank
money

Keynote speech by Piero Cipollone, Member of the Executive Board

of the ECB, at the 30¢h Annual Congress of Financial Market
Professionals organised by Assiom Forex

Genoa, 9 February 2024

Since their inception, central banks have continuously adapted to the changing requirements of the

payment sector. They have also taken a keen interest in ensuring it functions smoothly, to protect
financial stability and the implementation of monetary policy.

Central banks provide the financial system with a safe asset at its core: central bank money.
Convertibility into central bank money is what keeps the value of private money stable. And the pivotal
role played by central bank money is what connects all the different parts of the payments system. In
short, central bank money ensures the singleness of money and the integration of the payments
system.

This is particularly valuable in a monetary union like the euro area: central bank money - cash or
reserves - can be used to settle transactions from and to all parts of the euro area. This ensures that
one euro in Lisbon is the same as one euro in Riga.

But for central bank money to retain its stabilising and unifying role, it must stay at the forefront of
technology to ensure it remains an attractive means of settling payment transactions. There is no
reason why central banks should be the only stakeholders not keeping pace with the digital
transformation. In fact, they should be at the vanguard of this transformation, acting as an anchor of
stability for financial innovation and providing a safe path for modernising finance. The Eurosystem is
working to maintain this role.

This is true for retail payments. That is why we are working on a digital euro, so that everyone can use
central bank money not just in its current physical form - cash - but also in digital form.

Today, however, I will focus on new technologies for settling transactions between financial institutions
in central bank money, often referred to as wholesale CBDC to distinguish it from retail CBDC, which is
used by the general public.

Historically, central banks have played a key role in simplifying the settlement of these transactions,
supporting and often leading the transition from physical forms of money to book-entry formats, and to
the electronic clearing and settlement of payments, making it possible to update accounts almost
instantaneously.)

We now find ourselves on the brink of another significant shift: the advent of tokenisation. According to

market participants"), digitally representing claims using distributed ledger technology (DLT) has

great potential. However, this transformation could redefine current financial intermediation and
wholesale settlement structures.

To enable central bank money to continue performing its stabilising role, even as the financial system
undergoes this transformation, we need to find technological solutions that will allow it to also be used
to settle transactions recorded on new DLT platforms.

Let me now explain the role central bank money currently plays as an anchor of stability for wholesale
payments. I will then discuss the promises and risks of new technologies for wholesale payments
before telling you a little more about how we are exploring new technologies for central bank money
settlement of wholesale transactions.

Central bank money as an anchor of stability for wholesale
payments

While "wholesale CBDC' is generally presented as something new, made possible by the emergence
of DLT, central bank money has in fact been available in digital form for wholesale transactions

between banks for decades. In 2022 the Eurosystem's large-value payment system, TARGET2 (T2),
processed 92% of the total value settled by large-value payment systems in euro and remained one of
the largest payment systems worldwide, processing 102.6 million transactions amounting to €570.5

trillion. In other words, every six business days T2 settles transactions equivalent to the euro area's
annual GDP.

Financial institutions use central bank money mainly for two reasons.

First, central banks issue the safest and most liquid settlement asset, avoiding the credit and liquidity
risks associated with private money systems. Being able to convert into central bank money the
money that commercial banks issue strengthens public confidence in private means of payment. This
in turn reassures market participants that the value of a euro is the same, regardless of its issuer.
Second, settling in central bank money limits the risk associated with wholesale financial markets of

payment activities becoming concentrated in individual players.

The widespread use of central bank money to settle wholesale payments therefore minimises the risks
for the financial system as a whole and provides an anchor of stability for payments. International
standards recognise how crucial this is. 8

That's why the Eurosystem has continued to modernise its market infrastructure services to make
them future-proof and ensure they can meet the needs and expectations of market participants.

In March 2023 a new T2 platform was launched, providing modernised services, enhanced cyber
protection and optimised liquidity management across all TARGET services. The platform aligns with
ISO 20022, facilitating the exchange at global level of more granular data in a more structured manner.
Moreover, in November we will launch the European Collateral Management System, a unified system
for managing assets used as collateral in Eurosystem credit operations that will ensure collateral flows
freely across the euro area, contributing to financial integration.

In the context of securities settlement systems, the EU is also considering a shift from T+2 settlement

to T+1 or even T+0, potentially decreasing counterparty credit risk and collateral needs.!2] Successfully

implementing this change requires careful analysis of costs and strong coordination between all
market players. At the same time, we must take into account that other jurisdictions, such as the

United States, are making the transition to shorter settlement cycles. While experience suggests
that the coexistence of different settlement cycles in the EU and other non-EU jurisdictions is feasible

at the technical level], we must prevent this mismatch in settlement times from weighing on the
attractiveness of European capital markets. We must therefore carefully consider whether, and how, to
harness the benefits of aligning standard settlement cycles across major jurisdictions, provided this
does not impair the smooth functioning of EU financial markets and financial market infrastructures.

Alongside these challenges of a more traditional nature, we also face challenges relating to the rapid
digitalisation of the economy. While the market is calling for standard transactions to be settled more
efficiently, it is also calling for solutions to accommodate new use cases. As central bankers, we have
to monitor these developments closely and be prepared to respond to them.

New technologies for wholesale payments: promises and risks

The advent of blockchain technology has spurred experimentation among a broad range of market
players, including banks and financial market infrastructures.

The application of distributed ledger technology to wholesale financial transactions is still at the
exploratory stage, despite the financial industry's strong interest in DLT. Currently only around 22% of

European banks use DLT, while another 22% are testing or experimenting with it."2] But a majority of

market stakeholders surveyed by the Eurosystem expect a significant uptake of DLT for wholesale
payments and securities settlement in the next five to ten years.)

The benefits of DLT for trading financial assets are twofold. First, it can enhance efficiency by allowing
market participants to perform the three key phases of a transaction - trading, settlement and custody
-on the same distributed ledger. Of the many advantages this offers, participants mention lower credit
risk, fewer failed transactions and less need for extensive reconciliation. DLT can operate on a 24/7
basis, which would tackle the issue of international market fragmentation caused by different time

zones. Lastly, the use of smart contracts!" can help streamline the process of verifying and executing
transactions.

Second, DLT opens avenues for new applications, such as providing new ways to raise capital and
trade financial instruments. A shared platform could make the trading of financial instruments more
efficient and resilient, particularly those not currently serviced by financial market infrastructures like
over-the-counter traded securities or credit claims. Thanks to lower costs and reduced complexity, DLT
platforms could be more easily accessed by small and medium-sized enterprises (SMEs). This would
underpin the EU's capital markets union objective to improve SMEs' access to capital." Moreover,
experiments with tokenised bank deposits are underway to assess innovative ways of transferring

funds - using blockchain technology, for example - between clients of the same bank or group of
banks.

DLT is also being explored as a possible means to improve cross-border payments.

However, it is worth noting that these solutions are not always radically innovative, as the benefits
associated with them can also be achieved in other ways. For instance, the Eurosystem's TARGET
Instant Payment Settlement (TIPS) service offers immediate payment settlement in central bank
money 24/7, facilitates automated and conditional payments through application programming
interfaces and is establishing itself as a useful platform for cross-border payments.

Potential DLT-based innovations are still at an early experimental stage. Nevertheless, central banks
cannot afford to sit on the sidelines, as any widespread adoption of such innovations could jeopardise
the anchoring role of central bank money in guaranteeing the efficiency and stability of our payment
system. Many explored DLT use cases involve transactions, notably in securities, currently settled
between banks using central bank money. These include delivery-versus-payment settlement in both
primary and secondary markets, along with recurring payments during the life cycle of securities, such
as coupon payments.

Insofar as these applications lead to a proliferation of decentralised private money-based settlement
systems, including stablecoins and tokenised deposits, they could lead to the refragmentation of
wholesale payments. This in turn could impair central banks' ability to provide liquidity in periods of

financial stress, elevating financial stability risks.

Eurosystem surveys show that this is not the desired outcome for market participants. They would
generally prefer to continue settling in central bank money, or even to expand the range of central bank
money settlement services available.

In fact, the absence of solutions enabling settlement in central bank money could impede innovation
due to the credit risk associated with private settlement assets. Market players might shun promising
new technologies if central bank money is unavailable as a settlement asset.

The availability of solutions for settling DLT-based wholesale financial transactions in central bank
money could have the added benefit of facilitating the interoperability and integration of decentralised
systems. It could also create opportunities to use central bank money to settle transactions currently
settled in commercial bank money, such as over-the-counter derivatives, thereby reducing credit risk in

the system.

The ECB's exploration of new technologies for wholesale central
bank money settlement

The Eurosystem envisages two options for DLT-based infrastructures for settlement in central bank

money.

The first involves unified ledger solutions." In these solutions, euro central bank money and other
assets, such as securities or foreign currency, would be recorded and settled on the same DLT
platform. This could potentially be operated by the Eurosystem or jointly with other parties, subject to
compliance with Eurosystem rules.

Although it may be easier to realise the envisaged benefits of new technologies if all assets and cash
involved in transactions are on the same platform, reaching consensus on how to regulate and

manage this is not without considerable challenges]. This could take years given the difficult
technical, legal, governance and business considerations , especially when multiple types of assets

and jurisdictions are involved."8] Moreover the implications of using DLT for the conduct of monetary
policy need to be fully understood and possible risks duly assessed and mitigated.

Moreover, the move from existing systems to DLT platforms is likely to be gradual, as the market is still
in the early stages of development and market players still need to make major technological
decisions. This means there would be coexistence with legacy systems, whether operated by central
banks or private stakeholders. This situation calls for solutions that can adapt to rapid market
innovation while still serving traditional use cases and enabling seamless interaction between old and
new systems. By achieving sufficient harmonisation and interoperability, there is a good chance that
the desired automation can be attained, even across different platforms.

The second option for DLT-based infrastructures for settlement in central bank money is thus based on
interoperability-type solutions. Such solutions are likely to be faster to develop and less costly, and
they do not prevent us from continuing to assess unified ledger solutions. The Eurosystem has for
some time been looking at interoperable solutions and conducting exploratory work in cooperation with
interested market participants. These solutions could respond to immediate market demand and
involve creating a link between market DLT platforms and central bank payment infrastructures. This
link would, for example, enable securities or foreign currency transfer on a DLT platform to trigger
settlement in euro central bank money, which may alternatively be provided in the form of DLT tokens,
registered on a platform operated by the Eurosystem, or in central bank accounts in infrastructures
based on existing technology.

Several interoperability-type solutions have been developed by national central banks within the
Eurosystem, including the Deutsche Bundesbank's Trigger Solution, the TIPS Hash-Link solution

developed by the Banca d'Italia and the Banque de France's Full DLT Interoperability solution.

The Eurosystem's exploratory work consists of experiments involving mock transactions and trials in a
test environment in which a limited number of actual transactions will be settled. In December we
published a call for expression of interest to participate in these experiments which will be conducted
this year. The results will form the basis for the Eurosystem's future considerations about wholesale
payment infrastructure.

The Eurosystem is not alone in exploring new technologies for wholesale financial transactions.
Currently, up to 86 central banks around the world are exploring various ways to interact with DLT

platforms."2] Cross-border projects coordinated by the Bank for International Settlements (BIS) and its
innovation hubs are exploring how new technologies could potentially improve cross-border
transactions.

Achieving a truly integrated market for wholesale transactions, whether DLT-based or not, requires
collaborative efforts between public authorities, central banks and the market. In this respect, the

European Union is at the forefront. By adopting a pilot regime!" for DLT-based market infrastructures,
European legislators have made it possible to experiment using real transactions. And by developing a
solution for central bank money settlement of wholesale financial transactions recorded on DLT
platforms, the Eurosystem is backing regulation with innovation. This has the potential to give Europe
a competitive advantage in developing its industry base for DLT trading and in supporting the

international role of the euro./24]

Stakeholders considering a move to DLT should ensure they do not trigger the recurrence of market
fragmentation. This involves enabling interoperability between platforms, harmonising protocols or
adopting a common data taxonomy. Agreeing on industry standards and implementing them across the
ecosystem is crucial, not only for DLT-based transactions but also for settlements using existing
technologies.

Conclusion
Let me conclude.

The rapid growth of digital technologies has sparked widespread market interest and experimentation.
DLT-based technology is seen as promising, with the potential to increase efficiency for some existing
transactions and to facilitate new use cases.

But we must be cautious that such innovations do not undermine the stabilising role of central bank
money in settling transactions among financial institutions. Instead, central banks must be ready for
the possible broad adoption of new technologies and keep pace with them as they have done in the
past. This will help to combine innovation with financial stability, facilitating the modernisation of
finance.

Achieving this requires public-private partnership to shape the future ecosystem for wholesale central
bank money settlement. This collaboration should harness the benefits of new technologies while
ensuring that settlement remains secure and efficient.

As we push the technology frontier, we must recognise that there are still many aspects that need to
be understood in greater depth. The Eurosystem is playing its part by making central bank money
solutions available for exploratory work. It is also conducting further analysis to develop its vision for
the future wholesale financial transactions ecosystem. However, it is ultimately the market's
responsibility to demonstrate the added value of DLT for wholesale business cases, and to establish
and implement the necessary standards.

Thank you for your attention.

1.

I would like to thank Mirjam Plooij, Cyril Max Neumann and Jean-Francois Jamet for their help in
preparing this speech.

2.

See Cipollone, P. (2023), "The digital euro: a digital form of cash", ECB, 17 November; and Panetta, F.

(2023), "Shaping Europe's digital future: the path towards a digital euro", introductory statement at the
Committee on Economic and Monetary Affairs of the European Parliament. See also ECB (2023),

"Digital euro: The next step in the advancement of our currency", 18 October; and ECB (2023), "A

stocktake on the digital euro - Summary report on the investigation phase and outlook on the next

phase", 18 October.
3.

Norman, B., Shaw, R. and Speight, G. (2011), "The history of interbank settlement arrangements:

exploring central banks' role in the payment system", Working Paper, No 412, Bank of England, June.
4.

According to this article, 97% of institutional investors believe it will revolutionise asset management.

5.

Distributed ledger technology (DLT) refers to a family of technologies that allow users to modify
records in a shared database (the ledger) without relying on a central validation system.

6.

In other words, wholesale CBDC already exists. What is new is the exploration of solutions for central
bank money settlement of wholesale financial transactions recorded on distributed ledger technology

(DLT) platforms. See Panetta, F. (2022), "Demystifying wholesale central bank digital currency",

speech at the Symposium on "Payments and Securities Settlement in Europe - today and tomorrow"
hosted by the Deutsche Bundesbank, Frankfurt am Main, 26 September.

7.

See ECB (2023), TARGET Annual Report 2022, June.

8.
See Bank for International Settlements, (2012), "Principle 9: Money Settlements", Principles for
financial market infrastructures, April. This principle foresees that "[a financial market infrastructure

(FMI)] should conduct its money settlements in central bank money where practical and available.".

9.

See European Securities and Markets Authority (2023), Call for evidence - On shortening the
settlement cycle, 5 October.

10.

China has transitioned to T+0 for interbank market government bonds. India has already moved to T+1
for shares traded on exchange while the United States and Canada are planning to move to T+1 fora
broader set of financial instruments by the end of May 2024. The United Kingdom is assessing a

possible move to T+1 or T+0.

11.
Both the US government and government agency debt markets as well as the UK government bond

markets have been settling on a T+1 basis for a few years now.

12.

See European Banking Authority (2023), "Box 10: Digitalisation trends at banks", Risk Assessment
Report of the European Banking Authority, December.

13.

See ECB (2024) "Central bank money settlement of wholesale transactions in the face of technological
innovation", Economic Bulletin, Issue 8/2023.

14.

Smart contracts can be used to automatically check if a contract's terms and conditions have been met
before executing the resulting action, e.g. a transaction or a flow of information.

15.

See Lagarde, C. (2023), "A Kantian shift for the capital markets union", speech at the European
Banking Congress, Frankfurt am Main, 17 November; and Panetta, F. (2023), "Europe needs to think
bigger to build its capital markets union", The ECB Blog, 30 August.

16.

This would not imply one global ledger for all assets and use cases. There could be a multiplicity of

individual unified ledgers, potentially connected to each other and to existing systems.

17.

the old, enabling the new", BJS Annual Economic Report, 20 June.

18.

Consolidation on a common platform - or perhaps more realistically on a limited number of platforms -
could be a long-term objective. However, this requires carefully assessing the implications of making
central bank money available on a platform that may be jointly operated with others or may involve
participants that do not currently have access to central bank infrastructures, new categories of market
participants or participants in other jurisdictions. Before moving towards any common platform,
assurance is needed that it can be implemented in such a way that central banks can continue to meet
their objectives, not least as regards the conduct of monetary policy. For the Eurosystem, a key
requirement would be the ability to control the central bank money we issue: any risk of external
parties creating or destroying euro central bank money, or euro central bank money falling into the
hands of anyone ineligible to hold it, must be avoided.

19.

See Kosse, A. and Mattei, I. (2023), "Making headway - Results of the 2022 BIS survey on central

bank digital currencies and crypto", BIS Papers, No 136, Bank for International Settlements, July.

20.
See Regulation (EU) 2022/858.

21.

the "Ten years with the euro" conference, Riga, 26 January.