The European Central Bank (ECB) has moved a step closer to pursuing a digital euro, becoming the latest global central bank to seriously consider following China’s lead in creating a digital currency.
China appears to be the clear leader in developing a sovereign digital currency, with pilot tests under way in several parts of the country.
But other central banks are starting to explore the idea, spurred on in part by the attention the Chinese project is getting and the nation‘s advanced system of electronic payments through mobile apps.
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The ECB outlined the potential benefits and pitfalls of a digital euro in a report released late last week, saying it must be designed to avoid “adverse effects on monetary policy and financial stability”.
Key risks include the impact on monetary policy, financial stability, the safety and efficiency of retail payments, cross-border flows, cybersecurity and legal and privacy issues, the ECB said.
“The move to introduce a digital currency in which users hold deposits directly with the central bank is quite a radical one, and there isn’t much research done on the effects on the economy, especially the banking sector,” said Leonhard Weese, president of the Bitcoin Association of Hong Kong.
Financial stability could be undermined if banks’ funding costs were affected by depositors changing their savings at commercial banks to a central bank-issued digital currency, the ECB said.
Banks might have to replace the lost deposits with borrowing from the central bank or directly from capital markets, which could mean the ECB would have to expand its role in the economy, potentially forcing banks to take on more risk to earn money.
“Were this demand to increase their funding costs, banks might have to deleverage and decrease the supply of credit, thus preventing an optimal level of aggregate investment and consumption,” the report said, adding this could ultimately drive up the cost of borrowing, hampering economic activity.
“Moreover, if their traditional business model is compromised, banks may decide to take on greater risks in an attempt to earn higher (nominal) returns and to offset the reduction in profitability.”
During a crisis, when savers have less confidence in banks, they might opt for the digital currency and so increase the likelihood and severity of bank runs, risking overall financial stability, the report said.
Despite the dangers, the ECB said it believed a digital euro could enhance the role of the second most traded currency in the world.
“A digital euro would support Europe’s drive towards continued innovation. It would also contribute to its financial sovereignty and strengthen the international role of the euro,” Fabio Panetta, member of the ECB’s Executive Board and chair of the digital currency task force, said.
China’s central bank has said it is important to become the first nation to issue a digital currency as part of its push to internationalise the yuan and reduce its dependence on the dollar payment system.
A growing number of central banks around the world are considering launching digital currencies. Sweden’s Riksbank is trialing the use of an e-krona, but the Reserve Bank of Australia concluded in a report last month there was no need for a digital currency at present.
The ECB report also recommended limited distribution and use of its digital currency by corporate entities and individuals “to prevent excessive shifts of commercial bank money into digital euro”.
“The technical implementation of a digital euro needs to be thoroughly tested and legal considerations carefully examined before any decision is taken on issuance,” said the ECB report, adding that it will come back with a decision “towards mid 2021” on whether to start a digital euro project.
The ECB said it has not made a decision yet on whether to launch a digital euro but will begin public consultation this week.
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