In its assessment of the potential economic and banking impacts of a central bank digital currency (CBDC) for the euro area, European Central Bank economists Ulrich Bindseil, Marco Marrazzo and Stephan Sauer examined the effects on central bank profitability, risk-taking, capital and other factors. Published as an occasional paper on 14 November 2024, their findings suggest that the financial impact on central banks is likely to be modest.

The economists argue that factors such as the decline in cash usage, along with the design features of retail CBDCs that limit their appeal as a store of value, could offset any growth in central bank liabilities. Furthermore, while the introduction of rCBDCs would create a new form of central bank monetary liability, it is unlikely to result in significant balance sheet expansion or drastically increased financial risks, contrary to common assumptions.

The study analysed several key design parameters for the digital euro, which could significantly influence its uptake and, consequently, its impact on central bank finances. These parameters include remuneration rates, holding limits, access restrictions and features intended to discourage the stockpiling of rCBDCs. For instance, the ECB has proposed that its digital euro would not pay interest and that households would face a €3,000 limit on rCBDC holdings. Additionally, certain features, such as the ‘reverse waterfall’ mechanism, would ensure that users do not need to pre-fill their digital wallets, allowing funds to be automatically drawn from their bank accounts when necessary.

Bank profitability

The authors argue that the overall effect of rCBDC issuance on central bank profitability will depend on several factors, including the volume of digital currency in circulation and the extent to which it replaces banknotes. They highlight that a pure exchange of banknotes for rCBDCs would not significantly affect central bank balance sheets. However, if significant quantities of rCBDCs are adopted, this could lead to higher income for central banks, especially in a positive interest rate environment. Despite this, they caution that the likely limited demand for CBDCs--due to design constraints--means any increase in income is likely to remain modest.

Cash to digital euro

As of December 2023, €1.567trn in banknotes and €33.5bn in coins were in circulation within the euro area. The report models three possible scenarios for rCBDC take-up.

In the “low demand” scenario, where euro area citizens carry an average of €83 in cash at the start of the day, the average demand for digital euros is estimated to be around €30bn.

In a “medium demand” scenario, where half of the nearly 350m euro area residents adopt the digital euro and choose to pre-fill their wallets to €1,500 (half of the assumed maximum holding limit) instead of using the on-demand ‘reverse waterfall’ mechanism, the take-up would rise to €125bn.

Finally, in a “high demand” scenario, where 80% of eligible euro area residents adopt the digital euro and hold the maximum permissible amount of €3,000, the total take-up could reach approximately €512bn.

In contrast, this would lead to a decrease in banknotes and potentially deposits held by households, which could affect bank profitability. The resulting balance sheet changes, combined with assumed interest rates, would have an impact on bank profitability, according to the economists. To put these numbers in context, the Eurosystem made an average of around €30bn in annual profits between 2012 and 2021. In comparison, the withdrawal of deposits to convert them into non-remunerated digital euros would result in annual net interest income of €280m, €1.17bn and €4.80bn in the low, medium and high demand scenarios, respectively.

Risks

The financial risks associated with rCBDCs primarily concern the assets that central banks would need to acquire to match the increase in liabilities resulting from rCBDC issuance, the economists note. While central banks can manage these risks through established frameworks, the report suggests that significant risks would only arise if central banks are required to increase the size of their balance sheets by purchasing long-term assets. The impact on interest rate risk remains uncertain and would depend on the balance between interest rate-sensitive assets and liabilities.

In terms of capital and financial stability, the introduction of rCBDCs could stabilise central bank finances by preserving the role of central bank money in a digital economy. The authors emphasise that rCBDCs are unlikely to lead to a dramatic increase in central banks’ financial risks or capital requirements. This conclusion stems from the design features of CBDCs that limit their potential as a store of value and curb excessive demand.

Overall, the ECB economists conclude that digital euro issuance is unlikely to significantly expand ECB’s balance sheets or lead to greater financial risks. They argue that the design of rCBDCs will determine the extent of their impact, with current proposals suggesting a marginal effect on central bank profitability, balance sheets and capital needs.