Unlimited Central Bank Digital Currency

Central banks in developed financial jurisdictions such as the United States (US), European Union (EU) and United Kingdom (UK) have increasingly explored issuing a central bank digital currency (CBDC). The articulated rationale in policy papers revolve around providing choice in payment systems, but acknowledge that CBDC may compete with banks for deposits. Our recent article published in the North Carolina Journal of International Law agrees with the potential disruptive effects of CBDC for banking systems but argues that the far-reaching effects can perhaps provide an opportunity to rethink bank industry and regulation overhaul altogether.

In particular, we focus on the Euro-area in teasing out these far-reaching effects, which we argue are both timely and important. CBDC for the Euro-area can bring about much-needed shaking up for the banking sector towards healthier transformation, as well as provide new policy options for central banks and policymakers which oversee economic growth and financial stability in the Euro-area.

Although post-crisis regulation has prevented the collapse of confidence in the European banking industry, the sector has been radically impacted by regulation in terms of its business performance and activities, and there is a marked trend in the Euro-area in relation to banks moving away from the full intermediation of retail deposits (the ‘de-retailing’ trend). Our article highlights factual observations of this trend in parts of Europe such as Germany and the Netherlands, showing banks’ decreased willingness to accept deposits, usually beyond a certain level, while also not being able to allocate their excessive liquidity effectively. This trend has persisted during the low interest rate environment and it remains uncertain if the Eurosystem’s change in policy towards combatting inflation will change bank behaviour towards deposits, which are in excess compared to European banks’ loans. For example, German banks usually charge service fees for newly opened accounts, and negative interest is imposed on amounts exceeding certain thresholds.  These thresholds were lowered several times up to the year 2021 and ultimately stood at amounts that affected the vast majority of average retail depositors, eg to thresholds as low as EUR 25,000 of aggregate amounts held with a bank. The negative interest oftentimes came in addition to servicing fees for accounts and cards. In the rest of the Euro-area, the developments were very similar. In the Netherlands, banks have repeatedly lowered the thresholds above which they charge punitive interest, and negative interest applied to amounts above EUR 100,000.  In Spain, some banks charged negative interest of 0.3% for deposits above EUR 100,000.  In Belgium, banks lowered the threshold for punitive interest of -0.5% from EUR 1 million to 250,000. Whereas negative interest has recently disappeared as a result of the Eurosystem’s interest rate hikes, banks in the Euro-area still disadvantage their customers compared with banks in other parts of the world. Interest rates for retail depositors are still extremely low (usually between 0% and 1%), creating a trend that defeats the counter-inflationary efforts of the Eurosystem. Euro-area banks still get their funding (almost) for free from the public while currently earning 3% on their excess reserves with the Eurosystem. This trend raises worrying concerns regarding financial inclusion and meeting social needs of basic store of value.

Further, European banks have become less competitive and profitable. Surveys carried out by the European Central Bank in 2017 and the European Parliament in 2021 confirm that European bank profitability has been depressed in the low interest rate environment, compared to their American counterparts which recovered relatively well after the global financial crisis 2007-9. Although the changing interest rate environment may change the picture for European banks, there are other risks that affect them, such as their high holdings of sovereign debt which have come under severe price pressure following the interest rate hikes of central banks around the globe. We perceive opportunities for the banking sector to break out of its plight in light of the Eurosystem’s interest in offering a central bank digital euro (CBDE) which provides a public good in the form of digital public money. Our article argues that the advent of the CBDE, contrary to the Eurosystem’s policy paper, should not be too modest, but should be ‘unlimited’. By ‘unlimited’ we mean that there should be no upper limits to individuals’, households’ and business holdings of digital euros. This means that CBDE would act as an alternative to bank money, and we argue that this can  maximise the Eurosystem’s role in providing the public good of risk-free store of value. Further, providing CBDE as a public good need not exclude the private sector but can rely on it for custodial, security and payment services. The banking and financial sector can be compelled to transform towards more competitive and efficient services, equipped to intermediate more effectively for real economy needs.

The transformation of the banking and financial sector is further important for central banks and bank regulators, as their policies have been inevitably shackled in order to preserve bank stability in the Euro-area, given the size of the bank-based economy. Our paper discusses a bold and unconventional blueprint for changes to bank regulation in order to provoke out-of-the-box thinking on the future of bank regulatory policy. We take the view that by instituting CBDE as the public good for store of value and easy access purposes, it is possible to adjust the intensity of bank regulation, which has mostly focused on bank safety in light of its social and systemic importance. We show how capital and liquidity regulation can be changed to reflect commercial banks’ true risk-taking nature, and we also propose the abolition of deposit guarantee and the overhaul of bank resolution regimes, as these necessarily involve draconian exercises of public power and costly scrutiny thereafter. The article provokes thinking for a radical alternative to ever-intensifying financial regulation which has been described as an ‘iron law’ without losing sight of the need for social good to be protected. There may be more granular elements that can be further developed, but this article hopes to kickstart the possibility of exploring this unexplored policy space.

Iris H-Y Chiu is Professor of Corporate Law and Financial Regulation, UCL Faculty of Laws.

Christian Hofmann is Associate Professor of Law, National University of Singapore.