CBDC/digital euro: more than a token impact on banking profits

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Cryptocurrency’s appeal may have come and gone. But central bank digital currencies still spark enthusiasm, at least among some central bankers.

After two years of studying how a digital euro would work, the European Central Bank is planning its implementation. This “preparation phase” should take two years from November 1, the ECB announced on Wednesday.

The ECB maintains that current bank financial models will be little changed. Others see problems ahead. Banks could see profit decline by up to 20 per cent, according to one analysis.

The hit to fees will have a significant impact, believes Andrea Filtri at Mediobanca Research. The digital euro’s underlying infrastructure would remove European payments from the current patchwork of costly national systems. Savings on payments would follow.

If around half of debit payments and bank transfers switched, the hit to EU bank profits would be about 3 per cent. CBDC payments would also suck deposits from the banking system.

Central bankers are proposing a cap on CBDC account size, likely to be about €3000. Even so, full uptake would still mean significant pain. The digital euro could draw almost €1tn of deposits out of the European system or equal to 10 per cent of retail deposits.

Banks could be forced to make up any shortfall by drawing down excess reserves. That worst-case scenario would sap net interest income and shave another 9 per cent from bank profitability. Fee income would also fall.

Banks would have to find new ways to exploit technology and find growth. CBDC’s likely use of a digital ledger will open the door to further sources of fees such as smart contracts for financial products.

There is a counter argument, of course. Banks could reduce deposit flight with higher rates for short-term money. And it is always unwise to underestimate the lethargy of bank customers.

High street banks depend on inertia for their dominant positions. They will hope inertia in government will forestall CBDCs, now that the crypto threat to fiat money has receded.

The Lex team is interested in hearing more from readers. Please tell us what you think of CBDCs in the comments section below.