There has been increasing media coverage and discussion in recent weeks about the progress made on the design of a digital euro, its planned introduction, and the opportunities and dangers of digital central bank money. So, just what does this mean and what are the implications for our society, for banks and, in particular, for businesses?
In 2014, when the cryptocurrency hype first reached an all-time high in public attention and interest, it gave rise to an insightful discussion about a new concept1: digital currencies issued and managed by central banks.
As the popularity of cryptocurrencies and related technological advances grew, digital payments took off while cash payments declined, and the prospect of fighting money laundering and payment fraud (as a result of being able to track transactions and thus create more transparency) improved, governments all over the world began to take an interest in the idea of digital central bank money.
One of the first governments to rise to this challenge was China. The People's Bank of China took the initiative and began researching this revolutionary technology back in 2014. Nearly a decade later, China has consolidated its leading role in this field and introduced the digital yuan (e-CNY), making the country one of the pioneers in digital central bank money.
But it is not only in Asia that progress is being made. First steps towards digital central bank money have also been taken in the Euro area. The European Central Bank (ECB) is currently conducting an exploratory phase for a digital euro. This phase, set to last until autumn 2023, is meant to serve as the basis for deciding whether to enter a three-year implementation phase.
Recently, an important milestone for the digital euro was reached on 28 June. On this day, the proposed draft law was presented by the EU Commission, laying a decisive cornerstone for further development.
Just what is digital central bank money or Central Bank Digital Currency (CBDC)?
In today's economic system, there are two main forms of money: Cash, which is issued by the central banks, and Giro money, which is created by commercial banks when they grant loans and create deposits in their customers' accounts in the process. The digital central bank money is intended to serve as a virtual variant of cash, issued and regulated by a country's central bank. Unlike cryptocurrencies, which are decentralized and not directly regulated by any institution, CBDCs are centralized and recognized by law.
Initially, CBDCs could become the digital equivalent of cash or credit balances in bank accounts, thus replacing cash in the retail sector. In a second step, it is conceivable that CBDCs could also be used in the business-to-consumer (B2C) sector and as such replace giro money in any form. This combination opens up the possibility that CBDCs will transform the entire monetary system in the future by merging the properties of cash and fiat money and helping central banks to retain control over the monetary system. Without this, governments could run the risk of competing cryptocurrencies exerting control over the issuance of money and the flow of funds, thus depriving them of their grip on the monetary system. This would pave the way for the transition to a cashless society.
How will digital central bank money affect society, banks, companies and treasury departments?
The advent of digital central bank money could drastically transform our daily lives and open the way to a cashless society. This shift would be felt particularly strongly in sectors such as hospitality and retail, where the daily handling of money could change significantly.
On a positive note, it would make access to accounts simple and inexpensive, enabling socially disadvantaged groups who previously had no access to traditional banking services to finally gain access to financial services. This would contribute to a more inclusive financial system and promote broad acceptance in society.
However, the public is also concerned about data protection and privacy, particularly with regard to the greater opportunities for central banks and public authorities to monitor and track money movements. According to a survey conducted by the European Central Bank in 2021, data protection and the security of access data are among the top priorities of respondents. This means that the security and adequate protection of data and privacy will be crucial in the ultimate design of CBDCs.
Efforts to create a simpler, safer and more inclusive financial system underscore the importance of this digital innovation and could catalyze a significant shift in how money is handled and used in our society.
To date, the exact architecture and accessibility of digital central bank money for bank customers has not been defined. There are various hypotheses circulating, which if confirmed could profoundly impact various areas of the financial world.
One key conundrum relates to account management for digital central bank money. Right now, it is unclear whether accounts can be opened directly at the central bank and who will be responsible for the corresponding services. One hypothetical suggests that commercial banks could be eliminated as intermediaries, resulting in companies and individuals being able to interact directly with the central bank. Such a paradigm shift would have far-reaching consequences for commercial banks, including:
- Increased tendency by businesses and citizens alike to store money in CBDC accounts that are perceived to be safe
- A decline in deposits at banks, which could affect the lending process
- The further emergence of FinTechs, which could further revolutionize traditional banking
However, if it becomes possible to open accounts directly with the central bank, it needs to be clarified who is responsible for servicing and managing these accounts. Given the central bank's public mandate, this could present FinTechs with an opportunity to launch a new service or business area in the central bank environment. A further opportunity would be for banks to act as intermediaries, adding this new function to their existing service and thus offering new, innovative and integrated financial products. Instances of innovative products could include CBDC wallets or purpose-built payment solutions for digital central bank money.
CBDC adoption is expected to increase the volume of digital payments, as users are likely to find the new payment option supported by the central bank secure and trustworthy, and will also have their digital payments processed faster and more efficiently than traditional direct debit or wire transfer payments. The programmability of digital money also permits for the generation and collection of additional market data.
For this reason, it will be crucial to make the appropriate adjustments to ensure both the stability of the financial system and the needs of customers.
The impending introduction of central bank digital money will likely have a profound impact on the way business is conducted. Even though the primary focus of the proposed digital euro in the EU is on individuals and the final model has yet to be determined, the potential implications for businesses need to be considered.
Of note here is the possibility that CBDCs could improve the speed and efficiency of foreign transactions in foreign currencies. This is being made possible by the fact that both parties are using CBDCs, meaning that transactions are being processed in real time, in the same digital currency, and without delays from any intermediaries. The need for conversion into foreign currencies would then be eliminated through directly managed accounts at the various central banks. Also, CBDCs could lead to significant cost savings by eliminating banks as intermediaries and enabling direct payments. It would be particularly important in the case of cross-border transactions, where the introduction of CBDCs could lead to significant improvements in terms of transaction duration and costs.
One other aspect relates to business-to-consumer (B2C) transactions. The introduction of the digital euro introduces a further payment option in addition to the existing payment methods, such as credit and debit cards, mobile payments like ApplePay, GooglePay and PayPal. Both retailers and businesses will need to adapt to this new form of payment and integrate it into their business processes. The digital landscape may be further transformed by the emergence of established and potentially new FinTechs with innovative systems and approaches.
Additionally, the programmability of digital money offers new opportunities. CBDCs could for instance use smart contracts2, enabling the automatic execution of payments based on defined rules and conditions. It is conceivable, for example, that international trade transactions would be tied to specific customs or other regulations. The linking of information to transactions could also facilitate processing in ERP, accounting and treasury systems, while increasing transparency. This adds to processing efficiency and streamlines invoicing or accounting processes.
For the time being, the impact on the business-to-business (B2B) sector is limited due to the envisaged cap on digital payments. But in general, the implementation of the digital euro could bring far-reaching benefits for companies' liquidity management and payment transactions. Increased transaction speed and automation could simplify corporate liquidity planning and cash management.
Eliminating banks as intermediaries in transaction processes will result in significant cost savings for companies. This could be particularly relevant for treasury departments, above all when it comes to account management and transaction processing. Cutting these costs would significantly increase operational efficiency and help reduce the company's total cost of ownership. But whether this actually becomes a reality remains to be seen.
In addition, if companies are allowed to hold accounts directly with foreign central banks, exchange fees are likely to decrease, which in turn would lower the cost of foreign remittances and have an impact on FX risk management.
These changes will give companies more flexibility in raising capital and strengthen their competitiveness.
All in all, it is clear that digital central bank money has the potential to profoundly change the way companies conduct financial transactions and, in particular, the way they process their payments. The overall improvements in transaction speed and efficiency, cost savings, and simplification of global transactions could potentially make digital central bank money a breakthrough innovation in payments and interactions with financial transaction partners.
With that said, it is critical to also be aware of the potential risks and challenges that come with adopting this new technology. Companies, and in particular their treasury departments, will therefore want to take a close look at this issue and prepare for this potential upheaval in the financial landscape.
Disclaimer: Please note that at the time of writing, the currently published draft legislation on the introduction of the digital euro could not yet be assessed and evaluated. Therefore, all analyses and conclusions in this article are based on the information available to date and may be rendered outdated or inaccurate due to changes in the political and regulatory landscape. Any changes or developments on the subject that occur after the publication of this article have not been taken into account.
Source: KPMG Corporate Treasury News, Edition 134, July 2023
Nils Bothe, Partner, Finance and Treasury Management, Corporate Treasury Advisory, KPMG AG
Tobias Riehle, Manager, Finance and Treasury Management, Corporate Treasury Advisory, KPMG AG
1 Unlike legacy means of payment such as cash or electronic bank deposits, CBDCs are issued and transferred on a technological platform such as a blockchain or distributed ledger system. With these technologies, transactions are processed in real time, transparency is ensured, and security is enhanced.
2 Smart contracts are self-executing contracts that are based on a digital carrier technology, such as the blockchain and are implemented without manual intervention.
Nils A. Bothe
Partner, Financial Services, Finance and Treasury Management
KPMG AG Wirtschaftsprüfungsgesellschaft