Politico reported that some European states, including Germany, France, the Netherlands and six other countries, are concerned about the European Central Bank (ECB) having the right to specify holding limits for the digital euro central bank digital currency (CBDC).
A concern is that the ECB could set the wallet limits too high, resulting in deposits flowing out of banks. One diplomat called it a “battle for power” between central banks and politicians. An opposite worry is that the limits might be viewed as inhibiting financial freedoms and hence a Big Brother move. A related concern is that the digital currency could be out of touch with consumer needs and not adopted.
While the EU’s treaty gives the ECB certain privileges, the digital euro will have its own legislation, which has yet to be passed. Before the recent European elections, several amendments were proposed to a draft. Politico viewed the notes of one of the meetings, which showed that nine countries objected to the ECB deciding on wallet holding limits.
If the ECB sets the holding limit, it views this as preserving any decision from political pressures.
How would digital euro holding limits work?
A couple of key points were not covered in the Politico piece. Firstly, the whole point of the digital euro is to create a pan European payment system in an attempt to dislodge the dominance of non-European players such as Visa and Mastercard. While SEPA may be pan European, it is purely a backend solution. Hence, it seems logical that there needs to be a single limit for the entire EU block.
If the ECB doesn’t get to decide, how would it work practically? An annual vote on limits?
Messy waterfalls
The messier point is the implementation of the holding limits. If the holding limit is €3,000 and someone receives money that pushes the balance over, then any excess funds will be swept into a bank account. On the other hand, if someone makes a payment and doesn’t have enough digital euros in their wallet, it can automatically pull the money from the connected bank account. These are the waterfall and reverse waterfall functions.
This has a few implications. At a practical level, some people like to keep tabs on how they spend money. If there’s a lot of movement between your bank and the digital euro wallet, that gets rather messy and hard to track. A lack of visibility also helps fraudsters.
Changing tack, one of the potential advantages of a CBDC is it could provide super efficient payments. However, with the waterfall and reverse waterfall, some payments could have three payment legs: the sender doesn’t have enough funds so it pulls money from their bank; the CBDC payment; and the recipient now has too much in their wallet, so that’s swept into their bank account. That’s why several countries believe there will be pressure to provide higher limits, so there’s less need to use the waterfall functionality.
Some have noted that the waterfall also requires all banks in the EU to support real time payments 24/7, involving significant work. However, EU instant payment regulations were adopted earlier this year, so that will be a requirement with or without the digital euro.
Debates around setting the holding limit
In one of the more recent legislative proposals, it was suggested that banks and payment providers could set the limits themselves. The Dutch central bank published a digital euro paper concluding that holding limits would be critical, especially during the transition phase. Another report commissioned by the European Banking Federation found a €3,000 limit with a 40% takeup would increase bank funding costs by €8.8 billion.
For its part, the ECB says it would set the limits based on the economic circumstances at launch. However, one of the tasks it’s been working on recently is coming up with a methodology to make the decision.
