Think Twice Before Introducing a Holding Limit for the Digital Euro

The ECB's Proposal for a Digital Euro Holding Limit

In October 2020, the European Central Bank (ECB) released a Report on a digital euro outlining the principles and requirements for a potential digital euro. One key requirement is that the digital euro should be limited to a means of payment and not become a form of investment. As a result, the ECB has proposed limiting each user to holding a maximum of €3,000 of digital euro at any time (the "holding limit").

Addressing Criminal Activity and Financial Stability Concerns

The holding limit is proposed mainly to address two concerns: (1) the digital euro facilitating criminal activity and being incompatible with anti-money laundering and countering the financing of terrorism (AML/CFT) regulations; and (2) money flowing out of Eurozone bank deposits and into digital euro holdings, leading to disintermediation of banks as credit intermediaries and promoting financial instability.

Balancing AML/CFT Regulations and User Privacy

There is a trade-off between combating AML/CFT and allowing users to retain some privacy for their payment activities. However, the holding limit could effectively prevent the digital euro from providing anonymity to its users, undermining its potential as a cash substitute.

Impact on Eurozone Banking Sector and Economy

The assumption that the digital euro would lead to depositors moving their funds from bank accounts to CBDC wallets, reducing bank funding and lending, and harming the economy, is not entirely clear. Banks may respond by increasing the interest rates they offer to depositors and charge borrowers. In fact, deposits may increase and bank funding costs may decline in response to the presence of the digital euro. Factors such as bank market power, alternative means of saving, and competing sources of credit should be considered.

Adjustments and Challenges in the Eurozone Banking System

The presence of the digital euro would alter the dynamics of the Eurozone banking system, and adjustments would need to be made by stakeholders to preempt its likely impact. The ECB may need to recycle excess inflows of the digital euro back into the banking system, and assumptions regarding depositor behavior that underpin prudential regulation and bank risk models may need to be updated.

Adoption Barriers and the Holding Limit's Impact

There is a risk that the digital euro will struggle to reach mass adoption, and measures like the holding limit could further undermine its adoption. Most retail depositors may not see a reason to adopt the digital euro due to the presence of deposit insurance and the lack of understanding of the difference between central bank money and commercial bank money. The holding limit could act as an additional barrier to the digital euro's success.

Read the full paper here.

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This article was prepared by the author/s. The views expressed in this article are the author’s own and do not necessarily reflect the views of the Digital Euro Association.