Authors

José Manuel Mansilla-Fernández^[1]Public University of Navarre (UPNA) and Institute for Advanced Research in Business and Economics (INARBE).

 

Figure 1. The status of Central bank digital currencies projects in the world

Notes: Map retrieved from CBDC Tracker. Available at: https://cbdctracker.org/. Accessed on September 10, 2024.

 

Figure 2. Central bank digital currencies project status and central bank independence

Notes: Own elaborations. Project score, measured in the horizontal axis, is an index that takes the value 0 for jurisdictions without any CBDC work publicly announced by the central bank, 1 for projects in early stages, 2 for pilot projects, and 3 for jurisdictions that have already introduced a CDBC; data are the updated version of those in Auer et al. (International Journal of Central Banking, 2023), available at https://www.bis.org/publ/work880.htm. Central banks’ independence, measured on the vertical axis ranges from 0 (the lowest level of independence) to 1 (the highest level of independence); data are the updated version of those in Romelli (2022, Economic Policy), available at https://dromelli.github.io/cbidata/index.html. The size of the bubbles represents the aggregate GDP of the countries in each category. The sample includes 124 countries.

 

Figure 3. Central bank digital currencies project status and central bank responsibility for banking supervision

Notes: Own elaborations. Project score, measured in the horizontal axis, is an index that takes the value 0 for jurisdictions without any CBDC work publicly announced by the central bank, 1 for projects in early stages, 2 for pilot projects, and 3 for jurisdictions that have already introduced a CDBC; data are the updated version of those in Auer et al. (International Journal of Central Banking, 2023), available at https://www.bis.org/publ/work880.htm. Central banks’ responsibility for banking supervision, measured on the vertical axis ranges from 0 (banking supervision not entrusted to the central bank) to 0 (banking supervision entrusted to the central bank alone); data are the updated version of those in Romelli (2022, Economic Policy), available at https://dromelli.github.io/cbidata/index.html. The size of the bubbles represents the aggregate GDP of the countries in each category. The sample includes 124 countries.

 

Figure 4. Central bank digital currencies project status and bank concentration.

Notes: Own elaborations. Project score, measured in the horizontal axis, is an index that takes the value 0 for jurisdictions without any CBDC work publicly announced by the central bank, 1 for projects in early stages, 2 for pilot projects, and 3 for jurisdictions that have already introduced a CDBC, distinguishing between retail and wholesale projects; data are the updated version of those in Auer et al. (International Journal of Central Banking, 2023), available at https://www.bis.org/publ/work880.htm. Bank concentration, measured in the vertical axis, is the share of total assets of the three largest banks in each country; data are from the World Bank Global Financial Development Database, available at https://www.worldbank.org/en/publication/gfdr/data/global-financial-development-database. The sample includes 140 countries.

 

Figure 5. Central bank digital currencies project status and payment habits.

Notes: Notes: Own elaborations. Project score, measured in the horizontal axis, is an index that takes the value 0 for jurisdictions without any CBDC work publicly announced by the central bank, 1 for projects in early stages, 2 for pilot projects, and 3 for jurisdictions that have already introduced a CDBC, distinguishing between retail and wholesale projects; data are the updated version of those in Auer et al. (International Journal of Central Banking, 2023), available at https://www.bis.org/publ/work880.htm. Payment habits, measured in the vertical axis, are measured by the share of the population 15 years of age or older that made a digital payment in each country; data are from the World Bank Global Financial Development Database, available at https://www.worldbank.org/en/publication/gfdr/data/global-financial-development-database. The sample includes 113 countries.

Authors

Giorgio Barba Navaretti^[1]University of Milan., Giacomo Calzolari^[2]European University Institute. and Alberto Franco Pozzolo^[3]Roma Tre University.

 

1. Introduction

A large number of initiatives are underway to introduce Central Bank Digital Currencies (CBDCs). Currently, 134 countries, representing 98% of global GDP, are exploring a CBDC, 68 countries are in the advanced phase of exploration and the Bahamas, Jamaica and Nigeria have fully launched a CBDC. In the Numbers section, we map the level of advancement of CBDC projects by country.

Implementing a CBDC entails the digital extension of a currency issued by a sovereign central bank, alongside establishing a digital payment system utilizing this digital currency.

CBCDs are multi-tasking policy tools addressing a wide range of objectives. In the section on institutions, where we briefly summarize many of such initiatives, it emerges clearly that the goals pursued by central banks vary in emphasis and importance depending on the issuing country. These objectives can be distilled into five primary goals: (i) safeguarding monetary sovereignty and ensuring the effectiveness of monetary policy; (ii) maintaining financial stability; (iii) curbing the market power of private entities in digital payments; (iv) protecting the privacy and security of transactions; and (v) promoting the interoperability of payment systems.

CBCDs imply direct public interventions in activities otherwise carried out by private sector players, e.g., digital money (i.e., cryptocurrencies and stablecoins) or carrying out payments (e.g., Visa and Mastercard). Consequently, they affect market configurations, turning them into mixed oligopolies. Mixed oligopolies are characterized by the co-existence of private and public players where the action of public ones, by pursuing other than typical market objectives, should, in principle, favour the achievement of socially optimal outcomes. These outcomes are usually also pursued and continue to be pursued through traditional instruments like regulation, supervision, or competition policies.

Therefore, it is useful to discuss CBDs with respect to the market failures they aim at mending and to the effectiveness of their mending action compared to other alternative

public policy tools. In this editorial, we will follow this approach and rely on the many valuable insights from the articles collected on this issue of European Economy.

We conclude that if we consider each objective individually, there are no compelling arguments for CBDCs being superior to other policy tools. Nonetheless, as discussed, CBDCs can address multiple objectives at the same time. While CBDCs might not be the most effective tool for achieving specific individual goals, their effectiveness lies in the broad range of outcomes they can deliver. Moreover, they do not replace standard oversight, supervision, and anti-trust policies, possibly reinforcing their impact.

In addition, CBCDs also imply snowball effects. If they are accepted, used by market players, and rapidly spread (which is not a small if, as discussed below), they will be hardly reversible. This is not the case for all other policy tools that might achieve the same objectives, especially if they take the form of ex-post market interventions like competition policy and antitrust. Consider, for example, the impact CDBCs have on fostering competition. By directly changing market configurations into mixed oligopolies, they will not suffer the problems of potentially weakening and reverting the actions of competition and regulation authorities: capture, limited information, and partial commitment.

Nonetheless, it is important to acknowledge the significant costs associated with implementing and maintaining CBDCs, which warrants further detailed analysis. Although proper estimates are lacking, a CBDC entails fixed and variable costs across several key categories, including infrastructure (most likely in the order of billions of euros for the case of a European CBDC), operations and maintenance, regulatory compliance, and public awareness.

As thoroughly discussed in this number of European Economy, the design of digital currencies also involves broader policy issues, especially for activities where a sizeable role of private agents may have other implications than pure market efficiency. For example, the issuance of digital coins by private organizations like the big digital platforms – e.g., Libra by Facebook, although it was never introduced – or the diffusion of cryptocurrencies may limit the scope and the effectiveness of monetary sovereignty by central banks, which is, of course, a matter of concern, with inherent risks for financial stability.

There are also considerable geopolitical issues. A first mover in the CBDC space could rapidly expand its influence and secure a dominant position in global payment systems. This dominance could, in turn, diminish the usage and relevance of other national currencies in international transactions and financial markets. This prospect is especially meaningful for currencies currently enjoying a central role in global finance, such as the US dollar and the euro. The digitalization of such currencies might favor a marginalization of national currencies in smaller jurisdictions. Or, in contrast, their dominance could indeed be challenged by other rapidly spreading digital currencies.

A key example of this geopolitical dynamic is the growing concern over the expansion of China’s digital yuan. As China accelerates its development and deployment

of a digital currency, it potentially positions the digital yuan to become a preferred medium of exchange in international trade, especially within regions heavily influenced by Chinese economic activity, such as Asia and parts of Africa. If the digital yuan were to gain widespread acceptance, it could challenge the dominance of the U.S. dollar and the euro in global trade and finance. This scenario alarms the U.S. Federal Reserve and the European Central Bank (ECB), threatening to erode their monetary sovereignty and influence in global markets (see Angeloni and Holden in this issue).

The geopolitical question appears especially relevant from the Euro area perspective, where there is limited interoperability across borders between national market players, and essentially, non-European payment providers carry out the large majority of digital and card payments. Of course, there is an argument for market dominance, especially in a market with sizeable network externalities. Still, several EU official documents and Giovannini on this issue stress that the Euro area faces considerable risks regarding data privacy and regulatory compliance because the dominant players are non-European. In this case, the argument for preserving a large degree of sovereignty in payment systems is based on security concerns rather than arguments of market efficiency.

Summing up, while we disagree that CDBCs are a solution in search of a problem – because the issue of the potential diffusion of unregulated private moneys in a world where payments are mainly electronic is evident and substantial – nevertheless, whether they are the best or only solution to these problems remains an open question that requires careful consideration and further debate.

In what follows, we will outline the main conclusions emerging from this issue, discussing the role of CDBCs in mending the market failures related to the five policy objectives above, and we will also take up other broader issues not being covered by this frame of discussion. We start with examining the impact on the effectiveness of monetary policy, then on competition, and finally, on security and privacy. Before concluding, we will briefly consider the specificities of the case for a digital euro.

 

2. Monetary Policy

One of the main reasons urging central bankers to consider the introduction of a CBDC is the increased competition from private digital currencies. When at the 2019 IMF meetings, Facebook presented its plan for creating a digital currency (initially called Libra and eventually renamed Diem in 2020), the reaction of central bankers was rather fierce. As Davies (this issue) recalls, Benoit Coeuré, a member of the executive committee of the ECB, “described the Libra announcement as ‘a wake-up call’ and called for the ECB to ‘step up its thinking on a central bank digital currency.’”

Indeed, introducing a CBDC can enormously affect the functioning of monetary and financial markets. However, these effects need to be analysed in terms of how the monetary and financial markets would evolve without a CBDC, not how they work now.

In the following paragraphs, we will compare a scenario with a CBDC to the alternative of allowing an increasing role for private moneys, absent a CBDC.

The vast majority of payments are made today using bank money, a form of highly regulated private money. In the current system, private interbank relationships, in which banks regulate their positions by lending and borrowing bilaterally, coexist with payments made by transferring the reserves held at the central bank, which are central-bank liabilities. As shown during the global financial crisis, this dual system was crucial to allow payments through the central bank when the interbank market collapsed.

Because of recent technological innovations, a new realistic perspective has opened up whereby less-regulated private moneys might substitute bank money as the most widely used means of payment. If this were the case, the issuance of money might eventually escape entirely the control of monetary authorities, taking the system back to something similar to a ‘technologically-updated’ Free Banking Era, like the one in place in the United States between 1837 and 1863, in which private banks where issuing their currencies backed by their reserves.

Would this be a problem for the functioning of monetary and financial markets? How should such a system be regulated? Would regulation be sufficient, or would it be preferable to introduce a CBDC, creating a mixed oligopoly in the payment market, with the central bank competing with private money?

To answer these questions, let’s start with the pivotal activity of central banks, maintaining price stability. The Free Banking Era was characterized by a lack of centralized regulation and high variability in the quality and trustworthiness of different banknotes. This led to frequent bank runs and a high degree of price volatility. Due to the lack of a central authority regulating money supply, private banks often over-issued notes relative to their gold reserves, causing inflationary pressures when confidence in a particular bank’s notes waned.

An alternative and less fully market-oriented option was in place in Scotland between 1716 and 1845, where several banks issued their own notes in a competitive banking environment, coupled with prudent regulatory oversight, without causing significant price instability. Scottish banks were required to hold sufficient reserves and were subject to frequent audits, which helped maintain confidence in their notes. The competitive nature of the banking system incentivized banks to preserve the value of their currency, leading to a relatively stable monetary environment.

All in all, when private entities issue money in an unregulated environment, the overall money supply can increase rapidly, leading to inflationary pressures. But if reserve requirements for private issuers are enforced, private money retains its value and is therefore accepted and trusted, thus enhancing liquidity and facilitating transactions, with a potentially stabilizing effect on prices.

Transparency in issuing and managing private money is crucial for sustaining public trust. Equally important is the protection of consumers, ensuring they have access to clear, reliable information about the private currencies they utilize and are safeguarded

against fraud and financial loss. Regulators can uphold these standards by enforcing disclosure requirements and obligating private issuers to publish financial statements and details of their reserve holdings regularly. Additionally, regulatory bodies can establish rigorous auditing procedures to ensure compliance with regulations, enabling the early detection and resolution of potential issues before they become significant problems.

Regulating the conduct of market participants can also prove essential for preventing manipulative practices that can destabilize prices, curb speculative trading, and avoid market manipulation and insider trading, which can lead to volatile price swings. The global nature of many private moneys, particularly cryptocurrencies, also requires strong international coordination among regulatory bodies. International regulatory standards should be established to ensure consistent oversight and enforcement across different jurisdictions. Such coordination can prevent regulatory arbitrage, where issuers move to less regulated environments, and ensure a stable global financial system (a theme crucial in the reaction to Facebook’s Libra project).

It appears that strong regulation and supervision of private money issuance can guarantee the system from the risk of price instability. Interestingly, this seems to be the approach followed in the recent Markets in Crypto-Assets Regulation (MiCAR) approved by the European Parliament and the Council of the European Union in April 2023. MiCAR is very stringent for issuers of money-like instruments, particularly stablecoins, which promise to maintain a stable value by referencing a fiat currency. Issuers of stablecoins must be authorized, meet specific prudential requirements in terms of capital, governance, and risk management procedures, maintain a reserve of assets that fully back the value of the issued stablecoins, and guarantee the right of holders to redeem the stablecoin at par value, promptly and straightforwardly. This approach is very similar to an adaptation to private money issuers of the existing fractional reserve banking system, where commercial banks are indeed intensely supervised and regulated.

Given this potential option of tightly regulating private moneys, how should we consider a mixed oligopoly framework stemming from introducing a CBDC and hence expanding the scope of central bank liabilities to retail payments? A digital form of central bank-issued money, a CBDC would provide a safe, efficient, and most likely widely accepted medium of exchange. This would create a new competitive market environment where a CDBC would coexist with private moneys such as stablecoins. The competition with CDBCs may drive private issuers to improve the quality of their offerings, potentially enhancing stability and usability. In fact, introducing CBDCs would reduce the demand for private moneys unless they provide levels of credibility and stability like those associated with the currency issued by the central bank, thus mitigating risks for price stability.^[4]To avoid fragmentation in the monetary system if multiple forms of money coexist it would nonetheless be required to implement a clear regulatory framework which favours interoperability among … Continue reading

Interestingly, in this respect, we should not consider CBDCs as alternative policy tools to regulatory frameworks like MiCAR or supervisory and auditing frameworks for private currencies. But essentially as additional and complementary tools toward the goal of price stability, reinforcing the action of these other standard forms of regulation and supervision. A mixed oligopoly in itself would probably not be sufficient to achieve price stability, as far as money holders would also have the option to use unregulated means of payment.

CBDCs may also bring additional benefits for monetary policies (see Infante et al., in this issue). They can enhance the effectiveness of monetary policy by providing central banks with direct tools to influence the money supply and interest rates (that might eventually also be negative), helping maintain price stability more effectively than traditional monetary policy tools. CBDCs can also facilitate more accurate and timely data collection on economic activity, enabling central banks to make more informed decisions and respond more quickly to economic shocks (Bindseil, 2020; Kumhof and Noone, 2018).

CBDCs can also give central banks greater oversight and control over the digital currency landscape. By monitoring and regulating transactions into and out of CBDCs, central banks can ensure better compliance with monetary policy and financial stability objectives. In this respect, the evidence from Figure 3 in the Numbers section is consistent with the observation that CBDC projects are more advanced in countries where central banks are not encumbered by potentially conflicting responsibilities in banking supervision.

 

3. Financial stability

A key element in the debate between regulating private currencies and introducing a CBDC is their potential impact on financial stability and the overall functioning of financial markets.

The argument is the same as for price stability. It all depends on the quality and pervasiveness of regulation and supervision and on the ability of authorities to enforce prudential behaviour. Even here, CBCDs, by acting directly in the market, can be useful complementary tools to enforce and induce prudential market behaviour especially during times of stress or uncertainty.

There is, however, a further twist in the argument: bank disintermediation. In other words, even though it is very likely commercial banks will manage them, still CBDC wallets will be central banks’ liabilities. If there will be a sizeable shift from commercial banks to central bank accounts, this will imply a disintermediation of the banking system. Of course, this can also occur with cryptos, but given the safer nature of central banks-backed assets, their effect could be especially large. This is consistent with the broad evidence of Figure 4 in the Numbers Section, showing that CDBC projects are more advanced in jurisdictions with lower bank concentration.

The issue is even more relevant in the case of bank runs. If people can quickly and easily transfer their funds from banks into CBDCs, the convenience and speed of digital

transactions could make this process ‘one click away.’ Any sign of instability in the banking sector could lead to a massive shift of funds to CBDCs, precipitating a bank run (see Davies in this issue and Williamson, 2022).

The extent of this potential risk crucially depends on the specific architecture of each CBDC and particularly on the size of available CBDCs. If, as in the plans for the Digital Euro available, CBDCs wallets will be capped, this will limit both the likelihood of bank runs. But also, as argued by Davies in this issue, also the scope of digital currencies.

In extreme scenarios, if banks’ disintermediation really happens, this might considerably endanger financial stability, although it is probably safer if central banks rather than private players enact disintermediation. In the former case, at least, central banks have margins to put in place remedial measures.

There is a counterargument, though; this is also pretty extreme. Banks would perform less maturity transformation, thus strengthening their financial safety (see Infante et al., this issue, and Keister and Monnet, 2022). The final impact would be to transform commercial banks into investment banks. Would the system be more stable? Hard to say. What is sure is that in designing digital currencies, Central banks must carefully evaluate their impact on the banking system.

Given the fast technological evolution in payment technologies, can we conclude that CBDCs are necessary for central banks to guarantee price and financial stability? As argued, it is hard to say in both instances. Certainly, their interplay with other standard regulatory tools is essential in determining their final effect. Although stringent, effective, and coordinated regulation might be sufficient to guarantee a monetary anchor, the regulatory and operational architecture of a CBDC can be a powerful tool to strengthen its efficacy in reaching these goals. Indeed, if we see the relationship between regulatory authorities and market players as a game, where the former try to achieve a policy objective and they may be willing to circumvent regulations in their aim at profit maximization, having devised a reliable CBDC project, even without fully implementing it, can be a powerful tool to make the threat of regulation more credible.

 

4. Market outcomes and market power

By offering a CBDC, central banks can provide a public alternative to private digital payment solutions, possibly promoting competition and preventing excessive market power by private entities. Again, also here the evidence of Figure 4 in the Numbers session of the inverse correlation between concentration in banking markets and the advancement of CBDCs projects is consistent with this presumption,

This is particularly relevant for two reasons. First, cash cannot be used in the ever-expanding digital commerce. This calls for a corresponding evolution in payment systems for central banks to preserve their role in the monetary ecosystem, as discussed above (see also Dhamodharan et al. and Giovannini in this issue).

Second, payments are typically characterized by network externalities, significantly influencing market outcomes. Network externalities occur when the value of a product or service increases with the number of its users. In the context of digital payments, this means that as more people and businesses adopt a particular digital currency or payment platform, the more valuable and indispensable that platform becomes (Dhamodharan et al., Davies and Giovannini, in this issue, and Zeno-Zenkovich, 2023). This creates a self-reinforcing cycle where the most widely adopted digital payment solutions dominate, potentially leading to winner-take-all or tipping markets. Such markets can result in monopolistic control by a few private entities, stifling competition and innovation, as mentioned in Dhamodharan et al. (in this issue). This phenomenon can be seen in the dominance of major credit card networks like Visa and Mastercard and worldwide digital payment platforms like PayPal and Alipay in China, which have established significant market power due to widespread adoption.

Although network externalities and excessive market power can be dealt with ex-ante regulation and ex-post market intervention, such as the antitrust actions, introducing a public CBDC can mitigate the risks associated with these network externalities by offering a CBDC as a government-regulated alternative. Doing so limits the risk of market dominance by private digital currencies, ensuring a more competitive landscape. This environment can prevent any single entity from monopolizing the digital payments market, a common outcome in digital markets characterized by strong network effects, as mentioned by many authors in this issue.

Such a market structure with private operators coexisting with a public actor is known in the Industrial Organization literature in economics as a mixed oligopoly. It has the specificity of combining firms that maximize profits and the publicly controlled actor also aiming at other objectives. Specifically, in a mixed oligopoly within the digital payments market, a public or directly regulated digital payment provider, such as a CBDC, would operate alongside private providers. The CBDC’s objective could be to maximize consumer surplus while private providers would continue to maximize profits. This structure can create a balance where the public CBDC exerts competitive pressure on private entities, compelling them to lower costs and improve services, including price stability, to remain competitive.

By reducing reliance on private payment providers and increasing competitive pressure in the digital payments market, including banks, CBDCs can lower transaction costs, making payments more affordable for consumers and businesses. In other words, CBDCs can reduce the market power of banks and payment providers, transforming economic rents into consumer surplus and enhancing allocative efficiency.

The actual competitive pressure of a CBDC on private operators will depend on two relevant dimensions. First, it will depend on users’ interests and preferences for different digital payment solutions. It can be anticipated that if a CBDC is offered to citizens at little or no cost, and its acceptance by merchants is made compulsory, as seen in many current and planned implementations, this competitive pressure would likely become significant. Also, it is important to recognize that, at least within the ECB’s scheme, public and private operators will not solely function as competitors by introducing a CBDC. They will also engage in distinct yet vertically integrated operations, with Payment Service Providers (PSPs) delivering the payment service at the final point of interaction.

This vertical integration introduces an additional layer of complexity that is often overlooked. From the perspective of the economics of vertical integration in regulated markets, this arrangement raises questions about whether introducing a CBDC could effectively put pressure on PSPs and credit card companies to lower their fees, thereby enhancing competition and reducing costs for end users. A publicly provided CBDC may not automatically lead to reduced fees in vertically integrated markets unless a clear mechanism or regulatory framework compels PSPs and credit card networks to pass on cost savings to consumers. This interplay between competition and vertical integration in the context of a CBDC necessitates further investigation to understand its potential impact on pricing dynamics and market efficiency.

Another potential effect of CBDCs is their impact on innovation. The hybrid model of a mixed oligopoly leverages the strengths of both types of actors, private and public, ensuring that the public’s need for secure and affordable payment methods is met without stifling private sector innovation. The presence of a public player in the digital payment industry can push private providers to innovate more intensively to maintain their market positions. Although the economic literature on innovation in mixed oligopolies is limited, and the relationship between innovation and competition is complex, the increased competitive pressure induced by a CBDC may indeed foster innovation. Private entities must develop new features, improve user experiences, and enhance security measures to compete effectively with a government-backed digital currency. This environment can lead to a more vibrant and innovative digital payment ecosystem, ultimately benefiting consumers and businesses.

To summarize, considering market power, CBDCs have the potential to significantly alter the landscape of digital payments by reducing market power, lowering costs, enhancing financial inclusion, and fostering innovation. Central banks can ensure a more competitive and equitable financial system by introducing a public alternative to private digital payment solutions, addressing current market inefficiencies and future challenges in the evolving digital economy. Given the economic analysis of mixed oligopolies, several market outcomes can be anticipated. First, with the CBDC providing a low-cost alternative, private providers must reduce their fees and offer better services to remain competitive, thus increasing consumer surplus. Consumers benefit from lower transaction costs and improved service quality.^[5]Clearly, the design of a subsidized CBDC must carefully consider the risk that private providers could be pressured into lowering their fees to the point of being driven out of the market. This could … Continue reading Second, the competitive pressure from the CBDC can drive private entities to innovate extensively, introducing new features, improving user experiences, and enhancing security measures. This environment fosters a more vibrant and technologically advanced payment ecosystem. Third, the CBDC can enhance financial inclusion by providing accessible digital payment services to unbanked and underbanked populations, ensuring more people can participate in the digital economy. Lastly, the central bank’s dual role as provider and regulator ensures that the digital payment market remains fair and competitive, with stringent oversight preventing abuses of market power and ensuring consumer protection.

But is a CBDC necessary to reach these market outcomes? Why would addressing the specific issues for digital payments require a new public digital payment like a CBDC? Why can it not be obtained with regulation of the existing digital payment means? In principle, similar outcomes can be obtained with regulations. This happened, admittedly with significant delay, in the digital markets and the European regulations, Digital Market Act (DMA) and Digital Service ACT (DSA).

The digital payments landscape is rapidly evolving, and central banks worldwide are grappling with whether to introduce CBDCs or enhance the regulation of existing private digital currencies, or both.

Regulating existing PSPs offers the advantage of utilizing existing infrastructure, reducing the need for new investment and development. Private entities, driven by profit motives, can quickly adapt to changing market conditions and technological advancements, fostering a more dynamic payment ecosystem. This flexibility and adaptability encourage innovation and competition among PSPs. Regulation can also be more cost-effective than developing a new CBDC, as it avoids duplicating infrastructure and technology. It reduces the burden on the government, allowing the central bank to focus on its core responsibilities while ensuring the private sector adheres to regulatory standards. However, regulation is generally not an easy task.

However, regulating PSPs (and issuing private digital currencies) can also be less effective than creating a CBDC. A wide economic literature illustrates the primary limits of regulation: that the regulator is typically less informed than the regulated entities, the risk of regulatory capture, and limited commitment to regulation. Establishing and enforcing comprehensive regulations for numerous private entities can be complex and resource-intensive. Ensuring compliance across different jurisdictions and legal frameworks can be challenging, requiring substantial coordination and oversight. In particular, interoperability between different private payment networks may become an issue, stifling market entry and competition. A regulatory framework should ensure that various payment schemes can interact seamlessly with each other to enhance competition and liquidity and stability in the financial system. The risk is that ineffective regulations stifle competition and innovation in the payment systems.

Overall, if not correctly administered, dominant PSPs might still exercise significant market power, leading to monopolistic behaviours. Ensuring a level playing field among private entities requires continuous and vigilant regulatory oversight to prevent abuses of market power. In this respect, even in this domain of market competition CBDCs can integrate and strengthen regulators’ action.

 

5. Privacy and security

Modern private moneys, such as stablecoins and cryptocurrencies, present unique regulatory challenges due to their technological nature. Regulators should thus develop technological standards to ensure the security and stability of private money systems, including enforcing protocols for secure transactions, preventing hacking and fraud, and ensuring the robustness of the underlying blockchain technology.

The security issues associated with CBDCs encompass a range of concerns due to the public and centralized nature of CBDCs. Key risks include vulnerabilities to cybersecurity threats, such as hacking and digital theft. These are common to all digital financial systems but are especially critical for CBDCs, as they could become a high-value target for attacks, unlike more fragmented private digital money systems. Similar problems would also affect private digital money, which, for this reason, is subject to increasing levels of oversight by regulation authorities. In this case, too, the optimal solution depends on the trade-off between the risk of a fully centralized system managed by public authorities and several decentralized private systems under the oversight of regulatory authorities.

Privacy concerns are also central to the discussion surrounding both private digital currencies and CBDCs. While both forms of digital money raise significant privacy issues, the nature and implications of these concerns differ between the two.

With private digital currencies, the regulatory landscape is primarily concerned with accessing and using private information generated every time a digital payment is made. As these transactions involve releasing sensitive data, there is a pressing need for regulatory frameworks that safeguard user privacy. In the European context, the approach taken by authorities, mainly through the Second Payment Services Directive (PSD2) and the Digital Market and Digital Services Acts, has been to regulate the use of private information rigorously. These regulations ensure that private digital currencies operate within a framework that protects consumer data from misuse and promotes transparency and accountability among service providers.

Although private operators, particularly dominant non-European players like Visa, Mastercard or Paypal are required to comply with the regulations of the jurisdictions in which they operate, which mitigates some risks, there is a broader concern, often articulated especially by European authorities, about the reliance on foreign providers, specifically concerning privacy risks, also reflecting geopolitical anxieties regarding dependence on foreign technologies. In this context, the privacy risks are less about non-compliance and more about the strategic implications of data control by foreign entities.

CBDCs, on the other hand, introduce a different set of privacy concerns, primarily because they are state-backed and centrally managed. One of the most significant privacy issues with CBDCs is the potential erosion of user anonymity. Cash transactions are inherently anonymous, while CBDCs may not be able to offer the same level of privacy. Although CDBCs, notably the digital euro, could potentially incorporate offline functionality with privacy levels comparable to cash, as emphasized by Giovannini in this issue, achieving this result is complex, as the design of a CBDC must also meet regulatory requirements for traceability to prevent illicit activities. The challenge lies in offering ufficient privacy protections while ensuring the system is not exploited for criminal purposes. In this respect, it is somehow of concern that the most advanced CBDC projects have been developed in countries where central banks are less independent, which mostly happens where the form of government is not fully democratic (see Figure 2 in the numbers section)

The traceability of transactions in a CBDC system raises significant concerns. In this issue, Davies warns of the potential emergence of a “Surveillance State,” where central banks could excessively monitor consumer spending patterns, encroaching on personal privacy—a point also addressed by Holden. However, we believe this concern is equally relevant for private digital currencies, depending on their design and the degree of transaction privacy they offer.

In this case it is crucial to analyze privacy concerns against the correct counterfactual. While it might be technically impossible to guarantee the same level of anonymity with a CDBC as with cash, most transactions are already digital and are traced, recorded, and stored by private PSPs. Regulation on the treatment of these data is rather heterogeneous worldwide, and all privacy concerns characterising CDBC transactions extend to transactions with private moneys. Once again, the optimal solution must trade off decentralization under regulatory oversight with centralization under public authorities, with different degrees of attention depending also on how much the state might be able and willing to use this information for coercive purposes (on the matter, see also Holden, in this issue).

Finally, cross-border data privacy presents significant challenges for both private digital currencies and CBDCs. The complexities involved in ensuring privacy across diverse regulatory environments are particularly acute for CBDCs, given their potential for international use (Giovannini in this issue). Private digital currencies already navigate these complexities. However, a state-backed CBDC would need to reconcile these issues on a potentially more significant scale, involving diplomatic and regulatory coordination across jurisdictions.

 

6. A European case for CBDC?

While the previous discussion aimed at covering all the main pros and cons of introducing a CBDC, the case of the digital euro has some specificities of its own, due to the fact that it refers to a currency adopted by different countries that are part of a monetary union with not-fully-integrated financial markets.

The pressing concern within the Euro area is the fragmented state of its payment systems, which remains surprisingly disjointed despite the existence of a single currency, a single market, and an almost completed banking union. The limited expansion of sizeable European players in payment systems and the lack of a seamless, integrated payment landscape have significant implications for the region’s financial efficiency and sovereignty. Currently, the effective interoperability of payment systems in Europe largely depends on non-EU-based credit cards, such as Visa and Mastercard, which account for 46% of all payments, and other e-payment solutions like PayPal. This reliance on non-European providers is a major concern for the European Central Bank (ECB), as it not only undermines the efficiency and increases the cost of cross-border payments but also exposes the Euro area to risks related to data privacy and regulatory compliance, as argued by members of the executive committee of the ECB (e.g., Cipollone, 2024) and by Giovannini in this issue.

The fragmented payment landscape in Europe starkly contrasts the ideals of the single market and of the banking union. Although the Single Euro Payments Area (SEPA) has facilitated cross-border credit transfers and direct debits since its implementation in 2002, there remains a significant gap in the unification of payment systems at the point of interaction, particularly for digital and person-to-person payments. This is due to the lack of technological solutions that make national payment networks interoperable among themselves, a solution that is instead being offered by the Eurosystem through TARGET in the case of interbank transactions. Of course, incentives to provide these solutions were different since TARGET was essential to guarantee a smooth transmission of monetary policy decisions, while the unification of the national payment systems was less of a concern, more so at a time when electronic payments were not as common as today.

Since 2002, several steps have been undertaken by the Eurosystem to foster the interoperability of payment systems. In 2017 the SEPA instant credit transfer (SCT Inst) scheme was launched, allowing the provision of instant payment clearing services by a number of European automated clearing houses, and the TARGET Instant Payment Settlement (TIPS) service in 2018. These schemes allow for instant payments from bank accounts across the euro area. They might, therefore, be used to make electronic payments at any point of interaction, including a shop or an online transaction, for example, through NFC and QR code recognition. However, these technologies were scarcely adopted by PSPs and are not diffused among merchants and consumers.^[6]See the ECB’s document. Strengthening the use of TIPS is one of the pillars of the payments strategy of the Eurosystem, complementary to the digital euro.

Interestingly, with the acceleration of the digital euro project, some private sector initiatives have been recently launched. For instance, digital mobile payment frameworks are being developed through collaborations between entities like SIBS in Portugal, Bancomat in Italy, and Bizum in Spain. Additionally, the European Payment Initiative (EPI), spearheaded by central banks in France, Germany, Belgium, and Spain, aims to create a European-based instant payment solution. Remarkably, the EPI plans to leverage the SEPA instant credit transfer scheme and existing infrastructures like the Eurosystem’s TARGET Instant Payment Settlement (TIPS), offering a payment network and a wallet with NFC and QR code capabilities. This seems to mirror the evolution of EURO1, a private sector large-value payment system for single same-day euro transactions at a pan-European level that leverages on TARGET and has been developed by EBA-clearing, a partnership of several large European banks.

In principle, instant payments can provide a reliable alternative to private money for electronic payment. Representing bank money transfers provided by regulated PSPs would create no problems for the conduct of monetary policy and price stability. In fact, this technology is largely used for electronic payments at the point of interaction in China. However, the question remains whether these private sector initiatives can achieve the level of interoperability and integration needed across the Euro area.

And how will they be affected by the introduction of the digital euro? Will it strengthen the interoperability of payment systems across the Euro area borders through its design and implementation more effectively and rapidly than simply enacting policies supporting private sector projects like the EPI? And, in case all projects evolve together, will they be complementary, or will they compete with each other, possibly creating costly redundancies?

In any case, even with the introduction of the digital euro, the role of the private sector in European payments will remain crucial. The ECB’s design for the digital euro foresees a strong role for private PSPs managing digital euro accounts and transactions, including responsibility for identification and possible frauds. According to the project, digital euro wallets will be linked to traditional bank accounts, creating a significant connection between the digital euro and the services PSPs provide in facilitating payments at the point of interaction.

The backing of the ECB fuels a pervasive action, more than any private sector operator could achieve, to address key barriers to interoperability, such as networks. It could, for example, make it mandatory for sales points to offer payments through digital euros. Moreover, by combining payment services with private providers, the ECB could help establish a unified regulatory framework, thus overcoming some of the major impediments that have hindered interoperability to date.

Still, as Dhamodharan argues in this issue (from the perspective of one of the incumbent market players), the success of the digital euro will ultimately depend on whether consumers and businesses perceive additional benefits compared to existing digital solutions already available or those that the market could potentially develop. A key aspect that seems to be overlooked in the debate is the effectiveness of the digital currency from the users’ perspective. If alternatives to the digital euro offer a better user experience to make electronic payments, its diffusion will be smaller. As recalled by Angeloni (in this issue), in China, in the last year for which data are available, transactions per second in digital Yuan were 0.02% of those performed by Alipay alone.

The ECB also pursues a geopolitical issue in addressing the Euro area payment systems. As argued above, in several official documents of the Bank, there emerges a concern that presently, the interoperability of payment systems across the Euro area is provided to a very large extent by non-European operators like VISA and Mastercard. This, of course, raises concerns about compliance with European standards and regulations, including worries for security and privacy. But frankly, even concerning this issue, it is unclear why such concerns could not be addressed more effectively through adequate regulation and supervision. Especially given that interoperability is effectively granted by these operators, although in a framework of excessive market dominance, as discussed earlier.

In summary, the argument that a digital euro is essential for establishing an effective pan-European payment system due to the market’s failure to deliver one is, in our view, somewhat weak on its own. It remains uncertain whether market-driven initiatives, such as the European Payments Initiative (EPI), could ultimately offer viable solutions. Moreover, these goals might be achievable by enforcing a unified regulatory framework across the Euro area or by strengthening the Eurosystem’s oversight framework for electronic payment instruments, schemes, and arrangements (PISA). In any case, addressing the current shortcomings of the Euro area’s payment systems will require tackling key issues such as interoperability, regulatory fragmentation, market power, and user experience, regardless of whether a digital euro is introduced.

 

References

Angeloni, I. (2024). Digital Euro: Catching Up and Browsing the Daisy. European Economy: Banks, Regulation, and the Real Sector, 2024(1): 1-9.

Bindseil, U. (2020). Central Bank Digital Currency: Financial Stability Implications. Working Paper Series No. 2350, European Central Bank.

Chiu, J., and Keister, T. (2022). The economics of digital currencies: Progress and open questions. Journal of Economic Dynamics & Control, 142, 104496. https://doi.org/10.1016/j.jedc.2022.104496

Cipollone, P. (2024). Innovation, Integration and Independence: Taking the Single Euro Payments Area to the Next Level. Speech at the ECB conference on “An Innovative and Integrated European Retail Payments Market,” Frankfurt, 24 April 2024.

Davies, P. (2024). Central Bank Digital Currency: An Idea Whose Time Has Come, or a Dangerous Misstep? European Economy: Banks, Regulation, and the Real Sector, 2024(1): 10-25.

Dhamodharan, R. (2024). Mind the Gap: Assessing the Market Implications of Retail Central Bank Digital Currencies. European Economy: Banks, Regulation, and the Real Sector, 2024(1): 26-40.

Fernández-Villaverde, J., and Sanches, D. (2019). Can currency competition work? Journal of Monetary Economics, 106: 1-15.

Giovannini, A. (2024). Can a Central Bank Digital Currency Overcome Structural Barriers? The Case of the Digital Euro. European Economy: Banks, Regulation, and the Real Sector, 2024(1): 41-67.

Holden, R. (2024). We Need Fedcoin Now: The Case for a U.S. CBDC. European Economy: Banks, Regulation, and the Real Sector, 2024(1): 68-85.

Infante, S., Kim, K., Orlik, A., Silva, A. F., and Tetlow, R. (2024). CBDC: Issues and Prospects. European Economy: Banks, Regulation, and the Real Sector, 2024(1): 86-110.

Keister, T., and Monnet, C. (2022). Central bank digital currency: Stability and information. Journal of Economic Dynamics and Control, 142, 104501.

Kumhof, M., and Noone, C. (2018). Central Bank Digital Currencies — Design Principles and Balance Sheet Implications. Bank of England Working Paper No. 725.

Williamson, S. D. (2022). Central bank digital currency and flight to safety. Journal of Economic Dynamics and Control, 142, 104146.

Zeno-Zencovich, V. (2023). Digital Euro as a Platform and Its Private Law Implications. Media Laws-Law and Policy of the Media in a Comparative Perspective – n. 2/2023, Available at SSRN: https://ssrn.com/abstract=4567354 or http://dx.doi.org/10.2139/ssrn.4567354.

Authors

José Manuel Mansilla-Fernández^[1]Public University of Navarre (UPNA) and Institute for Advanced Research in Business and Economics (INARBE).

The following presents a snapshot of Central bank digital currency initiatives in the G20 countries according to CBDC Tracker (https://cbdctracker.org/; accessed on September 10, 2024).

 

Argentina (Research stage)

In 2023, the Argentine central bank committed to introducing a digital peso bill as soon as possible, accelerating its work on legislation to implement a Central bank digital currency in the country. However, no specific project has been presented by the authorities yet.

 

Australia (Research/Proof-of-concept stage)

The Reserve Bank of Australia (RBA) is actively investigating both retail and wholesale CBDC solutions, using research and proof-of-concept trials to assess the benefits and limitations of CBDCs in different contexts. While the projects are still in the early phases, Australia’s dedication to studying digital currencies underscores its commitment to remaining at the forefront of this field.

In 2020, the “eAUD” (Retail) project was launched as part of a broader research initiative by the RBA to explore the potential use cases for a retail CBDC in Australia. This project focuses on how digital currencies could be used for daily transactions among consumers, addressing the practical applications of a CBDC for retail purposes. Although still in the research phase, the RBA aims to determine whether a retail CBDC would bring benefits such as improved transaction efficiency, financial inclusion, and enhanced payment security. At this stage, no concrete implementation plan has been set, as the project remains focused on understanding the desirability and feasibility of a retail CBDC within the Australian market.

Simultaneously, the RBA also launched a wholesale version of the “eAUD”, focusing on large-scale transactions between financial institutions. The “eAUD” (Wholesale) project was announced in 2020 and quickly moved into the proof-of-concept stage.

Alongside these retail and wholesale explorations, in 2020 the RBA also initiated “Project Atom”, focusing on the use of a wholesale CBDC for atomic Delivery versus Payment (DVP) settlements, where both the delivery of assets and the corresponding payment are made simultaneously.

 

Brazil (Proof-of-concept stage)

Brazil has been proactive in exploring the potential of a Central Bank Digital Currency (CBDC) since 2017, through its project known as “DREX”, now at the proof-of-concept stage. The overarching goal of the “DREX” project is to assess how a digital currency could benefit Brazil’s financial system, with a focus on key areas such as financial inclusion, economic stability, and the effectiveness of monetary policy.

The Central Bank of Brazil (BCB) recognizes that a CBDC could play a critical role in addressing some of the country’s financial challenges. By providing a more inclusive financial platform, a digital real could help bring underserved populations into the formal financial system, increasing access to banking and payment services. Additionally, the implementation of a CBDC could help promote stability within the financial system by providing a more secure and efficient means of payment that is less prone to the risks associated with cash handling and private digital currencies.

Another major motivation for exploring a CBDC is the potential to enhance the conduct of monetary policy. A digital currency could provide the Central Bank with more precise tools for controlling the money supply and implementing monetary policy, enabling quicker adjustments to interest rates and more effective management of inflation.

In the coming year, the Central Bank of Brazil plans to launch a pilot program to test the practical applications of a CBDC. This pilot will help the BCB better understand the technical requirements, regulatory challenges, and economic impacts of issuing a digital real. The outcomes of this pilot phase will be instrumental in determining the feasibility of a full-scale launch of a Brazilian CBDC in the future.

 

Canada (Research/Proof-of-concept stage)

Canada has adopted a comprehensive and forward-thinking approach to CBDC development. Through proof-of-concept trials and extensive research, the Bank of Canada has positioned itself to respond to various scenarios, whether that involves the decline of cash or the rise of private digital currencies. While no formal decision to launch a CBDC has been made, Canada’s work in this space demonstrates its preparedness to implement a CBDC should the need arise.

In 2016, the Bank of Canada launched “Project Jasper”, a proof-of-concept initiative aimed at exploring how distributed ledger technology (DLT) could deliver greater benefits to interbank payments. This project marked the beginning of Canada’s exploration into wholesale CBDCs. “Jasper” also tested the potential for cross-border transactions, particularly through its collaboration with the Bank of England and the Monetary Authority of Singapore.

In 2017, Canada expanded its CBDC research with the “Digital Loonie” project, which focused on the conditions under which a retail CBDC might be introduced. The Bank of Canada considered launching a CBDC if the use of banknotes continued to decline or if private digital currencies became widely adopted as alternatives to the Canadian dollar. The Digital Loonie project emphasized the importance of being prepared in advance, as creating a general-purpose, cash-like CBDC would take several years.

Building on these efforts, in 2019, the “Jasper-Ubin” project was launched as another proof-of-concept initiative, aiming to explore how a wholesale CBDC could improve cross-border transactions and interbank payments, leveraging DLT to enhance the speed, security, and transparency of these transactions.

 

China (Pilot stage)

China has been a global leader in the development and deployment of CBDC projects. The People’s Bank of China (PBOC) began exploring CBDCs as early as 2014, making it one of the earliest central banks in the world to do so. The country’s primary project, “e-CNY” (also known as the Digital Yuan), was launched as a pilot with the goal of creating a more efficient, secure, and inclusive retail payment system. The People’s Bank of China’s early adoption, rapid expansion, and ongoing innovation in the CBDC space have positioned the country as a global leader in the digital transformation of financial systems.

The “e-CNY” project is designed to provide a digital alternative to traditional payment methods while preserving monetary sovereignty. It is intended to serve as a backup infrastructure for private-sector payment platforms like WeChat Pay and Alipay, ensuring competition and promoting interoperability in China’s vast digital payments market. Additionally, e-CNY aims to increase financial inclusion by providing an accessible payment method for people in remote areas or those underserved by traditional financial services.

Since its launch, e-CNY has expanded rapidly. Piloted in several major cities and promoted through large Chinese banks, the digital currency has been integrated with popular apps like WeChat and Alipay, allowing users to make NFC payments and even offline transactions. As of the latest updates, the total value of transactions conducted with e-CNY has surpassed 1.8 trillion yuan, underscoring its broad and growing usage.

One of the distinctive features of e-CNY is its potential to enhance cross-border payments. To this end, the digital yuan has already been integrated into cross-border platforms such as “mBridge”, launched in 2022, which is specifically aimed at improving international trade settlement.

The People’s Bank of China has also been forward-thinking in terms of user adoption strategies. Initiatives such as wallet-opening machines for tourists and the potential introduction of features like expiration dates to encourage spending reflect China’s commitment to increasing the everyday use of e-CNY. The system has also been designed with privacy in mind, incorporating controlled anonymity to ensure user privacy while maintaining transparency for government oversight.

 

Euro area (Pilot/Research stage)

The European Central Bank (ECB) has been working on several initiatives regarding the implementation of a CBDC within the Euro Area, focusing on both retail and wholesale CBDCs. These projects aim to modernize the financial infrastructure and improve the resilience and efficiency of the European payment system.

Announced in 2021, the “Retail Digital Euro” project is currently in the research phase. The goal of this initiative is to provide European citizens with access to a safe form of digital money, reflecting the fast-changing dynamics of the digital economy. A digital euro would not replace cash but rather complement it by offering an alternative in the digital realm. The primary motivation is to ensure that, as digital payments continue to expand, the public retains access to central bank-backed money, the safest form of currency.

In 2022, the ECB announced a pilot for the “Wholesale Digital Euro”. This project focuses on enhancing the efficiency of large-scale financial transactions, particularly between financial institutions. The main motivations behind this pilot are to consolidate and further develop ongoing work by Eurosystem central banks and to gain insight into how different solutions could facilitate interactions between TARGET real-time gross settlement (RTGS) services and DLT platforms. This would enable faster, more efficient cross-border payments and improve interoperability within Europe’s financial system.

Related to the ECB’s CBDC efforts is “Project Stella”, launched in 2016 as a joint research initiative between the European Central Bank and the Bank of Japan. This project explores the potential of using DLT to improve financial market infrastructure, particularly for payments and securities settlements.

 

India (Pilot stage)

India has made significant progress in its exploration of a CBDC through its “Digital Rupee” initiative, led by the Reserve Bank of India (RBI). Announced in 2020, the project has already moved into the pilot phase, with a focus on both retail and wholesale applications of the Digital Rupee.

The main objective of India’s CBDC project is to increase efficiency and reduce risks within the country’s financial system by leveraging features such as instant settlement and programmability, which allow for the automatic execution of transactions, including the return of funds at specific times without delays.

Currently, the RBI is gradually rolling out the Digital Rupee in a controlled manner, testing its application across various sectors and use cases. By conducting a phased implementation, the central bank aims to identify potential challenges and ensure the stability of the Digital Rupee before a full-scale launch.

 

Indonesia (Proof-of-concept stage)

Indonesia has been actively exploring the implementation of a CBDC through the “Digital Rupiah” project. Initiated by Bank Indonesia in 2018, the project entered the proof-of-concept phase with the aim of complementing the country’s existing banknotes and coins. However, at the time, Bank Indonesia clarified that there were no immediate plans to move forward with a pilot project or trial, and the issuance of the “Digital Rupiah” was still a distant possibility. At present, the project remains at the proof-of-concept stage.

The project aligns with Indonesia’s broader digital transformation agenda, which is reflected in initiatives such as the Blueprint for Indonesian Payment System (IPSB) 2025 and the Blueprint for Money Market Development 2025. These frameworks are designed to modernize the country’s payment systems and financial markets, ensuring that Indonesia remains competitive in the rapidly evolving global economy.

 

Japan (Research/Proof-of-concept stage)

Japan has made significant strides in developing its own CBDC through multiple initiatives, most notably the “Digital Yen” project. The Bank of Japan (BoJ) began conducting research on the Digital Yen in 2021, marking an important step as Japan seeks to keep pace with global advancements in digital currencies.

The “Digital Yen” project has now moved into the proof-of-concept phase, with the Bank of Japan working closely with private-sector banks to test the system’s capabilities. The upcoming program represents an end-stage trial, with a strong focus on real-world application and feasibility. The central bank will conduct trials to test deposits and withdrawals from accounts, ensuring the currency can function as a viable alternative to physical cash.

As the Bank of Japan pushes forward with its CBDC efforts, a local digital currency forum is simultaneously working on creating a digital currency for Japan’s private sector. This initiative is intended to complement the central bank’s work, highlighting the cooperative effort between public and private sectors to modernize Japan’s payment infrastructure and keep up with the evolving global financial landscape.

Beyond the Digital Yen, Japan has also engaged in research projects exploring the broader applications of DLT. One such project is “Project Stella”, a joint research initiative launched in 2016 with the ECB.

 

Mexico (Research stage)

Mexico has been making progress in the exploration of a CBDC through the “Moneda Digital del Banco Central (MDBC)” initiative, led by Banco de México (Banxico). The project entered the research phase in 2021.

The main objective of Mexico’s MDBC project is to provide a digital alternative to the national currency, enhancing the accessibility of financial services for the population. Financial inclusion is a key focus of this initiative, as the digital currency is expected to allow citizens to open accounts more easily, facilitating their entry into the formal financial system. This could help address the significant portion of the population that is currently underserved by traditional banking infrastructure.

Mexico aims to launch the digital currency by the end of the year, following extensive research and analysis on how it could be incorporated into the country’s existing monetary system. Banxico has indicated that the asset will be designed to complement the use of physical currency, providing a secure and efficient alternative that will contribute to the overall digitization of financial services in Mexico.

 

Russia (Pilot stage)

The “Digital Ruble” project, initiated by the Bank of Russia in 2019, is a key initiative aimed at modernizing Russia’s financial system using a CBDC. The project has now successfully completed the pilot phase.

One of the primary objectives of the “Digital Ruble” is to reduce costs associated with financial transactions. By providing a digital alternative to physical cash and traditional bank transfers, the Digital Ruble has the potential to lower transaction fees, making financial services more accessible and affordable for the general public. The digital currency is also expected to increase the speed of payments, ensuring faster and more efficient transactions, particularly for businesses engaged in domestic and international trade.

Additionally, the introduction of the Digital Ruble is designed to foster the development of innovative products and services within the financial industry. By providing a secure, digital platform for payments and financial transactions, it could encourage the growth of new financial technologies and services.

 

Saudi Arabia (Pilot/Research stage)

Saudi Arabia has been involved in several significant CBDC projects, demonstrating its commitment to advancing digital currency technologies for both domestic and international financial systems. The initiatives led by the Saudi Arabian Monetary Authority (SAMA) reflect the country’s forward-thinking approach to enhancing the efficiency of payments and financial settlements using digital currencies.

A major area of exploration for Saudi Arabia is the development of a wholesale CBDC. This research forms part of Saudi Arabia’s broader efforts to modernize its financial infrastructure and remain competitive in the global financial landscape.

In addition to its work on wholesale CBDCs, Saudi Arabia has also been researching the potential of a retail CBDC since 2019. The goal of this research is to evaluate the feasibility and advantages of a retail CBDC in Saudi Arabia, particularly in terms of improving financial inclusion and the efficiency of payments for individuals and businesses.

In 2019, the “Aber” initiative was launched as a joint project between the Saudi Arabian Monetary Authority (SAMA) and the United Arab Emirates Central Bank (UAECB). The primary goal of Aber is to create a digital currency that can be used for cross-border financial settlements between Saudi Arabia and the UAE. The digital currency is limited to central banks and select financial institutions, with the purpose of improving the efficiency of international remittances. In November 2020, the two central banks published the results of the pilot project, demonstrating the feasibility of using a digital currency for financial settlements between the two nations. It also highlighted the potential for a digital system to serve as a backup for domestic payments in the event of a disruption. While the Aber project has shown promise, the timeline for full-scale implementation of the CBDC has not yet been announced, and specifics about the underlying technology and blockchain structure remain undisclosed.

In 2022, Saudi Arabia joined the “mBridge” project, a pilot initiative aimed at improving international trade settlement using CBDCs.

 

South Africa (Research stage)

Since 2019, the South African Reserve Bank (SARB) has been engaged in research surrounding the development of a CBDC. The central bank is investigating the role that a CBDC could play in enhancing South Africa’s financial infrastructure. A key objective of this research is to evaluate whether a digital currency can serve as electronic legal tender, complementing physical cash in the economy.

South Africa’s approach to a CBDC is deeply rooted in ensuring security, which stems from the high prevalence of internet banking fraud in the country.

Also launched in 2019, “Project Khokha” is a major research initiative that examines the potential of DLT to support South Africa’s CBDC infrastructure.

 

South Korea (Proof-of-concept/Research/Pilot stage)

South Korea has been steadily advancing its exploration of CBDCs through several initiatives led by the Bank of Korea (BOK). These efforts include research, proof-of-concept projects, and pilot phases aimed at developing both retail and wholesale CBDCs, as well as exploring regulatory requirements for cross-border payments.

In 2020, South Korea moved forward with a pilot for the “Digital Won”, the country’s retail CBDC. The pilot completed its second phase in June 2023, during which the Bank of Korea tested various features of the Digital Won, such as its use in offline payments and cross-border remittances. While the pilot yielded positive results regarding these functionalities, the Bank of Korea encountered performance issues with the blockchain technology underpinning the Digital Won. These challenges suggest that further refinement and development will be necessary before a full-scale launch of the Digital Won can be considered.

In 2023, the Bank of Korea initiated research into a wholesale CBDC, focusing on understanding how such a CBDC could enhance the efficiency and security of interbank settlements and broader financial market transactions. Although the project is still in the research phase, it marks an important step in South Korea’s efforts to modernize its financial infrastructure.

Also launched in 2023, “Project Mandala” is a research initiative focused on compliance policies and regulatory requirements for cross-border payments, aiming to explore how a CBDC could streamline these processes.

 

Turkey (Pilot stage)

Turkey has been actively exploring the implementation of a CBDC through its “Digital Lira” initiative, launched by the Central Bank of the Republic of Turkey (CBRT) in 2018. The project is currently in the pilot phase, with the goal of establishing a robust financial sector that can support the financing needs of the real economy while promoting financial innovation and strengthening Istanbul’s position as a global financial hub.

The main objective of the Digital Lira project is to create a strong institutional structure that can respond to the financing needs of the Turkish economy at a low cost. In addition, the project seeks to offer a variety of financial instruments to a broad investor base through reliable institutions. The overarching vision is to support Turkey’s ambition of making Istanbul an attractive global financial center.

For the first phase of the pilot study, the CBRT is developing a prototype “Digital Turkish Lira Network” and conducting closed-circuit pilot tests in collaboration with technology stakeholders. These initial tests are designed to evaluate the feasibility and functionality of the digital currency in a controlled environment.

Additionally, the CBRT intends to diversify the scope of the project to include other important aspects of financial technology. This includes further testing the integration of blockchain technology, exploring the use of distributed ledger systems in payments, and examining how the Digital Lira can interact with instant payment systems.

 

United Kingdom (Research stage)

The United Kingdom has been actively engaged in research on CBDC projects, spearheaded by the Bank of England (BoE). These projects aim to explore various CBDC models and understand the practicalities of implementation for both the public and private sectors.

The “RSCoin” project, which began in 2015, was one of the first CBDC research initiatives undertaken by a central bank. The Bank of England introduced “RSCoin” as part of its “One Bank Research Agenda”. Since then, the BoE has continued to explore the architecture of CBDCs, examining different models to identify the most effective design.

In 2018, the BoE initiated the “Digital Pound” project, researching how a CBDC could work across the entire end-to-end user journey. The goal is to refine the functional requirements for both the Bank of England and private sector entities, ensuring that the eventual design of the CBDC is user-friendly and secure. The project emphasizes making the concept of a CBDC more tangible for internal stakeholders within the BoE and external players in the financial sector. By studying the user journey, the BoE is working toward a more practical and applicable digital currency, one that integrates smoothly with the existing financial infrastructure.

Also in 2018, the BoE launched a broader CBDC research initiative aimed at investigating the various implications of introducing a digital currency. The BoE is considering several design options, including how CBDCs would coexist with physical cash and how they could potentially reshape the UK’s financial landscape.

The architecture of the future CBDC remains undecided, as the BoE is still weighing the trade-offs between a direct model – in which the central bank directly manages transactions – and a hybrid model, where private institutions play a key role in processing payments.

 

United States (Proof-of-concept/Research stage)

The United States has been exploring the potential for a CBDC, with several key initiatives led by the US Federal Reserve. These projects range from research into the underlying technologies of CBDCs to proof-of-concept trials aimed at understanding the real-world applications of a “Digital Dollar”.

Initiated in 2020, the “Digital Dollar” project is currently in the research phase. In August 2020, the Federal Reserve published findings from its “FooWire” trial, which highlighted the potential of DLT for payment systems.

Additionally, the Federal Reserve Bank of Boston partnered with researchers from MIT’s Digital Currency Initiative (DCI) to embark on a multi-year collaboration aimed at building and testing a hypothetical open-source CBDC platform.

Launched in 2022, “Project Cedar Phase II” is part of a collaboration with “Project Ubin+”, a proof-of-concept project focusing on cross-border cross-currency transactions using wholesale CBDCs as settlement assets. The goal is to design a system that can achieve atomic settlement, a mechanism where both sides of a transaction are settled simultaneously, reducing the risks associated with cross-border payments.

The project aims to establish connectivity across multiple heterogeneous simulated currency ledgers to significantly reduce settlement risks, a major issue in international transactions.

In 2023, the Federal Reserve began further research into a “Wholesale Digital Dollar”, focusing on large-scale financial transactions between financial institutions.

Overall, the United States has adopted a cautious and thorough approach to exploring the potential of a “Digital Dollar”. Through a combination of research and proof-of-concept trials, the Federal Reserve is gradually building a body of knowledge that will inform its future decisions regarding the possible implementation of a CBDC. However, the Federal Reserve has not yet made a formal decision regarding the launch of a digital currency. The research continues to focus on understanding how a CBDC could integrate into the existing financial system and what challenges would need to be addressed for a full-scale implementation.

Authors

Giorgio Barba Navaretti^[1]University of Milan., Giacomo Calzolari^[2]European University Institute. and Alberto Franco Pozzolo^[3]Roma Tre University.

 

1. Introduction

Information is the main character in open banking (OB), which is about opening to third parties the access to information that is otherwise captive in a bilateral relationship between the incumbent provider of financial services and the client. With the words of Rivero and Vives in this issue, OB “refers to those actions that allow third-party firms, either regulated banks or non-bank entities, to have access under customer consent to their data through application programming interfaces (API)”.

Specifically, open banking aims at creating a market for customers’ transaction data, obtained (mostly although not only) from payment information. Traditionally, these data were accessible only by the financial intermediary performing the transaction and they were rather cumbersome to transfer. This gave banks the possibility to leverage on the data and extract higher rents from the interactions with their customers. OB allows customers to easily, swiftly and freely transfer their own payment information to any authorized third party of their choice, thus changing the conditions for transactions with their financial intermediaries.

Where does OB come from? The kick start comes from regulation. In the European Union, the starting point was the approval in 2015 of PSD2, the revision of the Payment Services Directive by the European Commission,^[4]Directive (EU) 2015/2366, known as PSD2, see the Institutions section below. which requires that financial institutions open up they data in favour of account service information providers (AISP), payment initiation service providers (PISP), and card-based payment instrument issuers (CBPII). In UK, PSD2 was transposed into legislation with The Payment Services Regulation of 2017, leading to the foundation in the same year of the Open Banking Implementation Entity (OBIE), an independent organisation of the 9 largest retail banks in Britain and Northern Ireland aiming to implement open banking. Similar legislations were implemented for example in South Korea and Australia, favouring the diffusion of open banking.^[5]See the Institutions and Numbers sections below. Also the market itself and the entry of new fintechs can give incentives to customers to share their financial information to obtain better services, in domains beyond payments, like loans, private banking, and so on.

In general terms, the reasons for opening access to information to third parties are three. First, enhancing competition. New third-party firms can use the information about the client to offer targeted services at better terms than the incumbent. Second, to favour inclusion. Because of a decline in costs, otherwise unbanked, unfinanced individuals may have access to financial services (see Bianco and Vangelisti in this issue). Third, to foster innovation. Competition and the focus on big data and programming interfaces is expected to favor the development of new tools, apps and services.

More specifically, the preamble of PSD2 emphasized the importance of increasing competition and guaranteeing free entry and a level playing field among incumbents and new participants.^[6]Paragraph (4) of the preamble recites: “(…) equivalent operating conditions should be guaranteed, to existing and new players on the market, enabling new means of payment to reach a broader … Continue reading However, and remarkably, the Directive focused almost exclusively on data about payment services. In fact, AISPs are guaranteed access only to data of payment accounts, i.e., accounts “held in the name of one or more payment service users which is used for the execution of payment transactions”. All the same, it became increasingly clear to the industry that granting access to customers’ payment information would have also eased the provision of other banking and financial services and the development of a range of innovative products. These developments were also judged positively by regulators. In this regard, it is illuminating that EBA, in reply to a question raised by the Bank of Ireland on the interpretation of the Directive, on 13 September 2019 stated that an AISP is not limited to providing the consolidated information on the different account positions to the payment service user, but with the user’s consent it can also make this information available to third parties.

This evolution towards an even broader OB is envisaged to have the potential to change financial intermediation radically. But for this to happen, two key factors must be present: first, consumers must be willing to share their data, and second, the technology must be in place to ensure seamless data access through the use of APIs and cloud computing. If these conditions are met, OB is expected to change the way financial intermediation occurs.

Yet, there are considerable limits to the diffusion of financial information and to the use of such information for the purposes of enhancing competition, inclusion and innovation. Open banking is essentially about enabling transfers of data and information to some third parties, but not making it generally available. Key to the understanding of the potential impact of this innovation with respect to the three objectives above is therefore the assessment of how information will in fact be spread and used. If we take this perspective, we believe that the scope and the aims of open banking, although potentially groundbreaking, may sometimes be overstated, and its desirable implications cannot be taken for granted.

Information, in principle, is a public good: non rival and spreadable at no (marginal) cost. It gains private value precisely when different forms of protection privacy rules), or property rights (patents and copyright) prevent it from being used as a public good. Even in the case of open banking, information has value, be it for the incumbent or for other third parties, only if it can keep being privatized, at least partly. This creates inherent limits to its complete diffusion and disclosure.

These limitations are relevant for both the supply and the demand of information. On the supply side, OB does not open information concerning a given client to everybody. The owner of the information, the client, decides whether to make it available to well-identified counterparts. Whatever the source of open banking, rules or markets, the starting point is that the client remains the sole owner of the data and information on her or his transactions. This causes an issue of selection. How many potential counterparts are clients willing to disclose their private transactions to? Possibly a small number, because of privacy and because of reluctance to disclose sensitive information. Hence the supply of information will likely be limited.

As for demand, entry of third parties in a given segment of the financial markets will be enhanced by OB only if entrants have some way of preserving at least part of the value of the information. If it were not at least partly privatized by the new third party, the information would have limited value and there would be no demand for it and, ultimately, no entry in the market. Of course, even in a world where information is fully disclosed, capable providers can leverage on freely accessible information to offer highly differentiated products, not fully in competition one with the other, and create value for themselves anyway. Yet, inevitably the value of information declines with its diffusion. Again, this sets, from the demand side, a limit to how extensively information would be spread out.

An additional issue is how the information can be effectively used, and we will discuss this extensively in the third part of this editorial. One option, as argued above, is that the information is granted by the customer to a limited number of selected counterparts. Even opening up the information to a single new provider can be beneficial to the client: compared to the incumbent, the entrant may offer new services or the same services at better conditions. Of course, as argued by several contributions in this issue, things are different if the new entrant is an established bank or a Bigtech i.e., the big digital platforms with strong and entrenched market power in (non-financial) digital markets, rather than a fintech. Still, the ability to offer new services would anyway have a positive impact on competition and innovation, and possibly, through a reduction in the cost of services, to inclusion.

A different scenario could emerge if the data were transferred to a platform, which brokers numbers of potential suppliers of financial services. The platform matches clients with services, and the information likely stays with the platform, i.e., it is not necessarily transferred to the providers of the financial services. This because the platform is the intermediary in a two-sided market and has the technology to use the information for efficient matching. The client can therefore be better off. However, as we will argue below, the platform would enjoy monopoly power and information rents.

Network externalities would also be another distinctive element of this scenario. Only platforms with a very large client base and a large number of potential suppliers can effectively use clients’ data to offer efficiently targeted services. In other words, services based on the use of data and clients’ information generate network externalities which create new monopolistic power and limit the diffusion of information, even if it is used to broker the services of many potential suppliers. The market power built on relationship-based financial intermediation with restricted data access, would be replaced by a new network-based market power with open data. We will discuss the implications of OB for competition extensively in the third part of the introduction. In the following one we first examine which type of financial services can be affected by OB.

 

2. Open banking’s products

Which financial products will be mostly affected by open banking? A distinction is to be made between the existing financial products and the new ones that may be created.

Since open banking is mostly based on sharing payment information, an obvious starting point is to look at payment services. In this respect, payment initiation service providers (PISP) – newly allowed by PSD2 – may compete with existing intermediaries to become the originators of customers’ transactions, favouring a reduction in the costs and an increase in the speed and security of payment transactions. Customers, for example, may authorize a PISP to directly charge their bank current account after their purchases on internet, while simultaneously giving the seller the guarantee that the payment is successful. Since internet purchases are typically regulated through rather expensive credit-card transactions, the benefits of having PISPs is in this case evident

However, focusing on payment services only gives a narrow perspective on how open banking can enhance competition in the market for existing financial products. The possibility of accessing customers’ transaction data will likely impact all markets where this information has value for the provision of targeted services (Fama, 1985). An obvious example is the loan market. Convincing empirical evidence shows that there are significant complementarities between offering the same client a deposit account and a loan (Mester et al. 2002). In fact, it is a common practice for banks to require clients to open a checking account when they are granted a loan. Indeed, information on incoming and outgoing financial flows can be extremely valuable to assess ex-ante the level of a borrower’s riskiness and monitor ex-post its evolution. Financial intermediaries that can access these data have, therefore, a competitive advantage with respect to their competitors, leading to a bundling of the markets for deposits and loans. With open banking, each customer can allow an AISP (account information service provider) to access his transaction data and use them to choose what it considers the best potential lender. If authorized by the payment account holder, an AISP can also make the information available to any third party of his choice. A competing bank could therefore either act as an AISP or obtain information from an AISP on the customer’s transaction data. Clearly, this would whiten the competitive advantage that banks have when granting loans to their deposit holders. The product that would benefit from increased competition made possible by open banking would in this case be traditional bank loans.

Another practice that is rather common among banks is to offer investment products to their deposit holders when they see that their balances on the checking account exceeds levels consistent with normal operativity. In this case, the customer only receives an alert on his liquidity position, and she is free to invest in products other than those offered by the bank where she holds her checking account. However, the bank that has access to the customer’s transaction data still holds a first-mover advantage with respect to potential competitors, and it also has a comprehensive view of the time evolution of the liquidity position of the customer and of its average liquidity needs. Once again, with open banking, a customer can choose to make all this information available to any provider of saving products through an AISP, therefore reducing the competitive advantage of the bank where she holds the checking account.

A parallel issue, emphasized by Redondo and Vives in this issue, is the sharing of information on other financial positions of a customer regarding his saving and investment accounts or his loans and mortgages. While this is not yet a central part of the debate on open banking, there appears to be no reason why the logic applied to transaction data should not be expanded to information on other financial positions.

But open banking is not only expected to increase competition in the markets for existing financial services but also to foster the creation and supply of new financial services. This may open the door to an entirely new business model, where banks become platforms between customers willing to make their data available and sellers of financial services and financial intermediaries willing to offer them products that are specifically targeted to their individual characteristics. While the implications of this potential revolution on the banking industry will be discussed in more detail below, new products are being developed and it is to be expected that a wide range of additional ones will be made available in the future.

At the moment, the fastest growing services seems to be those helping to connect different accounts – e.g., bank, credit cards, and investment accounts – to provide a comprehensive view of the financial position of an individual or a firm. Providers such as Emma (https://emma-app.com/), Tink (https://tink.com/) and TrueLayer (https://truelayer.com) already offer these services, and are extending their line of business in new directions. For example, some providers already offer contemporaneous access to investment platforms, including those allowing to acquire crypto assets, while others offer secure authentication for the access to all different accounts. Other services already available include those that alert customers (and possibly their authorized connections, e.g., parents of minors) when a payment is required that exceeds a given amount or a regular pattern of purchases, helping detect scams and frauds.

As discussed by Bianco and Vangelisti in this issue, an interesting set of services are those targeted to less skilled individuals to manage their finances better, helping them to avoid recurring to credit card loans when cheaper bank loans are available as alternative or alerting them when outflows are exceeding the sustainable pattern that can be foreseen based on past evolution. Indeed, if directed by adequate policies, open banking can be a powerful tool to improve financial awareness and inclusion.

The next steps are difficult to foresee, but they will likely depend on the amount of information that can be extracted from payment data. Detailed information not only on the inflows and outflows of money from an account but also on their origin and destination might allow to reconstruct the pattern of purchase of an individual, making the step towards targeted product advertisement very short. Clearly, this once again opens the Pandora box of the role of Bigtechs such as Amazon or Alibaba, that already collect this information from a different angle. The role of policy and regulation will therefore be crucial in shaping future developments.

The possible uneasiness of many customers to share information with unknown new players gives a strong advantage to incumbents. And while this may be contrasted by enacting regulations that limit access to customers’ information only to reliable and possibly supervised entities, such regulations may not be easy to implement since open banking services are offered through the Internet and may therefore come from entities based all over the world, including countries with loose or non-existent financial regulations on open banking and data protection. Indeed, an adequate balance between limitations imposed by regulation and the need to allow market access to innovative entrants is yet to be found, but certainly necessary.

The market is in rapid evolution. Emma, for example, was founded in 2010 by two computer scientists and has still managed to survive being privately owned. Tink, founded in 2012 by two independent entrepreneurs, has been fully acquired by VISA in 2022, likely planning to leverage its huge customer base. Instead, Yolt, an open banking personal finance management application offered by the Dutch bank ING that started operating in 2017, has already closed its activities.

 

3. The impact on the industry

As discussed above, the actual implications of OB, though, depend on the availability of adequate data flows. If financial customers are not interested in sharing their data or have concerns about privacy, the entire chain of consequences may not materialize. The more mature digital markets provide useful lessons, showing how platform companies successfully convinced users to give up and share their data. Many digital markets offer “freebies”, or zero-price services, such as search engines and recommendations, with monetization taking place on other sides of the market, such as advertising to digital users. This business model has pushed users to embrace the idea, consciously or not, of providing personal information in exchange for services. This could serve as a model for financial markets too, but it will require the development of a platform-based business model that, as illustrated above, would allow retaining the information with the platform intermediary, a model still to come in financial markets.

Assuming that financial consumers are convinced to share data, the question is who are the other financial operators that will receive them. Rivera and Vives, in this issue, convincingly note that if data flow reaches other incumbent operators, like traditional banks, then even if potentially competing, we may not expect significant impacts of data, with additional risks. We know that data availability may induce a “winners-takes-all” condition when companies offer multiple products and services. Again digital markets are an example with their strategies that rely on the reusability of personal data for multiple purposes and services, with an envelopment effect on customers. A realistic outcome of this data flow is a possible increase of market concentration in the hands of fewer traditional financial intermediaries, uniquely placed to offer bundles of services. They are unlikely to be challenged by platforms also offering several products and services, as they are yet to be seen in markets.

Clearly, as argued above, the flow of data mobilized by OB can also reach new players offering specialized and unbundled services, such as payment systems or lending services. Although in this case data could activate new tech players in financial markets such as Fintech, the implications on market structure and outcomes are, again, ambiguous and may not materialize quickly.

In fact, some recent papers in the academic literature (e.g. Parlour et al. (2022) on payments services and He et al. (2023) on lending) have highlighted that empowering Fintech players creates competitive pressure for traditional banks but, at the same time, can produce countervailing effects in terms of price and product discrimination and reduction of consumers’ surplus. Information is a peculiar input in financial intermediation. If the technology used by the new players to manage and elaborate information is significantly better than that of traditional players, this would enable them to segment the market and acquire the surplus of consumers of financial services. In other words, the unique nature of information as an input for financial activities can quickly generate excessive informational advantages for new entrants in terms of new services and better surplus appropriation.

Another risk could emerge when the data flow on financial transactions reaches mostly BigTech firms. These companies may extend their business envelopment and begin offering financial services (some already are, such as in China). On the one hand, this would increase competition, thus benefitting consumers of financial services. On the other hand, the strong envelopment tendency of a platform-business model should not be underestimated. We know from digital markets that these firms leverage detailed users’ information to capture users in several markets, with reinforcing feedback effect induced by even more data from the many services and products they offer. These are the consequences of strong complementarities between services and products (or indirect network externalities), reusability of data for several purposes and products, and specific properties of Artificial Intelligence algorithms employed to process these data.^[7]Calzolari et al. (2023) discuss “Scale and Scope” properties of Machine Learning tools that rely on the amount of data and the diversity of data-sources and also study the implications for the … Continue reading Digital platforms have also prospered thanks to a feedback-loop mechanism where more users provide more data, allowing for better algorithms, predictions, and services, thus attracting even more users. OB has thus the potential to favor BigTech companies disproportionally and reinforce their business model with the inclusion and mutual reinforcement of financial services in their ecosystems. Interestingly, BigTech may value the flow of data originated by OB more than traditional banks for the same mechanisms described above and may be quicker and more effective in convincing financial market customers to share data with them.

Will platform-based financial operators able to bundle a variety of services emerge? It is difficult to say at this stage. They may materialize from a transformation of traditional incumbent companies, such as banks, or from BigTech entering the financial market. However, whatever the origin of this development, this could become a radically new scenario with platforms operating as matchmakers between customers of financial services and financial service providers . As a first step, the relevant data might possible refer to payments and deposits, as discussed above, possibly merging this type of information from different banking relationships. So traditional banks and AISPs are currently better placed to become financial platforms at an initial stage. However, the envelopment effects of Bigtechs should not be underestimated. In addition, “Banking as a Service” may further evolve, again under the impulse of regulation, markets and technology, into broader future developments, as it could very much involve many other financial services not only those typically related to banking. The properties of such a market configuration with broad gatekeepers are not necessarily very competitive, as the digital markets have shown and as discussed above.

Padoan, in this issue, indicates what could be effective strategies for traditional banks. Rather than insisting on traditional approaches, the quicker way into the innovation flow for traditional banks seems to be collaborating with new players (or acquiring them). However, we think this will not suffice if the platform model prevails. The changes needed for banks to transform themselves into platform operators and benefit from the network externalities that, if large, they already enjoy, are anyway deep. Offering fintech services in parallel is just one step in creating an enveloping “ecosystem” for their own products or for those of partners.

These long-run effects of OB are challenging to predict at this stage, as they combine several elements, in particular innovative technologies with consequences on screening and matching, flows of data, and business models that are new to financial markets.

In this uncertain and evolving environment, regulation should play a key role. For example, currently, in Europe, the Payment Service Directive “PSD2” only refers to data flowing to payment service providers but not to providers of other financial services, such as saving accounts, credit cards, mortgages, pensions, or insurance. Because of the implications of data flow discussed above, this limited first step into OB could be considered a wise approach. However, this is leaving much of the potential of OB untapped, and, as Dalmasso elaborates in this issue, the limited span of the directive may in itself constrain the potential broader benefits of OB. Regulation should continue to lead the development that OB will have on financial markets, also because increased competition and shifts in profitability will affect financial operators’ charter values, thus inducing increased risk-taking appetite with perilous implications for financial stability.

Currently, the promise of innovative banking platforms remains unfulfilled, as new entrants primarily focus on creating effective application interfaces rather than offering truly ground-breaking financial services. As previously discussed, the impact of OB may remain limited. However, once OB reaches full potential, it will undoubtedly reshape the financial landscape. And it will be essential to guide this process to prevent market tipping and concentrations similar to those seen in digital markets. Historically, policymakers believed that ex-post interventions would suffice to address market power issues in digital markets. However, as we have learned from experience, this is not the case, and regulators have had to catch-up with new regulations like the Digital Market Act (DMA) and the Digital Service Act (DSA). In the case of financial markets, proactive regulation will be crucial to avoid a similar scenario of late intervention. To achieve this, it will be useful to learn from the lessons of digital markets while creating regulations tailored to the unique characteristics of the financial industry. The challenge will be to strike a balance between regulations like DMA and DSA, coexisting with those designed explicitly for financial markets.

 

References

Calzolari G., Cheysson, A., and R. Rovatti (2023) “Machine Data: Market and Analytics”. SSRN, CEPT and European University Institute working paper.

Fama, E. F. (1985). “What’s different about banks?”. Journal of monetary economics, 15(1), 29-39.

He, Z., Huang, J., and Zhou, J. (2023). “Open banking: credit market competition when borrowers own the data”. Journal of Financial Economics, 147, 449-474.

Mester, L. J., Nakamura, L. I., and Renault, M. (2007). “Transactions accounts and loan monitoring”. The Review of Financial Studies, 20(3), 529-556.

Parlour, C. A., Rajan, U., and Zhu, H. (2022). “When Fintech competes for payment flows”. The Review of Financial Studies, 35, 4985-5024.

 

Authors

José Manuel Mansilla-Fernández^[1]Public University of Navarre (UPNA) and Institute for Advanced Research in Business and Economics (INARBE).

 

Characteristics of Open Banking^[2]We wish to thank Platformable for making their data available for our research.

Figure 1. APIs development by banks.

Notes: Own elaboration on Platformable and world Bank data. The figure reports the first 30 countries ordered by the ratio of the number of APIs developed by banks in the Platformable sample and the total number of banks in the country.

 

Figure 2a. APIs development by banks in different world regions.

 

Figure 2b. APIs development by banks in Europe.

Notes: Own elaboration on Platformable database. The vertical axis represents the average number of APIs developed by each bank of the sample. The whiskers represent the maximum and the minimum of the distribution. The box is divided into two parts by the median, i.e., the 50 percent of the distribution. The upper (lower) box represents the 25 percent of the sample greater (lower) than the median, i.e., the upper (lower) quartile. The mean of the distribution is represented by ×.

 

Figure 3: APIs development and bank size.

Notes: Own elaboration on Platformable database. Correlation between banks’ size measured as the natural logarithm of bank’s i total assets (Ln(Total assets)) in 2022Q3, which is represented in the horizontal axis, and the number of APIs in 2022Q3, which is represented in the vertical axis. The sample includes banks from Austria, Denmark, France, Greece, Ireland, Italy, The Netherlands, Spain, and the United Kingdom.

 

On FinTech companies

Figure 4: Use of FinTech-provided services.

Notes: Own elaboration on Platformable database. The vertical axis represents the different FinTech categories by functions. The horizontal axis represents the share of the number of FinTech companies included in Platformable by category. The sample includes FinTech companies from Europe, The United Kingdom, and the United States.

 

Figure 5: Users of FinTech-provided services.

Notes: Own elaboration on Platformable database. The horizontal axis represents different users of banking services provided by FinTech companies. The vertical axis the share of each users. The sample includes FinTech companies from Europe, The United Kingdom, and the United States.

Authors

José Manuel Mansilla-Fernández

 

Open banking frameworks

Open banking is defined as the “sharing of customers’ permissioned information held by banks with so-called ‘third-party’ developers, who can use them to build applications and services comprising payments, synthetic information for account holders, and other marketing and cross-selling opportunities” (BIS, 2019).^[1]The term ‘third party’ can be defined as ‘legal entities’, rather than supervised banks. More precisely, ‘third parties’ can be supervised banks and / or regulated companies, sellers, and … Continue reading

Many authorities are planning to take actions to regulate Open Banking in their jurisdictions. A large part is following a prescriptive approach, which mandates banks to share customers’ information with the aforementioned ‘third parties’ willing to access, as long as they are included in a register established by regulatory authorities. Other jurisdictions are instead adopting a facilitating approach, avoiding explicit requirements to make data available to ‘third parties’ but providing guidelines or recommendations, as well as suggesting common standards for the application programming interfaces (API) used to access the data, that the whole industry is invited to adopt. Lastly, other authorities are following a market-driven approach, setting no specific rules the sharing of customers’ information between banks and ‘third parties’ (BIS, 2019). ^[2]The European Union countries follow the prescriptive approach. Japan, Hong Kong, Singapore, and Republic of Korea adopted the facilitative approach. Argentina, the US and China follow the … Continue reading Overall, the regulatory framework is still embryonic in many jurisdictions, and activities by regulators, banks and market developers are still in at the initial stage (OECD, 2023).

A thorough Open Banking framework can include rules, standards and practices aimed at solving the many issues that are likely to emerge from such a pervasive data-sharing environment. Most jurisdictions take the perspective of customer protection from possible problems caused by allowing access to bank customer-permissioned data to unregulated third (and possibly fourth, if data are further transmitted to other corporations) parties (Bains et al., 2022). From this perspective, a range of different authorities are involved in regulating open banking, including: i) bank supervisors, in their traditional role of with respect to the activities of regulated banks (that are the producers of customer data); ii) technical standards setting bodies, that establish standards for automated access to customer permissioned data through API, with a special focus on security and standardization, requiring all involved entities to comply with them; iii) competition authorities, that monitor, encourage and take actions to ensure the well-functioning of markets; iv) data privacy authorities, responsible of ensuring the protection customer data; v) alternative dispute resolution mechanisms, responsible of mediating disputes between consumers and financial service providers (BIS, 2019).

 

The regulatory framework in the European Union

The revised PSD2 (Directive (EU) 2015/2366), adopted from January 13th 2018, standardizes payment services across the European Union (EU hereafter), and is the reference framework for the regulation of the payment sector.

Among other seminal provisions – e.g., detailed security transactions for electronic payments – the PSD2 also establishes the key concepts for the definition of Open Banking, by including in the regulation the Payment Initiation Services (PIS) and the Account Information Services (AIS). In this regard, the Directive clarify that the ‘competition-enhancing objective’ by regulating services operating as competitors to main banks.^[3]Art. 108 of The Directive foresees reporting on the application of PSD2 to the European regulatory institutions, i.e., the European Parliament and the Council, the European Central Bank and the … Continue reading An important step in this direction was the reply by EBA to a question raised by the Bank of Ireland on the interpretation of the Directive, stating that an AISP is not limited to providing the consolidated information on the different account positions to the payment service user, but with the user’s consent it can also make this information available to third parties (EBA, 2021).

Despite the innovative content of PSD2, a recent document by EBA (2022) assessing the impact of PSD2 came to the conclusion that significant areas are still to be addressed so as to achieve the objectives to enhance competition, facilitate innovation, increase security of payment transactions, ensure the neutrality of the business model, and build a ‘single EU retail payment market’. In particular, the EBA proposes detailed interventions in four areas: 1) the prudential framework on licencing payment companies under the PSD2 regulation; 2) the responsibility of funds transferred by ‘third-parties’;^[4]In particular, EBA proposes for the Directive: (i) not to take into consideration maximum limits for the amount to block payers’ accounts if the transaction is known, but introducing some … Continue reading 3) the application of Secured Customer Authentication (SCA), especially regarding the regulation of the merchant-inititaled transactions; 4) the need to address social engineering fraud risk by introducing requirements on educational and awareness campaigns, incentivising Payment Service Providers (PSP hereafter) to invest in monitoring mechanisms and sharing information among PSPs related to possible cases of fraud or fraudsters. Interestingly, regarding the need for ensuring the maximum degree of ‘financial inclusion’, the EBA suggests that the Directive introduces a general provision taking into account vulnerability of customers. The EBA also suggests enhancing attention and training on authentication procedures.

 

The British regulatory framework

The United Kingdom’s (UK) Open Banking Initiative constitutes a reference worldwide. The Open Banking Working Group (OBWG hereafter) was created in September 2015 by HM Treasury to assess whether bank data sharing may benefit the whole sector. The group consists of representatives of financial institutions, open data groups such as the Open Data Institute (ODI hereafter), as well as consumers’ associations and representatives of ‘third-party’ corporations. The following year, the Group suggested that standardized APIs would be a useful step to facilitate the sharing of information. In addition, it argued that a decentralised system of Open Banking would be safer than a single, centralised system.

The crucial year for Open Banking in UK is 2017. The PSD2 was transposed into legislation with The Payment Services Regulation and the Competition and Markets Authority (CMA) conducted a ‘Retail Banking Market Investigation’, that reached the conclusion that “older and larger banks do not have to compete hard enough for customers’ business, and smaller and newer banks find it difficult to grow. This means that many people are paying more than they should and are not benefiting from new services” (CMA, 2016). As a result, the CMA introduced a major open banking initiative aimed at enhancing innovation and competition within the banking sector, requiring the nine largest banks to “give their personal and business customers the ability to access and share their account data on an ongoing basis with an authorised [by the government] third parties” (see Taylor-Kerr, 2020). Here, the term ‘third party’ refers to banks and FinTechs. Furthermore, the aforementioned banks were required to enable third parties to make payment services authorised by customers’ banks, the so-called payment initiation. Importantly, the access to the data must be free to the petitioner (under customers’ permission), and banks are mandated to allow it (Babina et al., 2022).

In allowing banks to access customers’ information, regulators intend to create an environment where financial might propose new or improved financial services for customers and enhancing competing environment.

Lastly, the Open Banking Implementation Entity’s (OBIE hereafter), which was created in May 2020 after a thorough consultation process, adjusted the ‘Roadmap’. The process was conducted in two steps of consultation: i) open workshops, and ii) the assessment over 75 pieces of feedback from representative stakeholders, including the banks, third party suppliers, and user representatives.

 

Regulatory framework in other jurisdictions

As argued above, the regulatory framework of open banking is still embryonic in many jurisdictions. This section describes briefly the situation and perspectives of Open banking around the World.

The Australian government introduced the Consumer Data Right (CDR hereafter) legislation in 2017. The CDR applies to a broad range of customers’ data, including banking, energy, telecommunication data information, which are aimed at generating interoperability across sectors. Furthermore, the Australian Open Banking application is exclusively dealing with data, but not on payments. Additionally, the Australian Competition Consumer Commission (ACCC hereafter) assumes the supervisory role, which is equivalent to that of the CMA in the UK, while operating along the Australian Payments Network. In this regards, Andi White, CEO of the Australian Payments Network, stated that “the regulatory stance is about a balance of stability and innovation but there is a desire for good competition with the rise of challenger banks” (ACCC, 2023).

In Canada, a consultation was announced in 2017 to analyse the capabilities of Open Banking for their banking sector. In particular, an ‘Advisory Committee on Open Banking’ was appointed to conduct the analysis, along with a secretariat within the Department of Finance. In June 2019, the ‘Standing Senate Committee on Banking, Trade and Commerce’ launched a report entitled “Open Banking: What It Means For You”, which deals with a number of recommendations aimed at consolidating the Open Banking in Canada (World Bank, 2022).

The Hong Kong Monetary Authority (HKMA) released the “Open API Framework for the Hong Kong Banking Sector” in July 2018. The HKMA is intended to allow their banking industry to set their own criteria without making it a regulatory requirement (HKMA, 2018).

India released the Unified Payment Interface (UPI) in 2016, which is developed by the National Payments Corporation of India (NPCI). The UPI allows data transfer among financial institutions using a strong API environment that includes a digital identity solution which is still missing in most European and US jurisdictions/markets. Importantly, a new category of entities called Account Aggregators act as data fiduciary managing data requests from institutions that have a legitimate interest and the providers of information, and the consent of the data subject. The model is a clear representation of the regulatory approach. Importantly, it does not pre-judge the type of services the data receivers will offer, and allows all institutions regulated by any of the financial sector regulators in India and the Department of Revenue, Government of India to be able to participate as data receivers (see Natarajan, in this issue).

In Japan, the Amended Banking Act introduces a system for TPPs and establishes the environment for the banks-TPPs collaborations, in addition to other voluntary partnerships among banks to release ‘digital payments initiatives’. However, the activities of adopting ‘third parties’ are still in a preliminary phase, partly because of the difficulty in negotiating contracts between banks and FinTechs.

Mexico has implemented a model similar to the British one, but considering ‘premium’ versions for APIs. In March 2018, Mexico passed the ‘Financial Technology Institutions Law’ (The FinTech Law) aimed at regulating the FinTech and the Open Banking companies. The Mexican government is now finalising its implementation. The National Banking and Securities Commission will be the Open Banking regulatory framework, which is also intended to enhance innovation and financial inclusion (Greenberg and Traurig, 2020).

New Zealand implemented a model of Open Banking similar to the British one. The similarity results from the tight collaboration between both jurisdictions, conducted under the administration of the local payments associations, namely PaymentsNZ. Furthermore, New Zealand’s programme includes information about customers’ accounts and their payments (World Bank, 2022).

In Nigeria, the ‘Open Technology Foundation’ launched the Open Banking Nigeria (OBN hereafter) in 2018, which was aimed at fostering innovation in the Nigerian banking sector. OBN was intended to standardize open APIs as well as foster financial institutions and FinTechs to open their APIs protocols. Unlike other Open Banking jurisdictions, OBN regards excessive the British standards for the Nigerian purposes. Hopefully, Nigeria is designing suitable standards for the needs of their banking sector, and for other West African countries. The OBN’s API framework is expected to reduce the cost of innovation and to provide a good customer experience (Kassab and Laplante, 2022; ODI, 2020).

In Singapore, banks are encouraged to adopt APIs to accelerate the implementation of Open Banking. The Monetary Authority of Singapore (MAS hereafter) is not directly intervening, but together with the Association of Banks in Singapore has released an API typescript to encourage financial institutions to take part in the programme. As a result, several banks are launching their own API portals (e.g., Citibank, DBS, Standard Chartered, among others).

In the US, the so-called “NACHA’s API standardisation programme”, which was announced in 2017, focusses on three areas: i) fraud; ii) customers’ information sharing; iii) access to payment services. Additionally, the Consumer Financial Protection Bureau’s principles advice banks to include APIs for customers’ information sharing.

 

References

Australian Competition and Consumer Commission (ACCC) (2023). The consumer data rights. Available at: https://www.accc.gov.au/focus-areas/the-consumer-data-right (Accessed on 23 March 2023).

Babina, T., Buchak, G. and Gornall, W. (2022). Customer Data Access and Fintech Entry: Early Evidence from Open Banking. Mimeo.

Bains, P., Sugimoto, N., and Wilson, C. (2022). BigTech in Financial Services: Regulatory Approaches and Architecture, FinTech Notes. Available at: https://www.elibrary.imf.org/view/journals/063/2022/002/article-A001-en.xml (Accessed on 22 March 2023).
Badour, A., and Presta, D. (2018). Open Banking: Canadian and international developments. Banking & finance law review, 34(1): 41-47.

BIS (2019). Report on open banking and application programming interfaces. Basel Committee on Banking Supervision. Available at: https://www.bis.org/bcbs/publ/d486.pdf (Accessed on 15 February 2023).

Competition and Markets Authority (CMA) (2022). Retail banking market investigation. Avaulable at: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/1048212/Final_revised_Agreed_Arrangements_190122.pdf (Accessed on 22 March 2023).

Competition and Markets Authority (CMA) (2016). CMA paves the way for Open Banking revolution. Available at: https://www.gov.uk/government/news/cma-paves-the-way-for-open-banking-revolution (Accessed on 22 March 2023).

EBA (2022). Opinion of the European Banking Authority onitstechnicaladvice on thereview of Directive(EU) 2015/2366onpayment services in the internal market (PSD2). Available at: https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/Opinions/2022/Opinion%20od%20PSD2%20review%20%28EBA-Op-2022-06%29/1036016/EBA%27s%20response%20to%20the%20Call%20for%20advice%20on%20the%20review%20of%20PSD2.pdf (Accessed on 15 February 2023).

EBA (2021). Guidelines on customer due diligence and the factors credit and financial institutions should consider when assessing the money laundering and terrorist financing risk associated with individual business relationships and occasional transactions (‘The ML/TF Risk Factors Guidelines’) under Articles 17 and 18(4) of Directive (EU) 2015/849. (Accessed on 22 March 2023). Available at: https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/Guidelines/2021/963637/Final%20Report%20on%20Guidelines%20on%20revised%20ML%20TF%20Risk%20Factors.pdf

GreenbergTraurig (2020). New Open Banking Regulation in Mexico. Alert – Financial Regulatory & Compliance. Available at: https://www.gtlaw.com/en/insights/2020/6/open-banking-en-mexico-nueva-regulacion (Accessed on 23 March 2023).

Hong Kong Monetary Authority (2018). Open API Framework for the Hong Kong Banking Sector. Available at: https://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2018/20180718e5a2.pdf (Accessed on 22 March 2023).

Kassab, M., and Laplante, P.A. (2022). Open Banking: What It Is, Where It’s at, and Where It’s Going. Computer, 55: 53-63 DOI: 10.1109/MC.2021.3108402.

Leong, E., and Gardner, J. (2022). Open Banking in the UK and Singapore: Open Possibilities for Enhancing Financial Inclusion. Journal of Business Law, 5: 424-453. DOI: http://dx.doi.org/10.2139/ssrn.4194256.

Natarajan, H. (2022). Regulatory Aspects of Open Banking: The Experience thus Far. European Economy. Banks Regulation, and the real Sector, this issue.

Open Data Institute (ODI) (2020). Open Banking preparing for lift off. Purpose, Progress & Potential. Available at: https://www.openbanking.org.uk/wp-content/uploads/open-banking-report-150719.pdf (Accessed on 23 March 2023).

OECD (2023). Data portability in open banking: Privacy and other cross-cutting issues. OECD Digital Economy Papers, No. 348, OECD Publishing, Paris, DOI: https://doi.org/10.1787/6c872949-en.

Parliament of Canada (2019). Open Banking: What it means for you. Senate, Ottawa, Ontario, Canada, K1A 0A4. Available at: https://sencanada.ca/content/sen/committee/421/BANC/reports/BANC_SS-11_Report_Final_E.pdf (Accessed on 2 March 2023).

Taylor-Kerr, A. J. (2020). Adopting Open Banking in Canada: An Analysis of Current Global Frameworks (Unpublished master’s project). University of Calgary, Calgary, AB. URI: http://hdl.handle.net/1880/114213

World Bank (2022). Technical Note on Open Banking. Comparative Study on Regulatory Approaches. Available at: https://elibrary.worldbank.org/doi/abs/10.1596/37483 (Accessed on 2 March 2023).

Legislation cited

The CDR Treasury Laws Amendment (Consumer Data Right) Act 2019. Available at: https://www.oaic.gov.au/consumer-data-right/cdr-legislation (Accessed on 15 February 2023).

Directive (EU) 2015/2366 of the European Parliament and of the Council of 25 November 2015 on payment services in the internal market, amending Directives 2002/65/EC, 2009/110/EC and 2013/36/EU and Regulation (EU) No 1093/2010, and repealing Directive 2007/64/EC (Text with EEA relevance).

Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 establishing a European Supervisory Authority (European Banking Authority), amending Decision No 716/2009/EC and repealing Commission Decision 2009/78/EC.

Hong Kong Monetary Authority (2018). Open API Framework for the Hong Kong Banking Sector. Available at: https://www.hkma.gov.hk/media/eng/doc/key-information/press-release/2018/20180718e5a2.pdf (Accessed on 15 February 2023).

Japan. Act No. 59 of 1981, as amended (Banking Act). Available at: https://uk.practicallaw.thomsonreuters.com/w-007-5339?transitionType=Default&contextData=(sc.Default)&firstPage=true (Accessed on 15 February 2023).

Mexico. DECRETO por el que se expide la Ley para Regular las Instituciones de Tecnología Financiera y se reforman y adicionan diversas disposiciones de la Ley de Instituciones de Crédito, de la Ley del Mercado de Valores, de la Ley General de Organizaciones y Actividades Auxiliares del Crédito, de la Ley para la Transparencia y Ordenamiento de los Servicios Financieros, de la Ley para Regular las Sociedades de Información Crediticia, de la Ley de Protección y Defensa al Usuario de Servicios Financieros, de la Ley para Regular las Agrupaciones Financieras, de la Ley de la Comisión Nacional Bancaria y de Valores y, de la Ley Federal para la Prevención e Identificación de Operaciones con Recursos de Procedencia Ilícita. Available at: https://www.dof.gob.mx/nota_detalle.php?codigo=5515623&fecha=09/03/2018#gsc.tab=0 (Accessed on 15 February 2023).