The impact of the digital euro on Austrian banks from a financial stability perspective

We study the impact the introduction of the digital euro might have on Austrian banks from a financial stability perspective. The premise is that the digital euro will not bear interest and will be subject to a holding limit. More specifically, we analyze (1) the impact on Austrian banks’ liquidity positions in a liquidity stress scenario and (2) long-run profitability effects on banks’ net interest income and income from payment services. With respect to liquidity risk, we find substantial effects only for extreme scenarios and high holding limits. For instance, at a holding limit of 3,000, the most extreme stress scenario we consider results in outflows of 9.0% of total retail deposits into the digital euro. Besides, 7.4% of banks (accounting for 4.2% of the sample’s total assets) would breach the regulatory liquidity coverage ratio (LCR) threshold of 100%. Smaller banks are disproportionately affected because they have a larger share of retail funding, which leads to higher outflows. The picture is similar with respect to the long-run effects on banks’ net interest income. In a similarly extreme scenario as above, we estimate that the digital euro would cause interest income losses and a drop in the aggregate sample return on equity (RoE) of 51 basis points – the aggregate sample RoE is 14.9% – at a holding limit of 3,000. Smaller banks and less capitalized banks would be affected more strongly. In a more realistic scenario, the effects are substantially lower, with 1.0% of total retail deposits outflowing and the aggregate sample RoE dropping by 5 basis points. Lower holding limits effectively contain adverse outcomes both with respect to interest income losses and liquidity risk. As to the effect on payment services income, it is harder to arrive at reliable estimates given a lack of suitable bank-level data and high uncertainty about the digital euro’s impact on transaction volumes and fees of retail current accounts and about how digital euro transactions and account management will be remunerated. In a tentative estimation, we find an aggregate sample RoE effect of around 26 basis points. By determining the remuneration of the digital euro, the central bank can effectively control the magnitude of this effect. Overall, we conclude that the introduction of a digital euro would not pose a threat to the stability of the Austrian banking system provided the digital euro is subject to a carefully designed holding limit and remuneration model. From a purely financial stability perspective, low holding limits would be preferable to higher ones.