Long-term implications of a digital euro on liquidity and funding costs in the German banking system

The introduction of a digital euro (D€) would allow euro area residents to exchange bank deposits for digital currency, thus offering an efficient addition to the European payment sector. It is currently being discussed how the D€ impacts liquidity outflows from banks and financial stability. To mitigate these risks, the European Commission's legislative proposal permits the ECB to impose limits on the use of the D€ as a store of value. This study contributes to the calibration of appropriate holding limits for a D€. We examine how banks adjust their liquidity buffers and funding structures in response to the D€. We explore banks' potential strategies to minimise funding costs, including raising deposit rates and expanding wholesale funding, and approximate a market equilibrium. Applying our model to the German banking system, we find that imposing a holding limit of €3,000 would reduce the return on equity by approximately 0.2 percentage points and the Liquidity Coverage Ratio by about 7 percentage points in the most adverse scenario. These findings suggest that the long-term impact remains relatively contained.