I want to debrief you on a comprehensive day of high-level discussions we had today here in Beijing. I met with President Xi, both in a joint meeting with President Emmanuel Macron and then in a bilateral meeting. I also had a meeting with Prime Minister Li.
Let me start with EU-China relations. It is an extensive and complex relationship that we have. For both of us, this relationship has a significant impact on our prosperity and our security. For China, because the European Union is the first export destination, while China is in the European Union the third export destination. If I give you one concrete figure, this means trade of more than EUR 2.3 billion per day in 2022. At the same time, our trade relationship is increasingly imbalanced. Over the last ten years, the European Union’s trade deficit has more than tripled. It reached almost EUR 400 billion last year. And we discussed that, because this trajectory is not sustainable and the underlying structural issues need to be addressed. I conveyed that European Union businesses in China are concerned by unfair practices in some sectors – unfair practices that impede their access to the Chinese market. For example, if you take the EU agri-food products, they face significant hurdles. Or if you take medical devices as an example, they are being excluded from the market by discriminatory ‘Buy China’ policies. All of these sectors I am speaking about are recognised areas of European excellence. So these sectoral issues are exacerbated by ever-growing requirements imposed by China that apply across the board: be it, for example, increasing pressures to submit to technology transfer; or be it excessive data requirements; or be it insufficient enforcement of intellectual property rights. All this puts European Union companies exporting to China, and also those producing in China, at a significant disadvantage, we discussed that. And we also discussed the fact that this contrasts with the level playing field that all companies operating in the European Single Market benefit from. So against this backdrop, the European Union is becoming more and more vigilant about protecting our interests and ensuring a level playing field.
In addition to these imbalances in our relationship, as you know, the European Union is growing more vigilant about dependencies. Some of these dependencies raise significant risks for us, as does the export of sensitive emerging technologies. Within this context, we all know that this leads to calls by some to decouple from China. I doubt that this is a viable or desirable strategy. I believe that we have to engage in de-risking. This means focusing on specific risks, while appreciating that there is of course a large majority of goods and services, so trade that is un-risky. Of course, different risks require different means to address them: We address the risk of dependencies through the diversification of our trade and investment relations. The risk of leakage of sensitive technologies that could be used for military purposes needs to be addressed through export controls or investment screening. But whatever the instrument we choose is, we wish to resolve the current issues through dialogue. So it is basically de-risking through diplomacy. This is why I called for – and we agreed in – the resumption of the High-Level Economic and Trade Dialogue. I am very glad that we agreed on this. Not only the High-Level Economic and Trade Dialogue, but along with this one also the High-Level Digital Dialogue. These two Dialogues should convene as soon as possible to make progress on all the different files and produce tangible results.
Let me now turn to the geopolitical environment. This visit is taking place in a challenging and increasing volatile context, in particular because of Russia’s war of aggression against Ukraine. China’s position on this is crucial for the Europe Union. As a member of the UN Security Council, there is a big responsibility, and we expect that China will play its role and promote a just peace, one that respects Ukraine’s sovereignty and territorial integrity, one of the cornerstones of the UN Charter. I did emphasise in our talks today that I stand firmly behind President Zelenskyy’s peace plan. I also welcomed some of the principles that have been put forward by China. This is notably the case on the issue of nuclear safety and risk reduction, and China’s statement on the unacceptability of nuclear threats or the use of nuclear weapons. We also count on China not to provide any military equipment, directly or indirectly, to Russia. Because we all know, arming the aggressor would be against international law. And it would significantly harm our relationship.
We also addressed human rights. I expressed our deep concerns about the deterioration of the human rights situation in China. The situation in Xinjiang is particularly concerning. It is important that we continue to discuss these issues. And I therefore welcome that we have already resumed the EU-China Human Rights Dialogue.
Besides Russia’s invasion of Ukraine, there are some areas of convergence and cooperation on specific global issues. In view of the size of our economies, we have a shared responsibility in resolving global issues, for example, first and foremost, to protect the climate and to protect our environment. I particularly welcome the positive role that China has played in delivering the Montreal-Kunming agreement on biodiversity. China has also been a driving force to reach a deal on the High Seas Treaty – this is particularly positive. On the fight against climate change, we want to see China make concrete and ambitious commitments in the run-up to COP28 in Dubai. We discussed this topic too. And I invited China to jointly prepare this COP28, in the context of our joint initiative with Canada. And of course, I would very much welcome if China would be choosing to join the Global Methane Pledge. We need China as an important player. These were the different topics in general that we have discussed and I am now looking forward to answer your questions.
Compliments of the European Commission.
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Rising tensions could trigger cross-border capital outflows and increased uncertainty that would threaten macro-financial stability
Concerns about global economic and financial fragmentation have intensified in recent years amid rising geopolitical tensions, strained ties between the United States and China, and Russia’s invasion of Ukraine.
Financial fragmentation has important implications for global financial stability by affecting cross-border investment, international payment systems, and asset prices. This in turn fuels instability by increasing banks’ funding costs, lowering their profitability, and reducing their lending to the private sector.
Effects on cross-border investment
Geopolitical tensions, measured by the divergence in countries’ voting behavior in the United Nations General Assembly, can play a big role in cross-border portfolio and bank allocation, as we write in an analytical chapter of the latest Global Financial Stability Report .
An increase in tensions between an investing and a recipient country, such as between the United States and China since 2016, reduces overall bilateral cross-border allocation of portfolio investment and bank claims by about 15 percent.
Investment funds are particularly sensitive to geopolitical tensions and tend to reduce cross-border allocations notably to countries with a diverging foreign policy outlook.
Financial stability risks
Geopolitical tensions threaten financial stability through a financial channel. Imposition of financial restrictions, increased uncertainty, and cross-border credit and investment outflows triggered by an escalation of tensions could increase banks’ debt rollover risks and funding costs. It could also drive-up interest rates on government bonds, reducing the values of banks’ assets and adding to their funding costs.
At the same time, geopolitical tensions are transmitted to banks through the real economy. The effect of disruptions to supply chains and commodity markets on domestic growth and inflation could exacerbate banks’ market and credit losses, further reducing their profitability and capitalization. The stress is likely to diminish the risk-taking capacity of banks, prompting them to cut lending, further weighing on economic growth.
The financial and real-economy channels are likely to feed off one another, with the overall effect being disproportionately larger for banks in emerging markets and developing economies, and for those with lower capitalization ratios.

In the longer run, greater financial fragmentation stemming from geopolitical tensions could also roil capital flows and key economic and financial market indicators by limiting the possibilities for international risk diversification, such as by reducing the number of countries in which domestic residents can invest.
How to curb risks
Supervisors, regulators, and financial institutions should be aware of the risks to financial stability stemming from a potential rise in geopolitical tensions and commit to identify, quantify, manage, and mitigate these threats. A better understanding and monitoring of the interactions between geopolitical risks and more traditional ones related to credit, interest rate, market, liquidity, and operations could help prevent a potentially destabilizing fallout from geopolitical events.
To develop actionable guidelines for supervisors, policymakers should adopt a systematic approach that employs stress testing and scenario analysis to assess and quantify transmission channels of geopolitical shocks to financial institutions.
Other steps include:
In response to rising geopolitical risks, economies reliant on external financing should ensure an adequate level of international reserves, as well as capital and liquidity buffers at financial institutions.

Policymakers should strengthen crisis preparedness and management frameworks to deal with potential financial instability arising from heightened geopolitical tensions. Cooperative arrangements between different national authorities should continue to help ensure effective management and containment of international financial crises, including through development of effective resolution mechanisms for financial institutions that operate in multiple jurisdictions.
The global financial safety net—a set of institutions and mechanisms that insure against crises and financing to mitigate their impact—must be reinforced through mutual assistance agreements between countries. These would include regional safety nets, currency swaps, or fiscal mechanisms—and precautionary credit lines from international financial institutions.
In the face of geopolitical risks, efforts by international regulatory and standard-setting bodies, such as the Financial Stability Board and the Basel Committee on Banking Supervision, should continue to promote common financial regulations and standards to prevent an increase in financial fragmentation.

Ultimately, policymakers should be aware that imposing financial restrictions for national security reasons could have unintended consequences for global macro-financial stability. Given the significant risks to global macro-financial stability, multilateral efforts should be strengthened to reduce geopolitical tensions and economic and financial fragmentation.
Authors:

MARIO CATALÁN
Fabio Natalucci
Mahvash S. Qureshi
Tomohiro Tsuruga

—This blog is based on Chapter 3 of the April 2023 Global Financial Stability Report,“Geopolitics and Financial Fragmentation: Implications for Macro-Financial Stability.”
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Interview with Fabio Panetta, Member of the Executive Board of the ECB, published as an article by Eshe Nelson entitled “Are Big Profits Keeping Prices High? Some Central Bankers Are Concerned.” in The New York Times, 31 March 2023 |
After months of fretting about whether workers’ rising pay would keep inflation uncomfortably high, central bankers in Europe have another concern: large company profits.
Companies that push up their prices above and beyond what is necessary to absorb higher costs could be fueling inflation that central bankers need to combat with higher interest rates, a policymaker at the European Central Bank warned, suggesting that governments might need to intervene in some situations.
Policymakers, long preoccupied with higher pay’s tendency to prompt companies to raise their prices, generating a wage-price spiral, should also be alert to the risks of a so-called profit-price spiral, said Fabio Panetta, an executive board member at the E.C.B. At a conference in Frankfurt last week, he pointed out that in the fourth quarter of last year half of domestic price pressures in the eurozone came from profits, while the other half stemmed from wages.
His concerns have been echoed in recent remarks by the E.C.B.’s president, Christine Lagarde, and the Bank of England governor, Andrew Bailey. Although inflation in Europe has begun to ease from last year’s double-digit peaks, the rates remain far above 2 percent, the target of most central banks.
“There’s a lot of discussion on wage growth,” Mr. Panetta said in an interview this week. “But we are probably paying insufficient attention to the other component of income — that is, profits.”
Profit margins at public companies in the eurozone — measured by net income as a percentage of revenue — averaged 8.5 percent in the year through March, according to Refinitiv, a step down from a recent peak of 8.7 percent in mid-February. Before the pandemic, at the end of 2019, the average margin was 7.2 percent.
There has been a similar phenomenon in the United States, where companies reported wide profit margins last year despite the highest inflation in four decades.
Companies could be increasing prices because of higher input costs (the expenses of producing their goods or services), or because they expect future cost increases, or because they have market power that allows them to raise prices without suffering a loss of demand, Mr. Panetta said. Some producers could be exploiting supply bottlenecks or taking advantage of this period of high inflation, which makes it more challenging for customers to be sure of the cause of price increases.
“Given the situation which prevails in the economy, there could be ideal conditions for firms to increase their prices and profits,” he added.
“I’m not here to pass a judgment on how fair or unfair” price-setting is, Mr. Panetta insisted, but rather to explore all of the causes of inflation. He is a member of the E.C.B.’s six-person executive board that sets policy alongside the governors of the 20 central banks in the eurozone.
There are sectors where “input costs are falling while retail prices are increasing and profits are also increasing,” Mr. Panetta said. “So this is enough to be worried as a central banker that there could be an increase in inflation due to increasing profits.”
The average rate of inflation for the 20 countries that use the euro has been falling for five months — to 6.9 percent over the year through March — but core inflation, which excludes volatile energy and food prices, a measure used by policymakers to assess how deeply inflation is embedding in the economy, has continued to rise.
Central bankers tend to focus on the risk that jumps in pay will lead to persistently high inflation, especially in Europe where wages tend to change more slowly than in the United States. The E.C.B. is even developing new tools to measure changes in wages more quickly.
But this intense focus on wages has provoked some criticism. Mr. Bailey of the Bank of England was called out last year for suggesting workers should show restraint in asking for higher wages.
As inflation persists, attention has turned to corporate profits. There is uncertainty about what will happen as prices for energy and other commodities keep falling: Will companies restrain themselves from raising prices further?
Last week, Ms. Lagarde raised the issue of profits, saying there needed to be fair burden sharing between companies and workers to absorb the hit to the economy and income from higher energy prices.
In Britain, Mr. Bailey told companies to bear in mind when setting prices that inflation was expected to fall. Across the Atlantic, last year Lael Brainard, who was then the vice-chair of the U.S. Federal Reserve, suggested that amid high profit margins in some industries, a reduction in markups could bring down inflation.
In Europe, companies were able to protect their profit margins last year from high inflation more than expected, Marcus Morris-Eyton, a European equities analyst at Allianz Global Investor, said.
“Corporates had more pricing power, at an average level, than most investors expected,” he said.
This year, he expects there will be more variety in profit margins. “The average European company will face far greater margin pressure this year than they did last year,” Mr. Morris-Eyton said. That’s because of higher wage costs but “partly because as input costs have fallen, there is greater pressure from your customers to lower prices.”
Last year, record-breaking profits by energy producers angered consumers who faced high energy bills, while governments spent billions to protect households from some of those costs. But as energy prices have fallen, consumers are still experiencing rising food prices. In the eurozone, the annual rate of food inflation rose to 15.4 percent in March.
“To a certain extent there’s been also an opportunistic move by some big manufacturers to actually increase their prices, sometimes above their own cost increases,” said Christel Delberghe, the director general of EuroCommerce, a Brussels-based organization representing wholesale and retail companies. “It’s kind of a free-riding on a high price environment.”
It’s a factor squeezing retail profits, alongside the rising costs of products they buy and resell and higher cost of operations.
There is a notable disparity in profit margins between food producers and retailers, a traditionally low-margin business. Unilever and Nestlé each reported profit margins in the high teens for 2022, while the French supermarket company Carrefour reported a margin of about 3 percent. Unilever raised prices for its products more than 11 percent last year and Nestlé more than 8 percent, but in both cases the companies said they had not passed on all the effects of higher costs to consumers.
Ms. Delberghe said she feared the blame for higher prices was unfairly going to land on retailers. “We’re extremely worried because indeed there is this perception that prices are going up and that it’s very unfair,” she said. Retail businesses are getting a lot of pushback, including from governments trying to take action to stop price increases in stores.
Mr. Panetta said governments should step in where necessary, in part because their fiscal support programs have helped keep profits high. “If there is a sector in particular where market power is abused or there is insufficient competition, then there should be competition policies that should intervene,” he said.
But it was also a message to companies.
“It should be clear to producers that strategies based on high prices that increase profits and inflation may turn out to be costly for them,” he said.
The cost? Higher interest rates.
Compliments of the European Central Bank.
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The Council and the Parliament negotiators today reached a provisional political agreement to raise the share of renewable energy in the EU’s overall energy consumption to 42.5% by 2030 with an additional 2.5% indicative top up that would allow to reach 45%. Each member state will contribute to this common target. This provisional political agreement will now need to be endorsed by both institutions.
The Council and Parliament negotiators provisionally agreed on more ambitious sector-specific targets in transport, industry, buildings and district heating and cooling. The purpose of the sub-targets is to speed-up the integration of renewables in sectors where incorporation has been slower.
Transport
The provisional agreement gives the possibility for member states to choose between:

a binding target of 14.5% reduction of greenhouse gas intensity in transport from the use of renewables by 2030
or a binding share of at least 29% of renewables within the final consumption of energy in the transport sector by 2030

The provisional agreement sets a binding combined sub-target of 5.5% for advanced biofuels (generally derived from non-food-based feedstocks) and renewable fuels of non-biological origin (mostly renewable hydrogen and hydrogen-based synthetic fuels) in the share of renewable energies supplied to the transport sector. Within this target, there is a minimum requirement of 1% of renewable fuels of non-biological origin (RFNBOs) in the share of renewable energies supplied to the transport sector in 2030.
Industry
The provisional agreement provides that industry would increase their use of renewable energy annually by 1.6%. They agreed that 42% of the hydrogen used in industry should come from renewable fuels of non-biological origin (RFNBOs) by 2030 and 60% by 2035.
The agreement introduces the possibility for member states to discount the contribution of RFNBOs in industry use by 20% under two conditions:

if the member states’ national contribution to the binding overall EU target meets their expected contribution
the share of hydrogen from fossil fuels consumed in the member state is not more 23% in 2030 and 20% in 2035

Buildings, heating and cooling
The provisional agreement sets an indicative target of at least a 49% renewable energy share in buildings in 2030.
It provides for a gradual increase in renewable targets for heating and cooling, with a binding increase of 0.8% per year at national level until 2026 and 1.1% from 2026 to 2030. The minimum annual average rate applicable to all member states is complemented with additional indicative increases calculated specifically for each member state.
Bioenergy
The provisional agreement strengthens the sustainability criteria for biomass use for energy, in order to reduce the risk of unsustainable bioenergy production. It ensures the application of the cascading principle, with a focus on support schemes and with due regard to national specificities.
Faster permits for projects
The provisional agreement includes accelerated permitting procedures for renewable energy projects. The purpose is to fast-track the deployment of renewable energies in the context of the EU’s REPowerEU plan to become independent from Russian fossil fuels, after Russia’s invasion of Ukraine.
Member states will design renewables acceleration areas where renewable energy projects would undergo simplified and fast permit-granting process. Renewable energy deployment will also be presumed to be of ‘overriding public interest’, which would limit the grounds of legal objections to new installations.
Next steps
The provisional political agreement reached today will first be submitted to the EU member states’ representatives in the Committee of Permanent Representatives in the Council and then in the Parliament for approval.
The directive will then need to be formally adopted by the Parliament and then the Council, before being published in the EU’s Official Journal and enter into force.
Background
The proposal to revise the renewable energy directive, along with other proposals, tackles the energy aspects of the EU’s climate transition under the ‘Fit for 55’ package.
The Commission presented the ‘Fit for 55’ package on 14 July 2021. This package aims to align the EU’s climate and energy legislative framework with its 2050 climate neutrality objective and with its objective of reducing net greenhouse gas emissions by at least 55% by 2030 compared to 1990 levels.
In addition, as part of the REPowerEU plan, the Commission proposed on 18 May 2022 a series of additional targeted amendments to the renewable energy directive to reflect the recent changes in the energy landscape. The elements of the proposal were integrated into the agreement found today.
The current renewable energies directive is in force since December 2018. It sets an EU-level target of 32% share of renewable energy in the total EU energy consumption by 2030 at EU level.
Compliments of the European Council and the Council of the European Union.
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Today, the European Commission adopted a proposal for a Directive making it easier for companies to expand the use of digital tools and processes in EU company law. The proposal aims to facilitate cross-border companies’ operations and to increase business transparency and trust by making more information about companies publicly available at EU level. It will also cut red tape for cross-border businesses, saving around €‎437 million of administrative burden per year, thanks to an EU Company Certificate or the application of the “once-only principle”. The proposal will contribute to further digitalisation of the single market and help companies, in particular, small and medium-sized ones to do business in the EU.
Cutting red tape and administrative burden
To cut red tape and alleviate the administrative burden for cross-border business, the proposed rules include:

Application of the “once-only principle” so that companies do not need to re-submit information when setting up a branch or a company in another Member State. The relevant information can be exchanged through the Business Registers Interconnection System (BRIS);

An EU Company Certificate, containing a basic set of information about companies, which will be available free of charge in all EU languages;

A multilingual standard model for a digital EU power of attorney which will authorise a person to represent the company in another Member State;

Removing formalities such as the need for an apostille or certified translations for company documents.

Improving transparency and trust in cross-border business
The proposal is updating the existing EU rules for companies (Directive (EU) 2017/1132) to adapt them further to the digital developments and new challenges, and to stimulate growth and competitiveness in the single market.
To ensure greater transparency and trust in companies the proposed rules are intended to:

Make sure that important information about companies (e.g. about partnerships and groups of companies) is publicly available in particular at EU level through the BRIS;
Make searches for information about companies in the EU easier by allowing a search through BRIS and, at the same time, through two other EU systems interconnecting national beneficial ownership registers and insolvency registers;
Ensure that company data in business registers is accurate, reliable and up-to-date, for example by providing for checks of company information before it is entered in business registers in all Member States.

Next steps
The proposal will now be discussed by the European Parliament and the Council. It is proposed that once adopted, Member States will have two years to transpose the Directive into national law.
Background
Companies are at the heart of the single market. Thanks to their business activities and investments, including on a cross-border basis, they play a leading role in contributing to the EU’s economic prosperity, competitiveness and in carrying through the EU’s twin transition to a sustainable and digital economy. To this end, companies need a predictable legal framework that is conducive to growth and adapted to face the new economic and social challenges in an increasingly digital world. The proposed measures will apply to around 16 million limited liability companies and 2 million partnerships in the EU.
The proposal provides for the second step of the digitalisation of EU company law. The 2019 Digitalisation Directive (EU) 2019/1151 ensured that company law procedures can be carried out online, and in particular that companies can be set up online. This proposal is complementary and aims to increase the availability of company information, in particular, at EU level and to remove administrative barriers when companies and authorities use such information in cross-border situations. Overall, the proposal promotes “digital by default” solutions when accessing or using company information in interactions between companies and business registers or authorities. The proposal will further rely on the use of trust services and will ensure that solutions such as the EU Company Certificate are compatible with the forthcoming European Digital Identity Wallet.
It will contribute to the digitalisation objectives set out in the Communications 2030 Digital Compass: the European way for the Digital Decade and Digitalisation of Justice in the European Union – A toolbox of opportunities, and will facilitate cross-border expansion by SMEs in line with Communications Updating the 2020 New Industrial Strategy and SME Strategy for a sustainable and digital Europe.
As announced in the 2023 Commission Work Programme this proposal is one of the key actions under the political priority of “Europe fit for the digital age”.
Compliments of the European Commission.
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Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted on 22 March by Kolja Rudzio | 29 March 2023 |
In recent weeks, banks have collapsed in the US and Switzerland. Could the same happen in the eurozone?
Let me first strongly emphasise that what we’re seeing in the euro area in terms of tensions is a spillover from the US and from Switzerland. And please remember that we had a severe banking crisis in the European Union 15 years ago. As a result of that, we now have very tight regulation and very tight supervision of the banks. So our baseline is that the European banking system has a lot of capital and banks have been prudent in their lending decisions.
“Baseline” means you think this is the most likely scenario.
Yes. Of course we’re closely monitoring developments and are on our guard, but we don’t expect to see the same situation as in the US or in Switzerland to be the most likely scenario here in the euro area.
You don’t expect it, but you can’t rule it out, can you?
The history of banking teaches us that it’s very important to maintain confidence. We don’t have any reason to believe that a major problem would emerge. However, if it did, the ECB is able to respond. We have many tools, we can provide liquidity, and we can make sure we don’t see the types of bank runs that were evident in these examples.
If banks had to be rescued in the EU, would taxpayers have to pay for it again?
Here in the European Union and in the euro area, one of the most important lessons was to make sure the banks have a lot of capital, so that they are very capable of absorbing losses. The European banking system is well capitalised and profitable. And the macroeconomic outlook is positive. These are not the circumstances in which, in the baseline, we expect to see the banking system come under significant pressure.
At a recent conference, you called the financial turmoil we just saw a “non-event”. Could you explain that?
We’ve seen significant issues in the US and in Switzerland. But in the end, only certain types of banks with very specific problems were involved. We don’t see that as a general issue in the banking system. Of course people ask questions immediately after a policy intervention such as in the US or Switzerland. But I think it remains the case that there’s no direct read-across to the euro area. In the baseline, we expect these tensions will settle down.
That means a non-event?
Yes, from a macroeconomic perspective. The next level up from a non-event is if the banks become risk-averse because of a loss of confidence. Then there would be some impact on the economy, but it would still be limited.
Are you seeing that already?
It’s too early to tell, but this is something we’ll be looking at in the coming weeks. The third scenario is if it becomes more severe. But in our jargon, it’s a “tail event”. It is at the far end of the probability distribution – very unlikely. So we’re monitoring, but it’s still too early to extrapolate that this is going to be a significant issue.
Were you surprised by the banking problems we just witnessed?
For many years, the European Central Bank and other institutions have run projects playing through what happens if interest rates go up suddenly. I, by the way, participated in one of these projects around 2015. What stress such rate rises might put on the financial system is something we’ve studied for years. The exact details of which particular bank, what particular scenario, of course, always contains an element of surprise.
But was the high pace of the rate hikes you decided upon at the ECB perhaps a surprise for people?
I don’t think it really has been something that’s so sudden or severe. Let me make a number of observations here. Number one is: behind the increase in interest rates is the fact that inflation rose quite quickly. In the context of inflation rising that quickly, it would have been a surprise if interest rates did not also go up relatively quickly. Number two: these increases were from super-low levels. It should not be surprising to anyone that rates went from -0.5 per cent to, let’s say, about 2 per cent. That essentially was normalising policy. That was always expected, even if there was the question of the timing of it. Now, because of high inflation, we needed to do more. This is why we’ve brought rates above their long-run value of about 2 per cent, now to 3 per cent, and we’ve signalled they will go higher, if needed. The third point is we started really around December 2021, so already 16 months ago. First of all, we ended the pandemic emergency purchase programme, then we ended Quantitative Easing in general in June last year, then we moved rates out of negative in July. But already from January onwards, the market understood that rate hikes were coming. So we have always gone step-by-step, in part to allow the financial system to adjust.
Are these tensions in the financial system the downside of the zero interest rate policy which central banks have been pursuing for so many years?
I don’t think that diagnosis is correct. The origin of the low interest rates was inflation that was too low, and the origin of the rising interest rates now is that inflation is too high. So I think what you described there is essentially a reflection of the actual issue, that inflation rose quickly. And it is clear as daylight that high inflation emerged because of the pandemic and because of the war in Ukraine. Of course, it is our job here at the ECB to make sure now that inflation comes down quickly to 2 per cent.
Inflation rose in 2021 and reached 5.1 per cent in January 2022 – before the war. So isn’t this development at least partly due to monetary policy?
No. Between summer 2021 and February 2022, when the invasion started, we had very strong goods inflation because of the pandemic and supply bottlenecks. Second, the European economy had just reopened after all the lockdowns. People were keen to go on holiday or were more relaxed about going to a restaurant and spending their money. Third, Russia had restricted energy supplies even before the invasion began. So we had three factors driving inflation at the beginning of 2022: bottlenecks, the war and energy prices, and the reopening of Europe. The inflation we’re seeing stemmed from these unusual factors. Finding the solution to that inflation, that’s our job.
You don’t see any misjudgement of the inflation by the ECB at that time?
Given the information we had at the time, I think we made reasonable choices. What is essential is that, if you see the world changing, you respond. We reduced the amount of money we put into the economy by buying bonds – from over one trillion euro in 2021 to net zero by June 2022. That was a huge turnaround. And many people predicted we would be reluctant to raise interest rates.
Weren’t you too reluctant? You only started raising interest rates in July.
Our priority in the first half of 2022 was to end this large bond-purchasing programme and start hiking rates afterwards. And the markets understood early on that we would raise our rates. For example, mortgage rates here in Germany also started to rise well before we began lifting our ECB rates. Thus the tightening has effectively been there since the end of 2021.
Let’s look forward. You predict that the inflation rate will go down rapidly from 10 per cent at the end of last year to 2.8 per cent at the end of this year and then further towards the inflation target of 2 per cent. Why you are so optimistic?
It’s a mix of factors. Energy prices are falling. Food prices are still very high and that is what people see when they go to the supermarket. But if you look at the earlier stages of production, at the farmgate prices, at the prices of the food ingredients, you will recognise: all of these have turned around. And history tells us that this will eventually lead to lower retail prices. Another factor: we have fewer supply bottlenecks. Car firms, for example, are able to get their microchips again. Therefore, the prices of goods should stabilise. Wages will rise on the other hand, but our overall assessment is a rapid decline of inflation at the end of this year.
Joachim Nagel, the president of the Bundesbank, warned recently that “price pressures are strong and broad-based across the economy”. How does that fit with your rosy outlook?
I agree with that statement. Our President, Christine Lagarde, said something similar. We are in fact probably in the most intense phase of inflation. It takes some time until the dynamics which I described reach the customer. Let’s say you’re a producer. You paid a high price last year for your inventory. When you sell these goods now, you’ll probably seek a correspondingly high price, even if your input purchase prices are already declining. So right now we still have this intense inflation pressure. Although, when you look further ahead, you see the improvement, gradual in spring and summer, but quite a bit in autumn.
Does this mean there is no need for more rate hikes?
Under our baseline scenario, in order to make sure inflation comes down to 2 per cent, more hikes will be needed. That is absolutely our diagnosis. If the financial stress we see is non-zero, but turns out to be still fairly limited, interest rates will still need to go up. However, if the financial stress we talked about becomes stronger, then we’ll have to see what’s appropriate.
So there is a trade-off between fighting inflation and stabilising banks?
No. If this financial stress weakens the economy, it would automatically reduce the inflationary pressures.
You mentioned rising wages. Do you see any sign of a wage-price spiral which could fuel inflation?
So far, rising wages have not been an important source of inflation. Last year a lot of the price increases could be put down to increased profits and rising energy costs. This year we think there’s a handover. We expect wages to go up more quickly as unions react to the high inflation of last year. But it’s very important for everyone – workers, firms – to recognise that inflation will be much closer to 2 per cent next year and in 2025. The wage-price spiral is a scenario which happened in the 1970s when expectations became entrenched that inflation would be high every year. This is not what we’re seeing. We’re seeing wage increases that are higher than normal, but in the grand scheme of things they look reasonably fair. But we have to keep an eye on this.
In Germany unions are demanding a pay rise of 10.5 per cent for the public sector. Could this trigger more inflation?
I’m not going to comment on any one particular set of negotiations. What I would say is, sometimes I read headlines of very high wage increases. But when you look at the details, there is often a one-off payment, which doesn’t increase labour costs permanently. Or the wage increase might be spread over 18 or 24 months. So the true increase per year is lower.
At what percentage does a wage increase start to get dangerous in terms of inflation?
Let me cite what we have in our forecast. Remember, under this forecast, inflation is coming down to 2.8 per cent at the end of this year and then continuing to improve towards our goal of 2 per cent. We assume wage growth of 5.3 per cent this year and 4.4 per cent next year. We’re putting a lot of effort into tracking wage settlements week-by-week, and so if we saw them coming in above that, then we would start to become more concerned.
ECB President Christine Lagarde said there should be a fair burden-sharing between employees and companies in this time of high inflation. What does that mean?
The spectacular rise in energy import prices was the trigger for high inflation. We’re paying more for imports of oil and gas from other countries now. Which means that there is less income to be distributed in our economy. There is a collective loss. And the question is: how much should the workers’ earnings go down and how much the profits of firms? The loss has to be absorbed somehow if we want the EU to remain competitive and to do well in global business.
Is the burden-sharing fair at the moment?
Well, profits did better than wages last year for a number of reasons. One reason, for example, is that wage negotiations take time. This year we expect wages to increase more. And we believe that firms will have less space to increase their profits through higher prices. For many reasons: demand should cool off and the supply bottlenecks should ease, for example. So the share of the burden changes over time.
But in general your outlook seems quite optimistic. You expect inflation to fall quickly while the economy grows. Does it mean we’re going to achieve a so-called “soft landing”?
It is possible. Some might object that it takes a recession to bring down inflation. But we have a very unusual situation. We’re coming out of a pandemic and out of a very severe energy crisis. We’ve lost so much growth momentum in the pandemic that it’s possible for the pandemic recovery to continue and for inflation to come down simultaneously.
Compliments of the European Central Bank.
The post ECB interview | Price vs financial stability: no trade-off first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

In 2022 the ECB conducted a climate risk stress test of the Eurosystem balance sheet as part of its action plan to include climate change considerations in its monetary policy strategy.[1] The aims of this exercise were to (i) analyse the sensitivity of the Eurosystem’s financial risk profile to climate change; and (ii) enhance the Eurosystem’s climate risk assessment capabilities. The scope of the exercise covered a number of the Eurosystem’s monetary policy portfolios, namely its holdings of corporate bonds, covered bonds, asset-backed securities (ABSs), as well as its collateralised credit operations.
This climate risk stress test used scenarios developed by both the Network of Central Banks and Supervisors for Greening the Financial System (NGFS) and the ECB. It employed three NGFS Phase II long-term scenarios[2] that project macro-financial and climate variables over a 30-year horizon. The scenarios differ in terms of the extent to which climate policies are assumed to have been implemented (primarily in the form of a carbon tax) and the different types of climate risk that are expected to materialise as a result. The hot house world scenario entails severe physical risk but does not lead to transition risk, as it is based on the assumption that climate policies are not enforced. Under the disorderly transition scenario, the implementation of climate policies is delayed, leading to severe transition risk but only limited physical risk. The risks stemming from the disorderly transition and hot house world scenarios are analysed against those arising from the orderly transition scenario, which assumes that climate policies are implemented in a timely manner. In addition, the stress test exercise considered two further short-term scenarios designed by ECB staff: a flood risk scenario, which includes severe physical hazards materialising over a one-year horizon; and a short-term disorderly transition scenario, which frontloads sharp increases in carbon prices over a short-term (three-year) horizon. In view of the challenges associated with designing long-term climate scenarios, these two short-term scenarios provided useful additional input to the analysis, with the flood risk scenario setting out how a severe physical hazard could potentially materialise across the whole of Europe.
The methodology and scope of the exercise were aligned with the 2022 climate risk stress test[3] conducted by ECB Banking Supervision and the 2021 ECB economy-wide climate stress test[4]. Under all five scenarios, the exercise applied credit risk shocks using satellite models specific to each type of financial exposure. These shocks are based on the aforementioned 2022 climate risk stress test by ECB Banking Supervision as well as on NGFS data. In addition to credit shocks, the exercise used market shocks in the form of increases in risk-free interest rates and corporate bond spreads.
This climate risk stress test of the Eurosystem balance sheet used the Eurosystem’s financial risk assessment framework as the basis for its risk estimation, using the aforementioned shocks. This framework, which is also used for the Eurosystem’s regular financial risk assessment and reporting tasks, is based on a joint market and credit risk simulation model. The analysed results take the form of an expected shortfall[5] estimated at a 99% confidence level over a one-year horizon. Two different perspectives were considered: a standalone risk approach, which calculates the risk of each portfolio independently; and a risk contribution approach, which determines the contribution of each portfolio to the total risk for the Eurosystem. The cut-off date for the Eurosystem balance sheet and market data was 30 June 2022.

Table A
Overview of the scenarios and main results of the 2022 climate risk stress test of the Eurosystem balance sheet

The results of the exercise show that both types of climate risk – transition risk and physical risk – have a material impact on the risk profile of the Eurosystem balance sheet. The disorderly transition and hot house world long-term stress scenarios produce risk estimates that are between 20% and 30% higher than those under the orderly transition scenario. The hot house world scenario generates a higher risk impact, showing that physical risk has a greater impact on the Eurosystem balance sheet than transition risk. Integrating climate change risk into the Eurosystem’s regular risk assessment and provisioning frameworks should make it possible to modify risk control frameworks and build up financial buffers over time, thereby addressing such risks.
The aggregate result is driven mainly by outright holdings of corporate bonds, which under all scenarios make a larger contribution to the total risk increase than the other types of financial exposures included within the scope of this exercise. The impact of climate risk on corporate bonds is particularly concentrated in areas that are specific to each risk type. The impact of transition risk, for example, is primarily concentrated in a limited number of sectors that are particularly vulnerable to climate risk (and which have, on average, a high level of emissions as a percentage of revenue), whereas the impact of physical risk is concentrated in certain geographical areas.
The Eurosystem’s corporate bond holdings entail a similar degree of climate risk as the outstanding market volume of securities eligible for such purchases. This can be seen by performing the same stress test on a benchmark sample of securities that meet the Eurosystem’s eligibility criteria and are weighted by market capitalisation. Under the two adverse scenarios, the resulting risk increases do not significantly differ from the results obtained for the Eurosystem balance sheet. This outcome was expected owing to the fact that, at the cut-off date, the Eurosystem’s corporate bond purchases were determined by a market capitalisation benchmark, as climate change considerations were only incorporated into those types of purchases as of October 2022.
The relative risk increase for both covered bonds and ABSs is greater under the hot house world scenario than under the disorderly transition scenario. The relatively high sensitivity of these assets to physical risk is also reflected in the outcome of the flood risk scenario. Under this scenario, the increase in risk estimates for covered bonds and ABSs is much higher than that for corporate bonds, and it is also higher than under the long-term scenarios. As a result, the contribution of covered bonds to the total risk increase under this scenario is particularly significant. This is not the case for ABSs, however, as the portfolio is considerably smaller. Also, the result for the flood risk scenario highlights the importance of the house price channel in the transmission of climate risk, as covered bonds and ABSs secured by real estate are particularly exposed to fluctuations in housing market valuations.
Collateralised credit operations, meanwhile, make only a small contribution to the total risk increase despite the large size of the exposure. This exercise considered credit operations collateralised by corporate bonds, covered bonds, ABSs and uncovered bank bonds. The lower risk per unit of exposure of these lending operations can be linked to their double default nature: although climate risk stress is channelled through both the counterparty and the collateral, the risk only materialises under scenarios whereby the counterparty defaults and the value of the collateral falls below the level of protection offered by applicable valuation haircuts. This typically occurs in instances when the collateral issuer also defaults. Climate risk is therefore concentrated in exposures to specific counterparties, especially under the hot house world scenario, in which certain institutions and the collateral they have posted are both located in regions that are severely affected.
Climate risk stress tests of the Eurosystem balance sheet are expected to be carried out on a regular basis in future. These future exercises should provide an opportunity to further enhance the methodology and expand the scope of the financial exposures covered. Looking ahead, climate risk considerations should also become an integral part of the existing risk management framework, which involves an analysis of the total financial risk for the Eurosystem against the existing financial buffers.
Authors:

Maximilian Germann
Piotr Kusmierczyk
Christelle Puyo

Compliments of the European Central Bank.
Footnotes:
1. For further details, see the press release “ECB presents action plan to include climate change considerations in its monetary policy strategy”, ECB, 8 July 2021. The climate risk stress test was conducted by the ECB’s Directorate Risk Management in cooperation with the Eurosystem’s Risk Management Committee.
2. For further details, see “NGFS Climate Scenarios for central banks and supervisors”, Network for Greening the Financial System, June 2021.
3. For further details, see “2022 climate risk stress test”, ECB Banking Supervision, July 2022.
4. The approach is described in Alogoskoufis, S. et al., “ECB economy-wide climate stress test”, Occasional Paper Series, No 281, ECB, Frankfurt am Main, September 2021.
5. This expected shortfall is a tail measure of the distribution of the losses on the Eurosystem balance sheet, which are computed based on relative price differences between the snapshot date and one year later: the shortfall is computed as the average of the worst 1% of losses in the distribution.
The post ECB | Results of the 2022 climate risk stress test of the Eurosystem balance sheet first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Countries around the world are examining whether they should offer central bank money to the public not only as banknotes and coins, but also in digital form.
The fact that the majority of central banks around the world have already started exploring the possibility of launching a state-owned digital currency comes as a response to the increased adoption of digital, contactless payments, cryptocurrencies and e-commerce, further accelerated by  Covid-19, b and also due to the possibilities offered by these digital currencies as a more flexible monetary tool compared to the existing non-digital currency.
Privacy, the protection of personal data and security are amongst the most important requirements, which impact the core design choices to be taken, as well as expected citizens’ trust and acceptance.
1. What is a central bank digital currency?
Money can mainly exist in two forms[1]: central bank money and private money.
Money created by central banks is central bank money, and cash is currently the only kind of central bank money available to the public. In fact, cash is a physical token in the form of coins and banknotes that represent value. Just holding the token means that one legally possesses it. Transfers can be executed by exchanging it between two people, without the necessity to have a third party (as a bank) to validate the transaction. Cash must be accepted if offered in payment within a jurisdiction (concept defining the “legal tender status”[2]).
Private money is created by commercial banks[3] when receiving cash in deposit and reusing it by granting loans. This money appears in the bank account, and it can be used to pay by using a various set of instruments such as debit or credit cards. Money, then, can be withdrawn in the form of cash, back to its original form of central bank money. The relationship between holders and commercial banks is based on the trust that money will be held safely and with acceptable risks. Nowadays, there is no payment instrument apart from cash that has legal tender status.
A central bank digital currency (CBDC) is a digital form of public money issued by a central bank. Essentially, a CBDC system consists of individuals and companies having access to a digital currency put at their disposal for transactions and savings accounts by their home country’s central bank. A distinction can be made between retail CBDC, available to citizens and companies, and wholesale CBDC, only available to financial actors. In this TechDispatch, we will mainly refer to the retail CBDC.
In other words, CBDC consists of a digital representation of coins and banknotes in the form of digital tokens. It is an electronic file that embodies a specific value with a reference to its owner attached to it. By just changing that reference, the value is transferred and a payment is made. CBDC is usually presented by central banks as a complement to cash, equipped with similar features (notably, having regard to the legal tender status), but adapted to some functional needs and to the ‘digital’ nature referred to above.
The key aspect of CBDC that differentiate it from any other means of electronic payment is its legal tender status. In other words, a CBDC must be accepted if offered in payment within a jurisdiction, while any other electronic means of payments can be refused.
Both physical and digital tokens are issued directly by central banks. This aspect – added to the legal tender status – is the main difference between CBDC on the one hand and, on the other hand, private money and the almost 22.000[4] different cryptocurrencies (including around 9000 top stablecoins[5]) issued by private actors existing in the last years, as of the latest developments in distributed ledger technology (DLT) and cryptography.
The actual digital payment landscape is driven by commercial banks and transfers are made using only private money. Moreover, customers have a claim to withdraw their money in the form of cash only to the commercial bank where this money is deposited. For this reason, risks related to the solvency of the bank where the person has deposited cash are present and the trust between holders and banks is a key element for the functioning of the whole system.
With CBDC, the situation will be more similar to cash. In fact, due to the legal tender status of the CBDC, the parties involved in the transaction will have a direct claim to the central bank issuing the CBDC, even in scenarios where transactions remain intermediated by commercial banks. In other words, in case of bankruptcy, the sum owned by a holder in a private bank in form of CBDC will not be lost. For this reason, solvency risk is very low. This change in the payment mechanisms has been considered by some authors as a change in the “soul” of the payment system[6], allowing a safer and more solid financial system to grow under this perspective. At the same time, the decrease in bank deposits due to CBDC calls for a limitation (and possibly a threshold per-citizen on the maximum amount of CBDC individuals can hold) to avoid a lack of deposits at banks, and, consequently, a lack of investments by banks via (decreased) deposited money. Under this viewpoint, CBDC presents risks to the financial system that need to be addressed.
Overall, the decision to issue a CBDC is not only a technical, but also, if not mainly, a political choice, which might have an important impact on the economy, as well as on the rights and freedoms of citizens and on society as a whole.
1.2. What is the possible design of CBDC?
The design and implementation of CBDC requires technical and organisational choices. The specific design choices are not pure technological elements but have profound implication in the underlying economic paradigm and in many other policy-related issues, including privacy of payments.  The most important design choices concern: 1) the underlying architecture; 2) the centralization level; and 3) the access modality.
 
Figure 1 – Different layers of design choices to be taken in the process of implementing a CBDC

1) The architecture relates to the operational roles of the central bank and private institutions in transaction management. A direct, indirect or hybrid approach is considered. An indirect CBDC is very similar to the actual payment system, where commercial banks manage transactions backed by central bank money. In this case, the central bank keeps no record of transactions and individuals only have claim against commercial banks. Instead, in a direct CBDC architecture, accounts are managed directly by the central bank that is the only institution handling payments. This scenario is a fundamental shift from  today’s payment system and could entail a dramatic increase of the operations of the central bank. Finally, hybrid models can be considered. Here, individuals hold money in the central bank, but the payment chain continues to be managed by commercial banks. Some of the possible benefits of this solution include easier portability of a CBDC account from one commercial bank to another, reducing impacts of technical faults or bankruptcy on individuals.
Figure 2 – Data flows in the diverse configuration of the architecture of a CBDC
 
2) The centralisation level of the CBDC transaction management is another important design choice. The CBDC can be based on a conventional centrally-controlled database or a novel DLT. Both technologies often store data in physically separate locations. The main difference lies in how data is updated. In conventional databases, data is stored over one or multiple physical nodes under the control of one authoritative entity, usually the controlling bank, that validates transactions. In DLT solutions, the ledger is jointly managed by different entities in a decentralised manner and without a single authoritative entity. Blockchain is a possible distributed ledger technology where new entries are first bundled into “blocks” and then sequentially linked to each other, forming a chain. Because each block incorporates a cryptographic coded summary of the previous one[7], the blockchain is hard to be tampered with.  Consequently, each update of the ledger has to be harmonised amongst the nodes of all entities. The resulting reduced speed of operation can limit direct CBDC to small jurisdictions. On the other hand, DLTs can be more easily used in indirect CBDC architecture, as the number of transactions to be managed by the central bank is limited, since  most of the overall payments will be handled by commercial banks.
3) The access modality relates to how and to whom the banks should give access to tokens to end-users (‘citizens’). A first option is to follow the conventional bank account model and tie ownership to a proven identity. A “bearer-based”, also referred as “token-based” options is also a possible access modality. Here, the holder needs to demonstrate knowledge of a certain information, like a private key (or digital signature).
An important aspect connected to the access modality is indeed also the offline usability of a CBDC. While online transactions can be made through websites and apps, offline payments could be made through smart cards, mobile devices and payment terminals that are pre-funded with an amount of digital tokens deducted from the balance that a user has online (in her/his bank account) before they are used offline. The trusted device would contain the current balance and adjust it upon payment by the user made via contact or contactless modalities (for instance, NFC capabilities[8] or Bluetooth). Offline functionality (with peer-to-peer validation of transactions) avoids the sharing of transaction details with parties other than the payer and payee, enabling the CBDC to become an equivalent to cash.
Programmability[9] of  CBDC is also an important design choice. Programmable payments are different from programmable money. Programmable money consists of a CBDC with built-in rules, imposing restrictions on the usage of that money. With this feature, a government could also define a positive or negative interest rate to incentivise or disincentive the use of money for the purchase of a particular good; limit its use to a certain category of services; set an expiry date.
Programmable payments enable automatic transfers of money when pre-determined conditions are met. For example, a person can instruct their bank account to send a certain amount of money at the end of every month to another account. In a machine-to-machine payment scenario, payments can be automated and money can be sent when a parcel is checked as delivered at a certain store room. At the same time, CBDC could be used as payments programmed as automatic transfers by a State actor (e.g. for welfare payments).
While programmability of money needs to be wired in the core design features of a CBDC, and it is something that has been rarely natively implemented in the current payment system, the case for programmable payments is different. We can already program our payments throughout bank accounts. In a similar way, in case of CBDC, the programmability of money would be provided, as value-added services, by financial institutions to their customers (notably businesses and citizens), on top of the CBDC infrastructure[10].
The different design choices described so far can result in very different user experiences. For example, in case of a decentralised, indirect, account-based solution, the users might indeed not feel major changes from the actual payment means in terms of user experience (exception made for the possible cap per-user).
In the opposite scenario of a centralised, direct, token-based solution a major change in payment experiences will be faced by users that will have to differentiate their expenditure between a CBDC wallet and the classic payment instruments offered by commercial banks.
1.3. Why issuing a CBDC?
Technology solutions and design choices are triggered by the main rationale for developing CBDCs pursued at political level. Reinforcement of monetary sovereignty, strategic autonomy and monetary policy implementation are the most relevant ones. The CBDC development can be also seen as a response to the broader trend of the creation of new form of private money by private actors that bypass the existing bank-based payment systems.
Besides, CBDCs can be designed with other important functions[11]. First of all, to stimulate competition and innovation in payments, removing barriers and avoiding closed payment systems created by platforms (e.g. the attempt of Meta of deploying its crypto-token, called “Diem”). Second, to foster financial inclusion, rendering the process easier for people that currently do not have a bank account. Third, to improve cross-border retail payments. While the European Union is reducing barriers[12], domestic payment systems are often not interoperable between countries all over the world. The current system architecture tends to be slow, expensive and difficult to automate. Moreover, risks related to money laundering, tax evasion and terrorist financing are typically high while the CBDC features of identifiability of the end-user and traceability of their transactions can render this tool more effective to prevent ML/FT, as well as frauds. Cross-border CBDCs, where one or more systems automatically handle cross-border payments between multiple domestic CBDCs, could significantly improve cross-border financial transactions.[13]
Finally, an additional argument in favour of central bank money is that it is of superior quality than other form of money created by commercial banks because it does not depend on the solvency of a private issuer. This however could have a profound adverse impact on the current banking system. In fact, the availability of such safe asset might encourage savers to withdraw their bank deposit and move the funds to their digital currency wallet or accounts at the central bank, causing a major disruption of the liquidity present in commercial banks.
For these reasons, as highlighted above, limits might be imposed by the central bank issuing the CBDC in form of caps/ceilings to account holders, where only a limited amount of digital currency can be owned by each person. Diversely, with a “tiering approach” no hard limit exists, but holdings above certain threshold would be dissuaded by fees or negative interest rate. The hard limit might coexist with the “tiering” (that is, money above a certain threshold would receive a negative interest rate, and there however will be a maximum threshold for all CBDC, including the one with negative interest rate). At the same time, doubts have been expressed on the added-value of CBDCs compared to existing retail solutions for payments[14].
To conclude, a CBDC is a policy project based on complex technical and organisational design choices that are strictly interconnected with the policy aims pursued by central banks/state actors. In any case, regardless of the specific policy objectives pursued via the CBDC project, a complex and robust regulatory framework needs to be adopted in order to tackle many challenges, including privacy and data protection.
2. What are the privacy and data protection issues?
Depending on the technical design choices made for a CBDC, different privacy and data protection challenges might emerge. A recent survey of the European Central Bank (ECB) showed that privacy is amongst the most compelling issues for European citizens. If implemented without proper security protocols and an adequate architecture, privacy and security issues of a CBDC could have a major impact due to the scale of such projects. Much would also depend on the policy objectives and use-cases of the CBDC. So, it is key to wire data protection and privacy requirements within the core concept of a CBDC and to maintain a data protection impact assessment over time to be able to take the necessary measures. At the same time, a clear specification of the policy objectives and use-cases, as well as of the possible interplay with other aspects and digital policy initiatives, is key.
2.1. Privacy and data protection issues in payments can be exacerbated by certain design choices
Design choices have strong impacts on the way privacy is ensured, managed and preserved.
On the one hand an account-based CBDC solution may require verified identities for all account holders to map each individual to one identifier across the entire payment system for both the functioning and security/compliance reasons, representing challenges in terms of privacy and data protection. On the other hand, whilst a token-based approach can in principle offer a more universal access and better data protection, there are downsides such as the risk of losing money if end users fail to keep their key secure.
Moreover, some design choices in the underlying technological infrastructure might exacerbate the privacy and data protection issues that already exist in the current digital payment landscape. For example, the unlawful use of transactional data for creditworthiness assessment and abusive marketing initiatives can become even easier according to the level of data accessibility agreed to each actor in the payment process (and facilitated, as possibility for user’s profiling, by the single and persistent CBDC user-identifier).
The technological choices of a new CBDC project potentially impact all citizens living in the jurisdiction of a central bank, resulting in large-scale processing operations with high risks for rights and freedoms of data subjects. For this reason, privacy and data protection requirements should be wired within the regulatory framework and in the core technological decisions on the design of the project, and all decisions regarding features, configurations and risk-acceptance should be duly evaluated and documented. A data protection impact assessment needs to be conducted and maintained in time and over different phases of the CBDC project[15].
From the very beginning, the CBDC design research and development process should be built with a clear data protection by design and by default approach. Retrofitting a CBDC due to a wrong design choice, if ever possible, in addition to the economic costs, would result in higher direct and indirect costs and further uncertainties that can lead to a loss of acceptance of the project itself by citizens and companies.
Complexities would emerge in case distributed ledger technologies are involved in the development of a CBDC, especially for what concerns data minimization and storage limitation principles due to the add-only and ever-growing nature of a blockchain.
Moreover, the design of a CBDC entails privacy and data protection risks with regard to cross-border payments. Payment operations must comply with domestic rules, and despite international standards, there can be significant differences in the implementation and controversial cross-border interplays. This will likely further complicate the implementation and design of cross-border CBDCs due to incompatibilities including among privacy, data protection and anti-money laundering (AML) rules.
These potential issues could be remedied through proper design, as well as multilateral coordination, to align technical, regulatory and supervisory frameworks. Standardization and harmonization efforts, translating into consistent privacy and transparency standards could also be implemented ensuring interoperability across jurisdictions and over time[16].
2.2. Privacy in payments risks to be diminished
Nowadays, cash is the only form of money exchanged in an anonymous way – under certain threshold[17] – that operates within regulated domains. Due to the increased adoption of digital means of payments and reduced use of cash as a means of payment[18], cash may be marginalised in few years. In fact, anonymity can be ensured for payments in cash, which can be exchanged between two peers without a third party that validate the transaction.  On the other hand, the private digital payment solutions available in the market enable an increasing data exploitation, leading to a reduction of anonymous payments. Anonymity under a certain threshold can become a clear unique feature for the token- based CBDC solution (which is a bearer-instrument like banknotes), differentiating it from all the other private digital payment methods used by citizens. This would be a unique opportunity for citizens, as secure, stable and anonymous cashless payments are inexistant currently.
Offline solutions (e.g. the token-based CBDC that would have offline transaction capability) can potentially offer the most in terms of privacy and data protection, since only minimal processing operations are required to realize the transaction. Moreover, offline payments are processed locally without the need of any third party to validate the transaction. Offline payments are also a secure back-up in cases of major internet outages. The token-based CBDC that would have offline transaction capability could become functionally equivalent to cash or an endorsed check.
Due to the digital nature of CBDC, it is inherently more transparent. Fully anonymous CBDC solutions might be difficult to reconcile with the need to hinder illegal activities such as drug trafficking, money laundering and terrorism financing that rely on anonymous cash transactions or alternative remittance systems. Here, the legislator can define the correct balance and the necessary use-cases, which could be implemented through advanced pseudonymisation techniques mixed with other privacy enhancing technologies[19].
Finally, a proper solution for identifying and allowing access and use of offline digital tokens shall be defined. Account-based identification can lead to identifying and potentially tracking of all end-user’s transactions and profiling thereof (see section 2.5), while an offline token-based CBDC system would enable anonymous payments.
2.3. The resulting interference of the adoption and use of CBDC on people’s private life might not fulfil the requirements of necessity and proportionality
Any design choices resulting in an interference with people’s private life should be proven necessary for the social need or policy objective pursued by the CBDC project.
In addition, each design option needs to be considered under the necessity and proportionality principle in order to determine if alternative technologies and processes could deliver safer options.
In particular, risks for individuals might emerge when privacy and data protection need to be balanced with other values and rights to be protected. As of any other means of payments, CBDCs need to be developed in compliance with other applicable laws and regulations in a sector that results to be one of the most regulated in the data processing landscape. For example, as is the case for non-CBDC use, anti-money laundering, anti-terrorism financing and anti-tax evasion laws require specific processing of personal data. The particular design and features of a CBDC can result in a specific risk profile in the anti-money laundering and anti-terrorism financing context, different from the one existing for other means of payments and cash. For this reason, these aspects should also be addressed in a forward-looking manner before the launch of any CBDC project[20].
Moreover, the privacy impact needs to be assessed carefully in order to find the right balance with specific and competing interests in CBDC as usability and auditability.
Depending on the chosen technical solution, for instance a fully centralized CBDC with clear and persistent user identification and full transparency on all online transactions of a user, the risk of generalized surveillance might emerge (see section 2.5).
2.4. Roles and responsibilities are complex to identify
According to the specific design choices adopted by the central bank, diverse actors within the payment ecosystem could process personal data (see Figure 2). Recognising data protection roles is of outmost importance for a correct application of obligations and responsibilities under the applicable data protection law. The decentralised governance and the multiplicity of actors involved in the processing of data could lead to difficulties if a DLT-based architecture is implemented. Albeit difficult, the identification of the data controller(s) is the first element necessary to distribute data protection responsibilities across the payment chain. For example, the relationship between central banks and the financial intermediaries is essential to determine who will have to notify a possible personal data breach or whom data subjects should contact to exercise their right to information, access or to withdraw their consent.
2.5. Systemic risks of profiling and surveillance are present
As already reported in our TechDispatch #2/2021 on card-based payments, tracking payments of a person can describe the consumers’ life in great detail, understanding people’s online and offline spending habits. The amount of personal information that actors involved in transactions’ management learn about each individual when a payment system operates is significant. This generates a systemic risk of profiling and surveillance by the parties operating the payment system. Specifically, in the CBDC domain, this risk is connected to design choices. For example, a design that does not allow central banks to process personal data or that implements strict data minimisation might avoid or reduce the risks for privacy involved in the current payment systems. On the contrary, a configuration that permits the central bank to identify and store personal information of the payments or where merchants[21] can collect and link payment data to customer profiles might amplify these risks compared to the currently existing payment methods.
Furthermore, issuing a CBDC increases the central bank’s – and by extension other public authorities’ – possibility to access financial information directly linked to an identity, entailing the risk of systemic public surveillance. In any event, whether repurposed in the future, transmitted to another public authority or leaked by accident, such a huge data collection presents a general risk of mass surveillance and unintended use.
For these reasons, privacy enhancing technologies, including advanced pseudonymisation techniques and zero-knowledge proof, should be used in order to limit information shared between transaction partners to the minimum necessary to prove that the payment has been made successfully.
Moreover, defining and imposing by law specific personal data retention period in relation to each the purpose of the data processing is a key requirement, also to reduce risks in case of data breaches or unlawful access to the CBDC technological infrastructure.
2.6. Data concentration can increase security risks
Until recently, little work has been done publicly in the cybersecurity and central banking world to actually understand the risks which are specific to CBDC[22]. Similarly to other means of payment, security is a key component of a CBDC. Security is also key to build the necessary trust that citizens need to have in order to be comfortable in adopting and using CBDC. Access credentials are needed for accessing and transferring funds. The most significant risk, credential’s theft or loss, is common to most of the other means of payment. In fact, credentials’ theft and loss could result in compromising accounts and data. Modern attack techniques such as social engineering, side-channel attacks and malware could be used to extract credentials from a CBDC user’s device. The impact of such an attack can be disruptive, with some mitigation if the architecture is implemented to process low amounts of digital currency.
‘Data concentration’ is also an important security risk to consider. In fact, if payment data of all citizens were concentrated in the database of a central bank, this would generate incentives for cyberattacks and a high systemic risk of individual or generalised surveillance in case of data breaches or, more in general, of unlawful access, as well as for denial-of-service attacks jeopardising the possibility to carry out payments, in particular in case of “direct” approach.
On the other hand, where a distributed ledger technology is adopted (and data storage occurs on device), “double-spending”[23] attacks need to be adequately minimised, especially in the offline, bearer-based configuration of a CBDC. Those consists in a form of counterfeiting where the CBDC is spent multiple times illegitimately.
Quantum computing might ultimately impact all financial services as it could compromise major data encryption methodologies and cryptographic primitives used for protecting access, confidentiality and integrity of data stored and transmitted and the need for possible post-quantum cryptography should be taken into account during technology design[24].
Lastly, fragmented efforts to build CBDCs at national level are likely to result in cybersecurity risks stemming from difficulties in ensuring interoperability, notably in a cross-border dimension. Central banks have been focused so far on domestic uses of CBDC, with too little thought for cross-border regulation, interoperability and standard-setting.  The multi-jurisdictional transfer of personal and transaction data may increase the scale, scope, and speed of data breaches.
In order to correctly handle the security risks, a technical governance should be integral part of a CBDC system in order to monitor new developments and anticipate risks. Adopting open-source models may help foster transparency, innovation and trust.
Security concerns in the CBDC infrastructure, whose relevant requirements and expectations are high, may turn into severe consequences among stakeholders and a significant loss of trust from users, with the consequent dismissal as a widely-used means of payment, thus resulting in the failure of the project.
3. Recommended readings
– European Parliament, The digital euro: policy implications and perspectives, January 2022 – https://www.europarl.europa.eu/thinktank/en/document/IPOL_STU(2022)703337
– Banca d’Italia, A digital euro: a contribution to the discussion on technical design choices, July 2021
– R. Auer, R. Bohme, The technology of retail central bank digital currency, BIS Quarterly Review, March 2020
– Digital Euro Association, Ahead of the digital euro, August 2022
– Raskin et. al., Digital currencies, decentralized ledgers, and the future of central banking, National Bureau of Economic Research, 2016
– Institute and Faculty of Actuaries, Understanding Central Bank Digital Currencies (CBDC), March 2019
– International Monetary Fund, F&D Series, The Money Revolution – Crypto, CBDCs, and the future of finance, September 2022
– Atlantic Council, Missing key: the challenge of cybersecurity and central bank digital currency, June 2022 – available at https://www.atlanticcouncil.org/in-depth-research-reports/report/missing-key/
– Bank of International Settlement, Central bank digital currencies: system design and interoperability, 2021 – available at  https://www.bis.org/publ/othp42_system_design.pdf
All links cited and listed have been lastly accessed on the 10th March 2023.

Authors:

Stefano LEUCCI
Massimo ATTORESI
Xabier LAREO

Compliments of the European Data Protection Security (EDPS) TechDispatch
Footnotes:
[1] To know more about money, currency and value see European Central Bank, What is money?, 2017 – https://www.ecb.europa.eu/ecb/educational/explainers/tell-me-more/html/what_is_money.en.html
[2] “Legal tender” status is a key attribute of currency: it entitles a debtor to discharge monetary obligations by tendering currency to the creditor – International Monetary Fund, Legal Aspects of Central Bank Digital Currency: Central Bank and Monetary Law Considerations, WP/20/254, pag. 8.
[3] Hereinafter, referred also as private banks and financial intermediaries. For more information, please see Investopedia, How Banking Works, Types of Banks, and How To Choose the Best Bank for You, accessed on November 2022 – https://www.investopedia.com/terms/b/bank.asp
[4] Source: https://www.forbes.com/advisor/investing/cryptocurrency/different-types…
[5] CoinMarketCap – https://coinmarketcap.com/view/stablecoin/ (accessed in October 2023).
[6] VoxEU CEPR, Central bank digital currency: the battle for the soul of the financial system, 2021 – https://cepr.org/voxeu/columns/central-bank-digital-currency-battle-sou…
[7] For more information on blockchain technologies, see https://www.oreilly.com/library/view/mastering-bitcoin/9781491902639/ch07.html
[8] For more information about NFC protocol, see Wikipedia – https://en.wikipedia.org/wiki/Near-field_communication (accessed in October 2022).
[9] For more information about programmable money, see Federal Reserve, FED Notes, What is programmable money?, June 2021, available at https://www.federalreserve.gov/…/what-is-programmable-money-20210623.html
[10]  For more information about programmability of money and payment, see P. G. Sandner, The Digital Programmable Euro, Libra and CBDC: Implications for European Banks, Conference: EBA Policy Research Workshop: New technologies in the banking sector – impacts, risks, and opportunities, 2020.
[11] Bank for International Settlements, BIS Papers No 125, Gaining momentum – Results of the 2021 BIS survey on central bank digital currencies, by Anneke Kosse and Ilaria Mattei, May 2022
[12] For more information about the work of the European Union on Intra-EU cross-border payments please see European Commission, Frequently asked questions: Intra-EU cross-border payments, February 2019, available at https://ec.europa.eu/commission/presscorner/detail/sv/MEMO_19_1170
[13] The need for intermediaries would be reduced or eliminated by allowing banks to directly hold foreign CBDCs;  and correspondent banking would be sped up through automated or integrated compliance and validity checks on an interoperable digital platform; both leading to reduced latency and fees for end users. – https://www.atlanticcouncil.org/…/Privacy_in_cross-border_digital_currency-_A_transatlantic_approach__-.pdf
[14] See, among others, the Analysis by the Danish Central Bank, New types of digital money, 23 June 2002, at page 28: “At present, and with the associated costs and possible risks, it is not clear how retail CBDCs will create significant added value relative to the existing solutions in Denmark.” The Study is available at: https://www.nationalbanken.dk/…/06/ANALYSIS_no 208_New types of digital money.pdf
[15] For a more extensive explanation on data protection impact assessment in the EU, see Article 29 Data Protection Working Party, Guidelines on Data Protection Impact Assessment (DPIA) and determining whether processing is “likely to result in a high risk” for the purposes of Regulation 2016/679, as last Revised and Adopted on 4 October 2017.
[16] For more information about privacy issues in cross-border payments see Atlantic Council – Geoeconomics Center, Privacy in Cross-border Digital Currency – A Transatlantic Approach, 2022 – available at https://www.atlanticcouncil.org/…/Privacy_in_cross-border_digital_currency-_A_transatlantic_approach__-.pdf
[17]  Different sectorial legislation have already balanced the privacy of payees against other competing values. In fact, the anti-money laundering directive prohibit credit and financial institutions from keeping anonymous accounts or anonymous passbook, defining also thresholds of amounts where to apply due diligence processes. For more information, see Directive (EU) 2015/849 on the prevention of the use of the financial system for the purposes of money laundering or terrorist financing.
[18] For more information, see European Central Bank – Study on the payment attitudes of consumers in the euro area (SPACE) – 2022.
[19] For more information, see World Economic Forum, The Next Generation of Data-Sharing in Financial Services: Using Privacy Enhancing Techniques to Unlock New Value, September 2019 and Future of Financial Intelligence Sharing (FFIS), Innovation and discussion paper: case studies of the use of privacy preserving analysis to tackle financial crime, January 2021
[20] Financial Action Task Force (FATF), Updated guidance for a risk-based approach, Virtual assets and virtual asset service providers, 2021
[21] A merchant represents a person or company that sells goods or services – for more info, please see Stax Payments, Explained Simply: What is a Merchant Services Provider?, available at https://staxpayments.com/blog/merchant-services-provider/
[22] For more information, see Atlantic Council, Missing key: the challenge of cybersecurity and central bank digital currency, June 2022 – available at https://www.atlanticcouncil.org/in-depth-research-reports/report/missing-key/
[23] Sveriges Riksbank, On the possibility of a cash-like CBDC, February 2021 – https://www.riksbank.se/globalassets/media/rapporter/staff-memo/engelska/2021/on-the-possibility-of-a-cash-like-cbdc.pdf
[24] Many banks around the world are already developing and testing post-quantum security capabilities. On this, see Bank for International Settlements, BIS Innovation Hub announces new projects and expands cyber security and green finance experiments, June 2022 – https://www.bis.org/press/p220617.htm  and Finextra, Banque de France tests ‘post quantum’ security tech, September 2022 – https://www.finextra.com/newsarticle/41018/banque-de-france-tests-post-quantum-security-tech

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The EU Commission welcomes the political agreement reached between the European Parliament and the Council to boost the number of publicly accessible electric recharging and hydrogen refuelling stations in particular across the European Union’s main transport corridors and hubs. This is a landmark agreement that will enable the transition to zero-emission transport and contribute to our target of reducing net greenhouse gas emissions by at least 55% by 2030.
The new Regulation for the deployment of alternative fuels infrastructure (AFIR) sets mandatory deployment targets for electric recharging and hydrogen refuelling infrastructure for the road sector, for shore-side electricity supply in maritime and inland waterway ports, and for electricity supply to stationary aircraft. By making a minimum of recharging and refuelling infrastructure available across the EU the regulation will end consumer concerns about the difficulty to recharge or refuel a vehicle. AFIR also paves the way for a user-friendly recharging and refuelling experience, with full price transparency, common minimum payment options and coherent customer information across the EU.
Infrastructure for road transport, shipping, and aviation
The new AFIR rules will ensure sufficient and user-friendly alternative fuels infrastructure for road, shipping and aviation. This will enable the use of zero-emission road vehicles, in particular electric and hydrogen light- and heavy-duty vehicles, as well as electricity supply to moored vessels and stationary aircraft. Specifically, the following main deployment targets will have to be met in 2025 or 2030:

Recharging infrastructure for cars and vans has to grow at the same pace as vehicle uptake. To that end, for each registered battery-electric car in a given Member State, a power output of 1.3 kW must be provided by publicly accessible recharging infrastructure. In addition, every 60 km along the trans-European transport (TEN-T) network, fast recharging stations of at least 150 kW need to be installed from 2025 onwards.

Recharging stations dedicated to heavy-duty vehicles with a minimum output of 350 kW need to be deployed every 60 km along the TEN-T core network, and every 100 km on the larger TEN-T comprehensive network from 2025 onwards, with complete network coverage to be achieved by 2030. In addition, recharging stations must be installed at safe and secure parking areas for overnight recharging as well as in urban nodes for delivery vehicles.

Hydrogen refuelling infrastructure that can serve both cars and lorries must be deployed from 2030 onwards in all urban nodes and every 200 km along the TEN-T core network, ensuring a sufficiently dense network to allow hydrogen vehicles to travel across the EU.

Maritime ports that see at least 50 port calls by large passenger vessels, or 100 port calls by container vessels, must provide shore-side electricity for such vessels by 2030. This will not only help reduce the carbon footprint of maritime transport, but also significantly reduce local air pollution in port areas.

Airports must provide electricity to stationary aircraft at all contact stands (gates) by 2025, and at all remote stands (outfield positions) by 2030.

Operators of electric recharging and hydrogen refueling stations must ensure full price transparency, offer a common ad hoc payment method such as debit or credit card, and make relevant data, such as that on location, available through electronic means, thereby ensuring the customer is fully informed.

Next steps
The political agreement reached this week must now be formally adopted. Once this process is completed by the European Parliament and the Council, the new rules will be published in the Official Journal of the European Union and enter into force after a transitional period of 6 months.
Background
The European Green Deal is the EU’s long-term growth strategy to make the EU climate-neutral by 2050. To reach this target, the EU must reduce its emissions by at least 55% by 2030, compared to 1990 levels. This week’s agreement is another important step in the adoption of the Commission’s ‘Fit for 55’ legislative package to deliver the European Green Deal. It follows other recent deals, most recently on sustainable fuels for shipping.
Compliments of the European Commission.
The post European Green Deal: ambitious new law agreed to deploy sufficient alternative fuels infrastructure first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.