How the Digital Euro Could Push European Banks to Compete
Sushant Shyam
Europe’s next major financial transformation might not be triggered by a crisis, but by deliberate design. As the European Central Bank (ECB) moves closer to issuing a digital euro, the project promises far more than a new way to pay. By giving households and firms access to a digital form of public money directly backed by the ECB, a well-designed digital euro could reshape how Europeans hold money and confront the long-standing weaknesses of the continent’s retail banking sector.
A central-bank digital currency (CBDC) would coexist with cash, allowing anyone to store risk-free central bank money in electronic form. This seemingly simple shift could profoundly reshape the relationship between banks and depositors, injecting competitive pressure into a market that has lacked it for decades.
The Purpose of the Digital Euro
The ECB envisions the digital euro as a fast, secure, and universally accessible means of payment that preserves public access to central bank money in an increasingly digital economy. When people use online banking today, they hold digital claims on a commercial bank, which are promises by that bank to repay them. Those promises are only as strong as the bank itself, even if deposit insurance offers partial protection. A digital euro, by contrast, would be a direct liability of the ECB. Like notes and coins, it would be fully backed by the central bank, which can always guarantee its value. Households and firms would therefore hold truly risk-free digital money rather than a claim on a commercial institution.
The project is designed to reduce Europe’s reliance on foreign payment providers such as Visa and Mastercard and to stimulate competition and innovation across the payments market. Over the long term, the digital euro could also enhance monetary policy transmission, especially if it were ever remunerated, by giving the ECB a more direct channel to households and firms.
Europe is not the only one considering this shift. More than 80% of central banks are actively exploring CBDCs, and around 10% expect to issue one within the next three years. The rise of stablecoins and other privately issued digital assets has already begun to reshape global finance, reinforcing the ECB’s view that a digital euro is both a strategic necessity and a natural extension of central banks’ traditional role.
Yet the digital euro would be introduced at a time when Europe’s banking sector continues to struggle with a deeper structural problem: weak retail competition.
Europe’s Competition Problem
For years, policymakers have warned that European retail banking suffers from weak competition. An OECD comparative report shows that national markets remain characterised by high switching costs, geographic fragmentation, and regulatory barriers that protect incumbents and discourage new entrants. These structural frictions help explain sluggish deposit-rate pass-through and the limited pressure on banks to innovate or improve services.
Empirical evidence reinforces this diagnosis. Since the 2008 financial crisis, consolidation has sharply reduced the number of credit institutions in Europe, raising concentration in many countries. National regulators continue to shield domestic “champions” by discouraging or blocking cross-border mergers, preventing the emergence of a truly integrated EU-wide retail banking market. Standard indicators tell the same story: the Lerner index, a common measure of market power, rose across euro-area countries after 2008, while persistently high margins relative to global benchmarks point to subdued competitive pressure. The crisis response itself, involving state aid and forced mergers, further distorted market dynamics and strengthened incumbents.
Fragmentation also limits banks’ ability to realise economies of scale. As a result, European consumers face lower-quality digital services, higher fees, and fewer product choices. Research by ECB and Federal Reserve economists shows that deposit rates in Europe have been unusually sticky during the post-pandemic tightening cycle. Meanwhile, cross-border activity remains muted: cross-border deposits are small, mergers are rare, and banks’ balance sheets remain overwhelmingly domestic.
Consumers ultimately bear the cost. They receive lower deposit rates, face limited cross-border offerings, and encounter uneven access to modern digital banking services. Despite repeated attempts to complete the banking union, progress has stalled, national barriers persist, and competitive pressure remains weak.
A Catalyst for Competition?
Current ECB plans do not envisage the digital euro paying interest. Yet even a non-interest-bearing version could reshape competition in retail banking by giving savers a credible, risk-free alternative to commercial bank deposits.
The mechanism is straightforward. Once depositors have a viable outside option, banks must work harder to retain them, whether by offering higher rates or improving the quality of services. An ECB working paper finds that even a non-remunerated CBDC reduces banks’ market power and pushes them to raise deposit rates to prevent outflows. In other words, a CBDC can enhance competition without meaningfully disintermediating the banking sector. A remunerated digital euro would amplify these effects by giving households and firms an even stronger alternative. The ECB has kept this option open, noting that remuneration could improve deposit-rate competition and enhance monetary-policy transmission.
Design choices can also mitigate fears of destabilising deposit flight. Research by the Bank of England finds that caps on CBDC holdings are effective at preventing large and sudden outflows from bank deposits when a digital currency is introduced. These limits help protect bank funding during the transition without undermining the core functionality of the CBDC.
Taken together, these findings suggest that a digital euro could provide exactly the competitive pressure missing from Europe’s retail banking market. Even modest holding limits and no remuneration would force banks to respond.
This potential disruption comes at a pivotal moment. After years of stagnation, European banks are increasingly profitable, their valuations have improved, and cross-border merger activity is tentatively reappearing. A well-designed digital euro could deliver the competitive shock the sector has long needed, not to weaken European banks but to push them to innovate, modernise, and compete.
Strategic Implications
Beyond its impact on banking, the digital euro carries significant strategic implications. By creating a European alternative to the dollar-centric payment infrastructure, it would strengthen the EU’s financial sovereignty and give Europe greater influence over global standards for secure digital payments. Rather than depending on foreign technologies and governance models, the EU could develop and promote its own.
However, greater autonomy brings difficult governance choices. How much transaction data should the ECB be allowed to access? How should the EU balance strong privacy protections with legitimate anti-money-laundering requirements? The credibility of the digital euro, and ultimately its adoption by the public, will depend on how these questions are resolved.
What Comes Next
The digital euro is the EU’s most ambitious monetary innovation since the launch of the single currency. Its significance extends well beyond payments. If designed with clarity and ambition, it could deliver the competitive shock that Europe’s banking sector has long lacked. It could strengthen monetary policy transmission, improve outcomes for consumers, and push the EU towards the integrated retail banking market it has struggled to build through regulation alone.
A timid version, built around restrictive caps, limited functionality, and political compromise, would accomplish little. A more ambitious version could promote innovation and align Europe’s banking sector with the scale and expectations of its monetary union.
The EU now faces a choice. It can create a digital euro that merely digitises the status quo, or design one capable of making Europe’s financial landscape more integrated, more innovative, and, crucially, more competitive.