Future-proofing Europe’s financial system

Over the last 30 years, we have constructed a Single Market across national borders spanning diverse cultures, languages, currencies, and economies. The next chapter of this story – one that has already been started – is digital. A well-designed digital asset ecosystem can create a more integrated European financial market, not as a distant aspiration but as a near-term reality.

As we all know, the transformation of the financial system is being driven in significant part by technological innovation, which is introducing new ways to conduct payments, manage assets, and access financial services. Advances such as distributed ledger technology (DLT) and tokenisation are creating the potential for greater speed, efficiency, and transparency with potentially transformative effects on the structure of our economies that are difficult to foresee today.

Designing and facilitating the future financial ecosystem raises fundamental policy challenges for central banks. Our role within this changing ecosystem crosses many aspects of our responsibilities, from the way we conduct monetary policy to the operating context for the firms we regulate and supervise. It may introduce new – and more rapidly-shifting – risks for our macroprudential policies to grapple with. And it is already requiring us to develop new frameworks for authorising and supervising entities that provide on-chain and assets in digital form.

Alongside all that, technological change also requires us to modernise our payment and settlement infrastructure. Geopolitical tensions have made this all the more important. European infrastructures are dependent on a small number of non-European providers. Although that has always been a vulnerability for the euro area economy, it’s now one we can’t afford to ignore.

The choices we make will determine whether this transformation strengthens Europe's financial system or fragments it further.

Modernising our own infrastructure is a key channel through which central banks lay the foundations for the future of the financial system. It will help us to maintain the anchor of central bank money in the economy, and advance European economic and financial integration.

Preserving the anchor of trust in the financial system…

For decades, the monetary system has been structured around a two-tier architecture. Central banks issue public money – banknotes (something everyone is familiar with) and reserves (a specialist topic) – which guarantees stability and trust in the monetary system. Commercial banks issue private money in the form of deposits, widely used for retail payments and backed by convertibility into central bank money at par. This framework – ‘the singleness of money’ – has supported efficiency, scalability, and financial intermediation while relying on the central bank as the anchor of confidence.

Central bank money is, in fact, the ultimate safe asset for settlement: risk-free, liquid, and stable. We play the key role in clearing and settling transactions across the financial system. Our counterparties can be sure that their transactions will settle, underpinning trust in the financial system.

Our goal is to enable central bank money to continue performing its stabilising role, even as the financial system undergoes a digital transformation. And to be clear, this isn't about opposing private innovation. It's about recognising that monetary stability, financial resilience, and consumer protection are public goods that require public stewardship. We want to enable public money for the digital age and we also want the private sector to use that secure public foundation to innovate and continue to meet the financial needs of households and businesses.

To operationalise the use of central bank money for a digital world, we can use innovative technology to build a unified shared digital infrastructure with low barriers to entry. Established governance and capacity to host multiple asset types would enable efficiency and seamless integration with other financial market infrastructures. In this way, we can provide pan-European ‘rails’ for both public and private digital money and tokenised assets with safe, instant settlement.

These infrastructures need to be available at retail and wholesale levels.  We are working with Eurosystem colleagues on both the digital euro as well as the roadmap for a European digital asset ecosystem (as discussed at a panel I joined in Brussels last week).

Advancing European economic and financial integration.….

A fragmented European financial system entails economy-wide costs. On the other hand, an integrated digital asset ecosystem would be strong, efficient, resilient, and globally competitive. It would reduce transaction costs, enable faster settlement, support capital efficiency, and allow private operators to compete and innovate on top of public infrastructure.  

DLT presents an opportunity to enable seamless and secure settlement in central bank money across Europe at scale in ways that traditional systems cannot. However, a digital asset ecosystem requires upfront investment in standards, governance and coordination to ensure it is open, pan-European and interoperable with private solutions. In other words, a range of enablers are necessary to make sure we leverage the benefits of a modern digital ecosystem. (We set these out in our recent discussion paper on DLT and Tokenisation in Financial Services (PDF 1.37MB).)

A key objective for central banks is to mitigate the risk of fragmentation within the existing ecosystem while at the same time monitoring risks from activities outside the perimeter that could interact with it. We need to pursue a balanced approach that seeks to align public and private interests. In my view that means preventing central bank money settlement from being displaced by riskier settlement assets on private financial market infrastructures (so that we avoid exacerbating market fragmentation and any unwelcome indirect societal costs).

But the objective of all European policymakers – not just central banks – should be for a more integrated financial system to enable a stronger European economy, building on the euro and the Single Market’s Four Freedoms (free movement of goods, services, people, and capital). For small, open economies like Ireland, being part of the Single Market allows us to achieve efficiencies of scale that greatly surpass the capacity of our domestic market. Our competitive advantage lies in the scale provided by an integrated European ecosystem.

Next steps…

Right now, I see three main tasks for central banks. The main focus of this blog so far has been on the need to modernise our infrastructure, the key channel through which we lay the foundations for the future of the financial system.

But there are two further – and no less important – dimensions to our work.

First, we need to ensure that the financial system of the future is safe.  Regulating and supervising well continues to be fundamental to managing risks arising from private sector offerings and protecting consumers and the wider system.

Second, we need to remain curious and engaged so that we can understand the dynamics that are driving innovation and their implications.  We need to deepen our understanding of the implications of the evolving digital ecosystem.  Effective policy requires a system-wide perspective and independent analysis.  To that end, we are engaging widely so that we can learn and respond appropriately. Moreover, within our Innovation Sandbox Programme, we are working directly with firms to provide regulatory advice and support on their innovative projects, in line with our public policy objectives.

We are also undertaking an analysis of the macro-financial and macroeconomic effects of innovation in money and payments for broad cohorts in society. We published two papers last week: a signed Article (PDF 1.04MB) that serves as a comprehensive analysis of the existing infrastructure that underpins both traditional and emerging payment systems, and a Staff Insight describing survey evidence looking at willingness to adopt the digital euro.

These publications mark the first in a series reflecting a heightened focus in our research on innovation in the payments system. It will help to inform us and the wider public on what are complex and rapidly-moving activities, and guide our understanding of how our financial system is likely to evolve.

Gabriel Makhlouf