Regulating, managing and creating a secure and safe financial environment around banking, crypto-assets and a digital currency are the leading challenges lying ahead for central banks and policymakers. Photo: Shutterstock

Regulating, managing and creating a secure and safe financial environment around banking, crypto-assets and a digital currency are the leading challenges lying ahead for central banks and policymakers. Photo: Shutterstock

From navigating the aftermath of the banking crisis to addressing the challenges presented by cryptoassets and the imminent digitalisation of currency and payments, European authorities need to actively adapt regulations to ensure stability and foster innovation, journalist Kangkan Halder writes in this opinion column.

The events that unfolded in the first half of 2023 have underscored the critical role of a robust regulatory framework in the financial sector. A short-lived banking crisis in March led to the collapse of and , the second-largest bank in Switzerland.

This crisis served as a crucial reminder of the importance of effective regulation and proactive supervision.

Banking

While the short-lived scare significantly impacted the United States and Switzerland, the euro area displayed resilience thanks to the implementation of effective regulations such as the Basel III framework, which applies to all European banks.

However, it is essential to acknowledge that good regulation alone is not always sufficient.

Proactive supervision, demonstrated by the European Banking Authority (EBA) within the European System of Financial Supervision (ESFS), complements the regulatory framework by ensuring its enforcement. The ESFS also encompasses the European Insurance and Occupational Pensions Authority (Eiopa) for the insurance sector and the European Securities and Markets Authority (Esma) for securities sector supervision.

Together, these entities instill confidence in the financial system and provide protection for customers of financial services.

Cryptoassets

Continuous monitoring and assessment are crucial in mitigating risks within the financial sector, which extends beyond traditional banking. The emergence of digital cryptocurrencies, tokens and stablecoins, which lack universal benchmarks and standardised regulatory frameworks, has witnessed significant incidents in the cryptocurrency field.

Examples include the collapse of FTX, BlockFi and Genesis, to name a few, and instances of hackers stealing coins and tokens worth billions of euros. Additionally, ongoing legal proceedings against Binance and CoinBase in the US further highlight the need for robust regulation in this evolving domain.

While the impact of the crypto-asset market turmoil on the broader financial system has been limited so far, interconnectedness and banks offering or investing in cryptoassets and engaging in any crypto-related operations may lead to higher risk exposure.

The collapse of FTX, which tallied up $8bn in lost assets, also reveals the limitations of regulating single sub-entities in specific jurisdictions.

Transparency obligations, including the preparation of consolidated financial statements, are critical for conglomerates in the cryptocurrency sector. Cross-border information sharing is also essential to understand their overall organisation and interdependencies.

While Europe has taken the lead by adopting markets in cryptoasset (Mica) regulation, further advancements are still necessary.

Digital euro, payments and services

With the increasing adoption of digital transactions in society, the idea of a digital euro has gained traction.

This “digital banknote” would possess characteristics similar to physical cash, including privacy, offline usability, legal tender status and wide acceptance across the euro area.

Additionally, it would open up opportunities and reduce costs for e-commerce, peer-to-peer payments and programmable transactions.

The members of the European Central Bank working on the feasibility of a digital euro foresee its potential launch in the next three to four years, possibly as early as 2027, provided everything goes according to plan.

However, the introduction of a digital currency, fully pegged at par with its paper counterpart, would not only lead to innovation in payment methods and services, but also the evolution of personal or communal lending practices.

Interoperability between various assets, encompassing both physical and digital realms, and potentially extending to a meta-world in the future, would be crucial.

However, this would also bring forth new regulatory challenges.

Furthermore, while it may be feasible to impose daily or monthly spending limits to comply with anti-money laundering measures, it remains unclear how restrictions on taking a digital currency to non-euro countries could be imposed, as is the case with limitations on physical paper currency.

A robust regulatory framework, proactive supervision and innovative advancements in the digitalisation of currency and payments will shape the future of European finance, gradually bringing us closer to a cashless and digital economy.

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