Central bank digital currency (CBDC)

 

Implementation of Retail central bank digital currency (CBDC) in India: How will it impact the existing payment channels and how can it enhance digital payments?                          

Central Bank of India e.g., RBI controls the monetary policy of India through money regulation (majorly Fiat money) and is likely to introduce digital currency based on blockchain technology. so, central bank digital currency (CBDC) can be defined as the virtual or digital asset version of the fiat currency. Unlike cryptocurrency, digital currency is not decentralised, while it aims to improve the efficiency of payment and financial inclusion.

As per the RBI concept note on CBDC the key motives to introduce the digital currency as a sovereign currency, CBDC has special advantages over central bank money, such as integrity, trust, safety, and liquidity. Among other reasons, lowering operational costs associated with physical cash management, promoting financial inclusion, bringing resilience, efficiency, and innovation to the payments system, enhancing the efficiency of the settlement system, fostering innovation in cross-border payments, and giving the general public access to uses that private virtual currencies can offer without the associated risks are the main reasons for introduction of CBDC in India. In rural areas, using CBDC's offline capability would be advantageous because it would increase availability and resilience even in the absence of internet service or electricity.[1]

In that concept note RBI proposed two broad types of CBDC:

1.   CBDC-R (retail) for general purpose

2.   CBDC-W(wholesale) for financial institutions

India is in the phase of digital revolution where Jan-dhan Yojna, Direct benefit transfer (DBT) and unified payment system (UPI) etc. are the key components. CBDC can be seen as a catalyst to this revolution, where CBDC-R addresses the large audience in India. There are several Features of CBDC mentioned below:

§  Interest bearing: it incentivises people to switch to the CBDC and also helps to smooth rate transmission in real time scenarios however it can disrupt the banking system and deposits in intermediate banks. So, it seems to be a trade-off between interest bearing and non-interest bearing CBDC.

§  Cost reduction: It reduces the cost of operation and transfers.

§ Encourage Financial inclusion: CBDC can be operational even in absence of Internet services, and attract a large retail audience.

§ Improve cross border payments: blockchain integration helps to improve the cross-border payments and reduce the latency of transfer.

§  Disintermediation: CBDC can be a risk for banks as intermediation, in financial instability depositors can digitally run off from banks.

§ Protecting monetary sovereignty: cryptocurrencies and some other nations’ digital currency majorly used by domestic people and acceptance of those unauthorised currency leads to sovereign issues for the Indian monetary system. 

Implementation of CBDC-R

Technical Implementation of CBDC: Digital currency can be implemented through Distributed ledger technology (DLT) which could be useful for innovation and decentralisation, but decentralised technology in finance could be risky and security issues so DLT along with decentralised finance (DeFi) technology used to implement the CBDC. This further divided into two categories token based or account based CBDC:

§  Token based technology is the two-way wallet-based technique which is closer to physical form. In the case of token-based CBDC, distribution of the currency will involve transfer of an object of value from one wallet to another. Token-based CBDCs ensure that the transaction is approved by the originator and beneficiary based public-private key pairs and digital signatures. Thus, the system provides a high level of privacy but adds more difficulty in tracing money laundering and fraudulent transactions.[2] this is more resemble to CBDC-R, which can be seen below:

Source: Deloitte CBDC paper

§  In Account-based CBDC, the distribution of currency will involve transfer from one account to another. The model would ensure that the transaction is approved by the originator and beneficiary based on the verification of user identities. In issuing such accounts, Central Banks would have to ensure the existence of a digital account for every user. Which can be seen in figure below:

Source: Deloitte CBDC Paper

Apart from the token and account based technical categorisation, CBDC also categorised into direct, indirect and hybrid models also. 

Bank for international settlements (BIS) along with some other entities observe the several possible pathways to implementation of CBDC for India. There are two types of proposed CBDC-R for monetary policy implementation and financial stability:

1.    Direct retail CBDC

2.    Indirect retail CBDC


Direct retail CBDC: in this case no intermediaries involved and direct payment can be possible through the central bank. As shown below:


Source: Deloitte CBDC Paper

Indirect retail CBDC: In this case the bank or other financial institutions can be intermediaries and transactions would go through them. As shown in figure below:


Source: Deloitte CBDC Paper

Monetary policy implementation and interest rate of CBDC-R:

The consequences of CBDC issuance for the implementation and transmission of monetary policy are directly related to how wide access to CBDC is and whether it is attractively remunerated. Implementation of CBDC can cause a disruption in the banking system, if we look at it from the perspective of interest-bearing tendency of digital currency, banks as intermediation can see disruption in deposits more frequently.

But at the same time, smooth policy rate transmission and operational cost reduction can reduce the overall cost and increase the healthy competition among the financial institutions. This further reduces the rates on borrowing and increases the rate on deposits.

Major Challenges in Implementing CBDC:

§  Data (Financial) Protection and Cyber threat

§  Regulatory and legal architecture

§  Advance Technology for smooth operation

§  Awareness and information dissemination

§  Maintain short term interest rate/monetary policy stability

Impact of CBDC on existing payment channels and payment system

§ Improved technical challenges such as high latency rate of transmission.

§  Cross-border payment mechanism will improve

§  CBDC along with UPI increase the financial inclusion

§  Concept of E-RUPI was inaugurated by PM Last year, in a research study it was observed that E-RUPI along with CBDC can have the social benefits like coupon-based approach of direct benefit transfer.[3]

§  Other payment channels would see the impact after the CBDCs’ complexity to users. In most of the cases it is observed that some countries like China fail to address the digital currency at large scale while on the other hand in Russia it is a big success after the Ukraine Russia war.

§  CBDC helps to improve the bilateral payment among countries, just like UPI did in oil purchasing by the Swap model of UPI with Russia.

Conclusion

Although CBDC has a long list of benefits along with challenges, it shows potential and evolutionary steps towards a financially stable and inclusive system. India is in its final phase to start the pilot projects with some particular financial institutions. Digital currency would not just benefit the economy but society as a whole for India.


Written By, Mr. Nishant Kumar Upadhyay at Critical Analyst blog platform
For any further opinion, information or query please contact on nishantupadhyay64@gmail.com  

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