Central Bank Digital Currency

In Context

The Reserve Bank of India (RBI) is in the process of implementing the Central Bank Digital Currency (CBDC) in a phased manner for wholesale and retail segments.

Status of Central Bank Digital Currency in India

The introduction of CBDC was announced in the Union Budget 2022-23.
Amendments have also been made to the relevant section of the RBI Act, 1934 with the passage of the Finance Bill 2022.
- The passage of the bill has enabled the RBI to conduct a pilot and subsequent issuance of CBDC.

About Central Bank Digital Currency

It is a legal tender and a central bank liability in digital form denominated in a sovereign currency and appearing on the central bank’s balance sheet.
It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different.
It can be converted or exchanged at par with similarly denominated cash and traditional central bank deposits.
It can be transacted using wallets backed by the blockchain and is regulated by the central bank.
CBDCs enables the user to conduct both domestic and cross-border transactions which do not require a third party or a bank.
CBDC and Private virtual currencies or Cryptocurrency:
- The CBDC will be a sovereign-backed digital currency.
- CBDC is a digital or virtual currency but it is not comparable to the private virtual currencies or cryptocurrencies that have mushroomed over the last decade.
- Private virtual currencies do not represent any person’s debt or liabilities as there is no issuer.

Benefits

Efficiency of transactions:
- It would reduce the cost of currency management while enabling real-time payments without any inter-bank settlement.
- Foreign trade transactions could be speeded up between countries adopting a CBDC.
  - The risks of dollar-rupee transactions, the time zone difference in such transactions would virtually disappear.
Reduction in high cash usage:
- India’s fairly high currency-to-GDP ratio holds out another benefit of CBDC as to the extent large cash usage can be replaced by CBDC.
Cost effectiveness:
- The cost of printing, transporting and storing paper currency can be substantially reduced.
- They could enable a cheaper and more real-time globalisation of payment systems.
- It is conceivable for an Indian exporter to be paid on a real-time basis without any intermediary.
Efficiency in the banking system:
- The adoption of CBDCs can also have important implications for the banking system.
- CBDCs can cause a reduction in the transaction demand for bank deposits and will reduce the intra-day liquidity for the settlement of transactions.
  - They could also cause a shift away from bank deposits.

The Global position of Central Bank Digital Currencies (CBDCs)

Global interest in central bank digital currencies (CBDCs) is on the rise, with 80% of all central banks investigating their issuance and half having progressed past research to running pilots.
Countries that do not have a digital fast payment system see CBDCs as a way to promote digital payments, forcing central banks to catalyse digital innovation where fintechs and banks have failed.
In countries where public holdings of cash are rapidly declining, CBDCs are being seen as an alternative to cash.
Developing countries see CBDCs as a way to bank the unbanked.
- Since CBDCs are issued directly by the central bank, they can, unlike other digital money, be used by citizens who don’t have bank accounts.
- This is even relevant in countries like India where, despite a sharp increase in new bank accounts, 20% still don’t have one.

Criticisms

The global countries looking towards implementing CBDCs either do not have a digital fast payment system or fintech companies are outside the regulatory rails of the central bank.
- India already has a fast payments system that performs well at scale and we do not need to issue a CBDC just to obtain those benefits.
- The Unified Payments Interface (UPI) was built by and under the supervision of the Indian banking sector regulator.
- We don’t need to issue a CBDC to regain control—we never lost it in the first place.
Today, 80% of adult Indians have bank accounts.
- Before we think of issuing a CBDC to those who don’t, we need to ensure that those with bank accounts are actually using them.
- Of the 500 million bank accounts in the country, no more than 35% are active.
- This means that despite its success, UPI still has to cover 65% of its addressable market.
- According to critics, rather than rolling out a new digital currency to cover those outside the banking system, it would be better to use our resources to get those who have bank accounts to use them more actively.

Issues in Implementation

Potential of weakening the banking system:
- The fear is that in the absence of the right policy framework, CBDCs could potentially weaken the banking system in the long run by denying them access to deposits and revenue.
Cyber Security:
- CBDCs may also pose a threat from a cyber-security perspective.
Financial inclusion and literacy:
- Further, in nations with low financial literacy, the dependence on a digital form of payment may substantially lead to an increase in fraud and financial crimes.
Internet Connections:
- Furthermore, for an economy to depend on a virtual currency, it would require deeper penetration of high-speed Internet and telecommunication services.

Way Ahead

The introduction of CBDC has the potential to provide significant benefits such as reduced dependency on cash, higher seigniorage due to lower transaction costs, and reduced settlement risk.
It would possibly lead to a more robust, efficient, trusted, regulated and legal tender-based payments option.
There are associated risks, no doubt, but they need to be carefully evaluated against the potential benefits.
It would be the RBI’s endeavour, as we move forward in the direction of India’s CBDC, to take the necessary steps which would reiterate the leadership position of India in payment systems.

Source: TH

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