Speaking at a webinar, the RBI deputy governor examined key issues related to bank-backed digital currencies and spoke about why they were important given the advent of cryptocurrencies.
The Reserve Bank of India is working towards a “phased implementation strategy” for the introduction of central bank-backed digital currency (CBDC), Digital Rupee, and examining use cases to ensure that its execution does not cause any disruption. Unlike cryptocurrency or private virtual currency (PVC) which is issued by private entities, a CBDC (same as a fiat currency) is issued by a country’s central bank, and is backed by assets such as government securities. It is also exchangeable one-to-one with the fiat currency.
Why does this matter: On January 29, according to an official Lok Sabha Bulletin, the Indian government had proposed to introduce a new bill to ban trading and investments in cryptocurrencies, which would at the same time, provide the RBI with necessary legal powers to develop a CBDC. Although the said bill has not been introduced yet, despite rumours that it may be brought in during the ongoing Monsoon Session, the RBI has time and again made its case for CBDC against cryptocurrency or private virtual currency.
RBI deputy governor T Rabi Sankar who was speaking at a webinar organised by the Vidhi Centre for Legal Policy said that the central bank is currently examining some key issues in regards to its implementation. They are —
- Whether bank-backed digital currencies should be used in retail payments or in wholesale payments
- Determining whether the technology should be a distributed ledger or a centralised ledger, or whether the technology should be based on use cases
- Whether validation mechanism can be token based or account based
- Whether the CBDC will be distributed by the RBI or through banks
- Conducting pilots in wholesale and retail segments may be a possibility in near future.
Introduction of CBDC has the potential to provide significant benefits, such as reduced dependency on cash, higher seigniorage due to lower transaction costs, reduced settlement risk. Introduction of CBDC would possibly lead to a more robust, efficient, trusted, regulated and legal tender-based payments option – T Rabi Sankar, deputy governor, Reserve Bank of India
These are the points that Sankar made during his speech regarding CBDC —
Why there is a need for CBDCs, according to RBI
Sankar gave the following reasons for justification for the adoption of CBDC —
- Central banks faced with dwindling usage of paper currency are seeking to promote “acceptable electronic form of currency” (like Sweden)
- “Jurisdictions with significant physical cash usage seeking to make issuance more efficient (like Denmark, Germany, or Japan or even the US)”
- Sankar said that central banks are seeking to meet the public’s need for digital currencies, which has manifested in the increasing use of private virtual currencies, and thereby avoid the more damaging consequences of such private currencies.
Advantage over other digital payments systems: Sankar said that payments made through CBDC will be final in nature and thus, would reduce settlement risk in the financial system. “Imagine a UPI system where CBDC is transacted instead of bank balances, as if cash is handed over – the need for interbank settlement disappears. CBDCs would also potentially enable a more real-time and cost-effective globalization of payment systems,” he said.
CBDCs necessary in India because of advent of private virtual currencies (cryptocurrencies) – Sankar said that developing India’s own CBDC can provide citizens with uses that any private VC can provide and which would help in retaining public preference for the Rupee. “It could also protect the public from the abnormal level of volatility some of these VCs experience,” he said.
CBDCS can reduce transaction demand for bank deposits: Sankar said that since transactions in CBDCs reduce settlement risk as well, they reduce the liquidity needs for settlement of transactions (such as intra-day liquidity). In addition, by providing a genuinely risk-free alternative to bank deposits, they could cause a shift away from bank deposits which in turn might reduce the need for government guarantees on deposits, he added.
Legal framework needed for CBDCs
Sankar said although CBDCs are conceptually no different from banknotes, the introduction of a CBDC would require a legal framework since the current provisions are made keeping in mind currency that is available in paper form.
He said, “There is a need to examine consequential amendments to other Acts like The Coinage Act, 2011, FEMA, 1999, Information Technology Act, 2000 etc. Even though CBDCs will be a primarily technology driven product, it will be desirable to keep the legislation technology neutral to enable coverage of a variety of technology choices.”
Types of CBDCs
A CBDC can take many forms. It can be issued on a blockchain ledger like regular crypto-currencies, or through a demat account or a specific payments instrument. There can be retail CBDCs, which would be accessible to all types of consumers, or wholesale CBDCs that are meant only for institutions. There are three models of issuing CBDCs:
- Direct: Issued by a central bank to banks and then to consumers; the claim on CBDC payments is on the central bank
- Indirect: Wherein digital currencies are issued by banks to customer; the claim on CBDC payments is on the bank or market players
- Hybrid: Market players on-board customers and issue CBDCs; the claim on payments is on the central bank
CBDCs can also be interest-bearing or non-interest bearing:
- Interest-bearing: For every Rs 100 in digital currencies, the wallet holder will receive some interest rate directly from the central bank. This helps the central bank directly affect people’s consumption expenditure in the fight against inflation. If inflation rises to 6%, the RBI can provide specific sets of customers with a 8% interest rate directly into their accounts without any bank intermediation. As inflation reduces, the RBI can reduce the interest rate.
- Non-interest-bearing: The value of the CBDC is pegged to the fiat currency. Just like money sitting in a bank deposit depreciates due to inflation, the value of a non-interest bearing CBDC depreciates due to inflation.