New e₹ - Money changing form to digital! What does it mean for all?

The Reserve Bank of India (RBI), in its concept paper, revealed plans to commence a pilot launch of e-currency for specific use cases.

RBI broadly defines CBDC as the legal tender issued by a central bank in a digital form. Central Bank Digital Currency (CBDC) would differ from existing digital money available to the public as it would be a liability of the RBI and not of a commercial bank.

The CBDC can be classified into general purpose or retail (CBDC-R) and wholesale (CBDC-W). The digital rupee (e|) will aid in further boosting the digital economy, make the monetary and payment systems more efficient and contribute to financial inclusion.

• Retail CBDC can provide access to safe money for payment and settlement as it is a direct liability of the central bank
• Wholesale CBDC has the potential to transform the settlement systems for financial transactions and make them more efficient and secure

CBDC can be structured as ‘token-based’ or ‘account-based’.

• A token-based CBDC is a bearer instrument like banknotes, which means whosoever holds the tokens at a given point in time would be presumed to own them
• In contrast, an account-based system would require maintenance of record of balances and transactions of all holders of CBDC and indicate the ownership of the monetary balances

There are two models for issuance and management of CBDCs i.e.

Direct model (single tier model) and indirect model (two-tier model). A direct model would be the one where the central bank is responsible for managing all aspects of the CBDC system viz. issuance, account-keeping and transaction verification.

In an indirect model, central bank and other intermediaries (banks and any other service providers), each play their respective role.

What benefits can it entail?

CBDC can help reduce the cost associated with physical cash management and expenditure incurred on printing, to some extent The total expenditure incurred on security printing in FY22 was | 4,984 crore vs. | 4,012 crore in FY21. Various media publications mentioned RBI and banks together may be spending | 22000 crore in physical cash management. There can be much more cost to government, bankers, RBI, general public, which is not quantified though.

Being a sovereign currency, CBDC will ensure settlement and, thus, reduces settlement risk in the financial system. In addition, it could also potentially enable a more real-time, cost-effective seamless integration of cross border payment systems.

It is fully guaranteed by the central bank with no risk of losing its face value and easily stored in large amounts.

Challenges to address?

CBDC does not alter the basic mechanics of monetary policy; Rather, it has the potential to enable timely transmission of monetary policy. The implications of CBDC for monetary policy essentially depends on the way it is designed and its degree of usage. In particular, it would depend on the following policy decisions:

• whether CBDC will be non-remunerated or remunerated - meaning interest will be paid or not on holdings

• whether it would be widely accessible just like physical currency, or limited to wholesale customers such as banks (as in the case of central bank reserves); and

• whether it will be anonymous like physical currency or ownership will be identifiable, which leaves the trail of different entries.

If CBDC could function like physical cash and fetch no interest income, in normal times, economic agents would prefer to keep their money in interest bearing bank deposits as opposed to CBDC. However, in the tail-risk event of economic instability or a system-wide bank run, CBDC could be viewed as a safer substitute of bank deposits. It is fully guaranteed by the central bank with no risk of losing its face value and easily stored in large amounts.

The recent innovations in technology-based payments solutions have led central banks around the globe to explore the potential benefits of issuing a central bank digital currency (CBDC). China has launched on a pilot basis in 2020 while 60 central banks have expressed interest in CBDCs and few of them are implementing on a pilot basis. During the FY23 Union Budget, Government of India had announced plans to launch the digital rupee.

It is similar to sovereign paper currency but in a different form, exchangeable at par with the existing currency and shall be accepted as a medium of payment, legal tender and a safe store of value. CBDCs would appear as liability on a central bank’s balance sheet and expected to minimise the cost of issuance of money and transactions.

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