India’s CBDC (e₹) will be a digital currency for payments rather than an asset with similar attributes and functionality as physical cash, like giving interests.
The Reserve Bank of India (RBI) on October 7 released a detailed concept note about India’s Central Bank Digital Currency (CBDC), a digital form of currency notes, to create public awareness about the technology and how it may work in the Indian context.
While most global central banks are exploring CBDCs, their issuance would be specific to each country’s needs. Thus, RBI’s concept note explains the objectives, benefits, and risks of issuing a CBDC in India.
CBDC is expected to provide an additional option to the existing forms of money besides transactional benefits of other forms of digital currency. The digital Rupee would offer ease of transaction similar to the paper currency.
The concept note also explores the implications of CBDC on the banking system, monetary policy, financial stability, privacy issues, etc. The RBI plans to launch a trial phase soon of CBDC or the Digital Rupee (e₹) to evaluate its efficacy accurately.
The Indian version of CBDC is not a new currency but an electronic version of the sovereign currency, i.e., the Rupee.
However, CBDC records may either be maintained in a conventional centrally controlled database or distributed ledger technology (DLT) like blockchain that works both offline and online. The bank noted that offline CBDC connectivity is critical in the Indian context since out of 1.4 billion Indians, about 825 million people have access to the internet.
Rajashekara V. Maiya, VP and global head of business consulting, Infosys Finacle, the FinTech subsidiary of IT company Infosys, said, "The wholesale CBDCs will help the banks and the trusted institutions to deal in bilateral transactions and also facilitate innovations in trade, payments, remittances, etc., whereas the retail CBDCs will act as the cash available in digital form for them to use in retail payment systems such as UPI."
The RBI, however, wants a smoother implementation of CBDC while ensuring it does not become a disruptive technology. “One of the main considerations is that the design features of CBDCs should be least disruptive,” said the RBI in the concept paper.
Karunya Sampath, co-founder and CEO, Payoda Technologies, a Texas (US) based IT company, said, "In the fast-changing world more transactions are processed online and less paper money is used. To adhere with the trend, governments all around the world are working towards digital fiat money. Central Bank Digital Currency (CBDC) is a new form of fiat money issued digitally by a central bank and served as a legal tender. CBDC is significantly different from cryptocurrencies. However, blockchain technology will be a front runner for CBDC as it can provide decentralization, traceability, immutability, anonymity, transparency and security."
The primary considerations for CBDC include the following:
· Type of CBDC to be issued (wholesale CBDC / retail CBDC)
· Models for issuance and management of CBDCs (direct, indirect, or hybrid)
· Form of CBDC (token-based or account-based)
· Instrument Design (remunerated or non-remunerated)
· Degree of anonymity
RBI wants the CBDC to be a payment instrument rather than an asset that bears an interest while acknowledging that interest payment would make CBDCs attractive. It noted that it could move the CBDC’s purpose from cash to a deposit like CBDC, which can impact a bank’s deposit-taking ability, thereby impacting their credit-creation ability.
Therefore, the Indian CBDC would be a non-interest-bearing instrument.
“Designing a CBDC that moves away from cash-like attributes to a “deposit-like” CBDC may have a potential for disintermediation in the financial system, resulting from loss of deposits by banks, impeding their credit-creation capacity in the economy,” said the RBI.
“Also, considering that physical cash does not carry any interest, it would be more logical to offer non-interest bearing CBDCs,” it further added.
Banks create credit in the economy by using their deposit and lending powers. For example, suppose you deposit Rs 1,00,000 in Bank A, and the cash reserve ratio (CRR) is 10 per cent. So the Bank A can use Rs 90,000 (Rs 1,00,000-10 per cent of 1,00,000) to give out loans. But since you have deposited Rs 1,00,000, you can claim that amount back from Bank A at any moment.
Now the borrower who took Rs 90,000 loan from Bank A goes and deposits it with Bank B, which will set aside 10 per cent (CRR is 10 per cent, so Rs 90,000*10 per cent) and lend Rs 81000 to another person. The process continues till the CRR percentage is equal to the deposited money.
Harish Prasad, MD, Banking Solutions, India, FIS Inc (Fidelity National Information Services), a US-based company, "RBI has put forth a considered view in preferring a non-renumerative type of CBDC, given the risk that a renumerative model poses of weaning away funds from the Banking system into CBDCs apart from other undesirable impacts. Given that the primary role of the proposed CBDC is to displace physical currency, and that physical currency does not offer any return in the form of interest to the holder of the currency, a CBDC could just mimic the physical currency in this regard, and this approach seems most sensible given the lack of any real-world experiences at scale around the introduction of renumerative CBDCs globally."
RBI said the issuance and management of CBDC will have two broad models: direct (single-tier) and indirect (two-tier).
· Direct (Single Tier): In the direct model, RBI would manage all aspects of the CBDC system, including account keeping, transaction verification, issuance, etc.
· Indirect (Two-Tier): In the indirect model, the central bank issues CBDC to consumers indirectly through banks and other service providers (intermediaries). The intermediary will handle consumer-related claims, and RBI will only handle wholesale payments to intermediaries.
The present Indian currency works on the indirect model, wherein the RBI issues the currency, but banks manage the distribution and other processes like KYC, anti-money laundering, transaction verification, etc.
The RBI has proposed two structures for CBDC: token-based and account-based. The central bank said it prefers a token-based version of CBDC suitable for retail, while an account-based version is preferred for wholesale.
"It is important to secure such usage at the retail level hence tokenization is planned to make sure that there are no duplicate payments, fraudulent payments. Whereas for the wholesale CBDCs, the account-based settlement works as seamlessly as it works between the central bank and other trusted institutions as it is today," Rajashekara V. Maiya Of Infosys Finacle further added.
The existing Indian banknotes currently work on the token system, meaning whoever holds the currency (token) would be presumed to own them.
In an account-based CBDC system, the RBI said it would require record maintenance of balances and transactions of CBDC holders, indicating ownership of the monetary balances.
The RBI has highlighted the difference between both systems, explaining which system is suitable for which customer. The RBI said that in a token-based CBDC format, the person who receives the token would verify its genuineness. In an account-based CBDC, the intermediary will verify the account holder’s identity.
Currently, physical cash works on the token system, and the person receiving it has to verify the authenticity of the banknote using measures like symbols, watermarks, etc.