RBI examining use-cases to implement digital currency

Crypto and other private virtual currencies (VC) have fast become buzzwords around the world. Their proliferation is a matter of concern for central banks around the world.

In that backdrop, T Rabi Sankar, Deputy Governor of the Reserve Bank of India (RBI), said a central bank digital currencies (CBDC) can have benefits for payments systems in India, and might be necessary to protect the general public in an environment of volatile private VC.

"A CBDC is the same as a fiat currency and is exchangeable one-to-one with the fiat currency. Only its form is different," Sankar said, during a webinar organised by the Vidhi Centre for Legal Policy on Thursday.

While interest in CBDCs is universal, very few countries have reached the pilot stage of launching CBDCs, he noted.

According to a 2021 Bank for International Settlements (BIS) survey of central banks, while 86 percent of the central banks polled were actively researching the potential for CBDC, and 60 percent were experimenting with the technology, only 14 percent were deploying pilot projects.

Why this sudden interest?

The adoption of CBDC has been justified for multiple reasons, Shankar said. One, central banks, faced with dwindling usage of paper currency, seek to popularise a more acceptable electronic form of currency (like Sweden). Two, jurisdictions with significant physical cash usage seek to make issuance more efficient (like Denmark, Germany, Japan, or even the United States of America).

And three, central banks seek to meet the public’s need for digital currencies, manifested in the increasing use of private virtual currencies, and thereby avoid any damaging consequences of private virtual currencies.

As central banks are engaged in exploring CBDC, and a few countries have introduced proofs of concept or pilots on CBDC, the question is where does India stand in the official digital currency race?

Shankar said that the Ministry of Finance had constituted a high-level inter-ministerial committee as early as November 2017 to examine the “policy and legal framework for regulation of virtual / crypto currencies”.

It had recommended the introduction of CBDCs as a digital form of fiat money in India. “Like other central banks, the RBI has also been exploring the pros and cons of introduction of CBDC for quite some time,” Sankar said.

Some countries have implemented specific purpose CBDCs in the wholesale and retail segments. Going forward, the RBI will evaluate the launch of general purpose CBDCs after studying the impact of these models, he said.

“The RBI is working towards a phased implementation strategy, and examining use cases which could be implemented with little or no disruption,” Sankar said.

The RBI is already examining five key issues around CBDCs. The first is the scope of CBDCs: if they should be used in retail payments or also in wholesale payments.

Second, the underlying technology: should CBDC be a distributed ledger or a centralised ledger, for instance? Further, if and how the choice of technology should vary based on use cases.

The third key issue Sankar cited was the validation mechanism: should the CBDC be token based or account based? Fourth, the CBDC's distribution architecture: should it be directly issued by the RBI, or through banks? And finally, the degree of anonymity among others.

“Conducting pilots in wholesale and retail segments may be a possibility in near future,” Sankar said.

Advantages of CBDC

Sankar also highlighted advantages of CBDC over other digital payments systems. Payments using CBDCs are final, and thus 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,” Sankar explained.

Further, CBDCs would also potentially enable a more real-time and cost-effective globalisation of payment systems. For instance, it is conceivable for an Indian importer to pay its American exporter on a real time basis in digital dollars, without the need of an intermediary.

“This transaction would be final, as if cash dollars are handed over, and would not even require that the US Federal Reserve system is open for settlement,” said Sankar. “Time zone difference would no longer matter in currency settlements,” he added.

Also, India’s high currency to GDP ratio holds out another benefit of CBDCs. “To the extent large cash usage can be replaced by CBDCs, the cost of printing, transporting, storing and distributing currency can be reduced,” Sankar said.

The introduction of CBDC would possibly lead to a more robust, efficient, trusted, regulated and legal tender-based payments option. While there are associated risks, they need to be carefully evaluated against the potential benefits, Sankar said.

Going forward, CBDCs are likely to be in the arsenal of every central bank. However, Sankar highlighted that setting this up will require careful calibration and a nuanced approach in implementation.

Also, drawing board considerations and stakeholder consultations are important, while technological challenges have their place as well. “As is said, every idea will have to wait for its time. Perhaps the time for CBDCs is nigh,” Sankar concluded.