The buzzword of the day is ‘CBDC’ or Central Bank Digital Currency (e-rupee) as indicated by the Reserve Bank of India (RBI) in a recent concept paper.
By S Ganesh Kumar
The buzzword of the day is ‘CBDC’ or Central Bank Digital Currency (e-rupee) as indicated by the Reserve Bank of India (RBI) in a recent concept paper. No innovation in the world of today can have a more far-reaching impact than that of the CBDC.
Let’s visualise a future scenario:
Sundar is a young professional working in a reputed company in India. Like all millennial adults, he prefers a ‘just-in-time’ lifestyle, aided substantially with technology tools and gizmos which make his requirements all inter-twined and meet the aspirations of a highly innovative generation of motivated young adults (Can we coin the term ‘HINGED’ to – HIghly INnovative GEneration of motivatED adults — to refer to this sub-set of the Indian population?) who want the best, using most convenient methods of usage and at any time and anywhere.
He has been asked by his boss to go over to his head office and make a presentation on a novel idea which he feels has the potential to change the way his company is offering its products to customers. It is already 6 pm and the time for the presentation — in a different city — is to take place at 9 am the following day.
The presentation is the easiest aspect. Making arrangements for his travel and stay are considerations which he has to now take care of. The flights are all booked and only business class seats are available — his boss will readily authorise this, but where will he go for the increased amount? He is used to only keeping small balances in his wallet and he may resort to the internet for planning his travel programme. He surfs his all-pervasive mobile app to get the best-suited flight for the late evening (or is it early night!) which also has an offer of a chauffeur-driven car from and to the airport at both the origination and destination locations at an unbelievably low rate. He could use his card for the transaction or settle the amount with the travel site using net banking.
Enter the e-rupee, and Sundar can request for, say, 20,000 units of this from his banker for his use. He has already been enrolled in this facility and when he concludes the booking, the sub-app for CBDC seeks his distribution plan for the 20,000 units. All Sundar has to do is indicate 18,000 units for the airline (for his travel ticket), 1,500 units to the limousine service company and 50 units as service charges to the app service provider (he would get this refunded later). He has some balance and indicates that he would like to tip 150 units to the taxi driver and have the balance 300 units for his personal use in the airport or on the way. All these transactions have not only been concluded, but the settlement has also happened in real-time because it is the e-rupee which has been used and each of the beneficiaries of this transaction is certain that the money has been received by them. Sounds similar to a current transaction cycle using digital means? Not quite
CBDC: The New Paradigm
Traditionally, the paper currency issued by the Reserve Bank of India is its liability when it is distributed by a bank to its customer for her/his use. This principle will continue with CBDC as well, but with differences. Differences in the accounting modes; differences in the manner of movement and settlement; differences in the time taken for money movement and, therefore, in the velocity of money in circulation; differences in the levels of security of CBDC vis-a-vis paper currency and above all differences in settlement of commercial transactions and liabilities of citizens of the country, making them easy, convenient, comfortable, safe and secure for the common man of the country.
Traditionally, the paper currency issued by the RBI is its liability when it is distributed by a bank to its customer for their use. This principle will continue with the CBDC as well, but with differences
What will change for the common man? One could hazard a safe guess that not much will change. It can be expected that CBDC usage will be largely similar to the use of today’s digital payment systems. The Reserve Bank is leaving no stone unturned to make it simple, easy to use and available across the country (offline will complement online transactions). What will, however, change is the form factor (everyone knows this), and the potential to change the payment systems scenario (now what is this?).
CBDC: Perspectives
In theory, CBDC will almost be akin to paper currency. Almost because some features may change marginally. There is a great deal of concern about anonymity which is a hallmark of paper currency. It is almost virtually impossible to track the movement of any specific currency note and this feature makes paper currency versatile in usage. Since CBDC is an electronic ledger unit, it can be tracked, just like all computer-based iterations are trackable and monitorable. It may be mentioned that it is possible to completely hide, or blank out the transaction trackability; this capability will provide anonymity for CBDC transactions as well. This may not be, however, across the board. Most transactions — such as those relating to trade and commerce and even relating to personal transactions may need to be having an audit trail. So what can be the optimal approach? Let the user decide, but within commonly accepted and customer-friendly frameworks which the RBI is well poised to make. This will make it more acceptable, provide confidence to the user and will be easy to implement as well.
Over 100 countries are exploring CBDCs. Ten have already launched their own digital currency, including Nigeria and Jamaica. The Bahamas in the West Indies was the first country in the world to roll out a national CBDC, called the Sand Dollar, in October 2020. China is due to launch a CBDC in 2023. Nineteen countries in the G20 – which represents the world’s largest economies – are exploring CBDC. The US and UK too are researching CBDC. Swedish, Norwegian and Israeli central banks launched a project with the Bank for International Settlements in September to test international retail and remittance payment with CBDC – WEF
CBDC and Banking
World over, banks facilitate the distribution of paper currency and also act as pillars of the central bank for achieving monetary policy objectives. It will be rather easy to replicate this model for CBDC, with certain changes in the treatment of CBDC when
* held on behalf of the central bank
* issued to the bank’s customer
* Received back from the constituent and
* held as deposits/investments, etc
There will be changes in the manner of reckoning interest for certain holdings of CBDC by banks. Since the units of CBDC are ledger entries, there will be more inter-relationships across different banks; between banks and the RBI; as also between banks and their constituents. Banking, therefore, is poised for changes once CBDC proliferates, with the basic definition of banking not changing but the way banking will be done will be more aligned with the customer and CBDC movements taking a centre stage.
It will be also a good idea that the broad contours of CBDC are laid down by the RBI with adequate legal backing and technology support micro details, and be all containerised so that when there is a change in one container the main system continues to operate with little or no disruption
CBDC and Central Banks
Monetary policy management will get a fillip with CBDC providing for a very quick and almost real-time impact on measures to be taken by the central bank. There will also be a definitive change in cross-border fund movements which are currently not very efficient. CBDCs of different countries can be settled using common IT systems, following established foreign exchange-related covenants and in a decentralised manner and across varying time zones, all of which will greatly reduce the current risks.
Personal remittances of individuals will also get a fillip once CBDC-based transfers occur — both in terms of quick turnaround time and in reduced costs and, more importantly, addressing credit, liquidity and settlement risks. The positive impact on trade-related funds flows can also be witnessed once many countries adopt CBDCs. Central banks will have to enhance their IT systems, provide for adequate redundancy so that CBDCs are available to all citizens anywhere in the country and at any point in time. A point which could be considered in this process is to have a system which is not a big drain on resources such as electric power and is climatically homogenous with the environment.
Personal remittances of individuals will also get a fillip once CBDC-based transfers occur — both in terms of quick turn-around-time and in reduced costs and, more importantly, addressing credit, liquidity and settlement risks
The central bank will also have to keep a hawk’s eye on cyber and information security-related aspects since even a small incident can have a negative impact on the safety-related perception of CBDC apart from possible financial loss; the systems will have to be ahead of the curve in this crucial area for which a good deal of R&D will have to be undertaken in line with changing technologies. This is not much different from the world of paper currency where too central banks will have to be always ahead of fraudsters and forged note suppliers.
The overall costs incurred in currency note printing, distribution and destruction will, in the long run, witness a downward trend with technology and the process being the key differentiators. There may also be a need to provide adequate legal frameworks for an entire system centred around CBDC; many existing Acts may have to be modified; some even completely replaced, all of which will take some time for being accomplished.
CBDC and Financial Inclusion
Perhaps the one area which will benefit immensely from the introduction of CBDC is financial inclusion. Technology has already made Know-Your-Customer (KYC) available easily for a large section of the population. CBDC will require a new form of KYC which is ‘Know Your Citizen’, based on which movement of CBDC from one person to another becomes relatively easier than at present.
There will be multiple means of identifying a citizen with the attendant uniqueness which will make it easy for including almost the entire population under the realm of financial service coverage. Direct benefit transfers, salary payments, fees, rents and tax payments… the list will be endless where CBDC can replace the paper currency. The RBI has already embarked on ambitious offline payment systems and these will aid substantially in CBDC also being made available using similar approaches.
CBDC will require a new form of KYC which is ‘Know Your Citizen’, based on which movement of CBDC from one person to another becomes relatively easier than at present
Implementation Perspectives
Any large-scale innovative system which is being implemented for the first time for a large population is bound to be based on a phased approach; a ‘tried and found fail proof’ mode and above all, subject to changes depending on feedback in the initial stages. It can thus be expected, that there will be pilot projects in the initial phase, to be followed by a small number of large value systems being migrated to CBDC (government transfers, corporate fund movements and the like). While retail common citizen-centric CBDC systems will also get parallelly tested, the large-scale rollout will be based on a careful assessment of the effectiveness and efficiency of the systems rolled out in the first phase.
A rollout of such a new system will require harmonious interaction not only among the financial sector players but also across the nation as a whole with a multi-pronged approach, including the extension of CBDC literacy, roping in first mover-based followers and the young population, and above all, getting on board most technology and fintech players. It will be also a good idea that the broad contours of CBDC are laid down by the central bank with adequate legal backing and technology support; micro details on processes, flows, actual technologies used etc, be all containerised, so that when there is a change in one container, that alone has to be changed and the main system continues to operate with little or no disruption at all. CBDC will also witness a paradigm shift in anti-money-laundering, manner of policing and/or investigating financial frauds, and if the design considerations for these are made appropriately, the country will stand to gain.
So, what does Sundar do after he has booked his flight ticket? He sits back, relaxed that his transaction flow is safe and concentrates on his presentation. The airline uses the money received to pay for its supplier almost immediately; his taxi driver is happy that he has got his tip even before the trip so he decides that he will be at the airport well on time since he knows that a bad service from his side can result in the tip being recalled; the entire process has been ‘straight-through’ with more alignment with the environment, there is a positive impact on the money-multiplier which aids economic growth and the RBI can show to the rest of the world yet another pioneering payment system initiative — the size and likes of which is unparalleled. Let’s welcome the e-rupee…
(The author is former Executive Director of the Reserve Bank of India)