Highlights of Concept Note on Central Bank Digital Currency

Reserve Bank of India (RBI) has released a Concept Note on Central Bank Digital Currency (CBDC) for India. Here are the highlights of the Concept Note.

What is Central Bank Digital Currency (CBDC)?

Reserve Bank of India (RBI) broadly defines Central Bank Digital Currency (CBDC) as the legal tender issued by a central bank in a digital form. 

What are the features of CBDC?

The features of CBDC include –

1. It is sovereign currency issued by Central Banks in alignment with their monetary policy.
2. It appears as a liability on the central bank’s balance sheet.
3. Must be accepted as a medium of payment, legal tender, and a safe store of value by all citizens, enterprises, and government agencies.
4. Freely convertible against commercial bank money and cash.
5. Fungible legal tender for which holders need not have a bank account.

What are motivations for issuance of CBDC in India?

The key motivations for exploring the issuance of CBDC in India among others include –

1. Reduction in operational costs involved in physical cash management.
2. To further the cause of digitisation to achieve a less cash economy. 
3. Fostering financial inclusion. 
4. Bringing resilience, efficiency, and innovation in payments system.
5. Adding efficiency to the settlement system and reducing settlement risk.
6. Boosting innovation in cross-border payments space.
7. Providing public with uses that any private virtual currencies can provide, without the associated risks. 
8. Safeguarding the trust of the common man in the Indian Rupee vis-à-vis proliferation of crypto asset.

CBDC is aimed to complement, rather than replace, current forms of money and is envisaged to provide an additional payment avenue to users, not to replace the existing payment systems. 

What are the design choices for CBDC?

The key design choices to be considered for issuing CBDCs include –

1. Type of CBDC to be issued (Wholesale CBDC and / or Retail CBDC)
2. Models for issuance and management of CBDCs (Direct, Indirect or Hybrid model)
3. Form of CBDC (Token-based or Account-based)
4. Instrument Design (Remunerated or Non-remunerated) 
5. Degree of Anonymity

Type of CBDC to be issued 

Retail CBDC (CBDC-R)	Wholesale CBDC (CBDC-W)
It would be potentially available for use by all viz. private sector, non-financial consumers and businesses.	It is designed for restricted access to select financial institutions.
It is an electronic version of cash primarily meant for retail transactions.	It is intended for the settlement of interbank transfers and related wholesale transactions.
It is believed to provide access to safe money for payment and settlement as it is a direct liability of the Central Bank.	It has the potential to transform the settlement systems for financial transactions and make them more efficient and secure.

Going by the potential offered by each of them, there may be merit in introducing both CBDC-W and CBDC-R.

Model for issuance and management of CBDC

Direct model (Single Tier model)	Intermediate model (Two-Tier model)
	Indirect Model	Hybrid Model
The central bank is responsible for managing all aspects of the CBDC system viz. issuance, account-keeping and transaction verification.	The central bank issues CBDC to consumers indirectly through intermediaries (banks and any other service providers) and any claim by consumers is managed by the intermediary.	Intermediaries handle retail payments, but the CBDC is a direct claim on the central bank, which also keeps a central ledger of all transactions.

Considering the merits of different models, the Indirect system may be the most suitable architecture for introduction of CBDC in India.

Forms of CBDC

Token-based CBDC	Account-based CBDC
It is a bearer instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them.	It would require maintenance of record of balances and transactions of all holders of the CBDC and indicate the ownership of the monetary balances.
The person receiving a token will verify that his ownership of the token is genuine.	An intermediary verifies the identity of an account holder.
It is viewed as a preferred mode for CBDC-R as it would be closer to physical cash.	It may be considered for CBDC-W.

Technology choice

The infrastructure of CBDCs can be on a conventional centrally controlled database or on Distributed Ledger Technology. The technology considerations underlying the deployment of CBDC needs to be forward looking and must have strong cybersecurity, technical stability, resilience, and sound technical governance standards. While crystallising the design choices in the initial stages, the technological considerations may be kept flexible and open-ended to incorporate the changing needs based on the evolution of the technological aspects of CBDCs.

Instrument Design

The payment of (positive) interest would likely enhance the attractiveness of CBDCs that also serves as a store of value. But, 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. Also considering that physical cash does not carry any interest, it would be more logical to offer non-interest bearing CBDCs.

Degree of Anonymity

For CBDC to play the role as a medium of exchange, it needs to incorporate all the features that physical currency represents including anonymity, universality, and finality. Ensuring anonymity for a digital currency particularly represents a challenge, as all digital transactions would leave some trail. The degree of anonymity would be a key design decision for any CBDC. In this regard, reasonable anonymity for small value transactions akin to anonymity associated with physical cash may be a desirable option for CBDC-R.

Fixed Denomination vs minimum Value based CBDCs

A token based CBDC may be issued either with minimum value or fixed denominations akin to existing physical currency denominations. The usage of minimum value of token may result in higher volume and, thus, lead to increase in processing time and performance issues. The introduction of CBDC with fixed Denomination as in physical currencies is expected to induce wider acceptance and adoption of CBDC. Therefore, introduction of fixed denomination CBDC is presently considered as preferable taking into account the Indian scenario.

What are the implications of CBDC for 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 –

1. Whether CBDC will be non-remunerated or remunerated.
2. 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).
3. Whether it will be anonymous like physical currency or ownership will be identifiable, which leaves the trail of different entries.

What are Balance Sheet implications of CBDC?

CBDC would only have benefits if general public and businesses hold it and use it to make payments. This means they must switch some of their funds out of banknotes and commercial bank deposits into central bank money in the form of CBDC. The impact of a switch from deposits to CBDC on the balance sheets of RBI and commercial banks will be as follows –

Switching from cash to CBDC

Banknotes and CBDC are just two different types of central bank liability, so a switch from banknotes to CBDC affects the composition — but not the size — of household and central bank balance sheets. Although banks may facilitate this conversion from cash to CBDC, the process has no impact on the size of the banking sector’s balance sheet.

Switching from deposits to CBDC 

A shift from deposits into CBDC has the same impact on bank balance sheets as a withdrawal of banknotes from an ATM or bank branch, reducing both the assets and liabilities of the bank and shrinking the bank’s balance sheet. Such transfer changes the composition of the central bank liabilities as reserve liabilities decreases and CBDC liabilities increases but there is no immediate change in the size of the central bank’s balance sheet. A flow from deposits to CBDC may result in commercial banks as a whole holding fewer reserves. If they end up holding fewer reserves than they need to meet their own or supervisory liquidity risk measures, they may wish to acquire more reserves from the central bank. If the central bank chooses to meet this demand by issuing new reserves, then the central bank’s balance sheet will expand by the amount of newly issued reserves.

What step have been taken towards introduction of CBDC in India?

• In November 2017, a High Level Inter-ministerial committee was constituted under the chairmanship of the Secretary, Department of Economic Affairs (DEA), Ministry of Finance, Government of India (GoI) to examine the policy and legal framework for regulation of virtual / crypto currencies and recommend appropriate measures to address concerns arising from their use. The committee had recommended the introduction of CBDCs as a digital form of sovereign currency in India.
• RBI had set up an Internal Working Group (WG) in October 2020 to undertake a study on appropriate design / implementation architecture for introducing CBDCs in India. The WG submitted its report in February 2021 with recommendations for issuance of e₹ (Digital Rupee).
• Government of India announced the launch of the Digital Rupee — a Central Bank Digital Currency (CBDC) from FY 2022-23 onwards in the Union Budget placed in the Parliament on February 01, 2022. The broad objectives to be achieved by the introduction of CBDC using blockchain and other technologies as a ‘more efficient and cheaper currency management system’ were also laid down in the budget.
• The Government of India vide gazette notification dated March 30, 2022 notified the necessary amendments in the Reserve Bank of India Act, 1934, which enables running the pilot and subsequent issuance of CBDC.
• An internal high-level committee on CBDC under the chairmanship of Shri Ajay Kumar Choudhary, Executive Director, RBI was constituted in February 2022 by RBI to brainstorm and undertake an extensive study on various aspects of CBDC. Based on the deliberations in the Committee, RBI has released the Concept Note on CBDC. 

What amendments have been made to RBI Act, 1934 for issuance of CBDC?

Following clauses have been inserted in Reserve Bank of India Act, 1934 to enable issuance of CBDC by RBI –

• Section 2(aiv) – “bank note” means a bank note issued by the Bank, whether in physical or digital form, under section 22.
• Section 22A – Nothing contained in sections 24, 25, 27, 28 and 39 shall apply to the bank notes in digital form by the Bank.

What is the way forward for CBDC?

As per recommendations of the internal Working Group (WG) set up by RBI in October 2020, RBI is exploring the option of implementation of account-based CBDC in Wholesale segment and token-based CBDC in Retail segment vide a graded approach.

What is status of CBDC adoption by other countries?

• 10 countries have launched a CBDC, the first of which was the Bahamian Sand Dollar in 2020 and the latest was Jamaica’s JAM-DEX.
• BIS innovation hub project involving the central banks of China, Hong Kong, United Arab Emirates and Thailand collaborating on the Multiple Central Bank Digital Currency (mCBDC) Bridge Project. This project aims to develop an international settlement platform through which central banks can utilise CBDC for transactions by financial institutions. The mCBDC project would enable cross-border payments that can be done in real-time between the four jurisdictions 24X7, with the foreign exchange leg settled in real time.
• Project Dunbar brings together the Reserve Bank of Australia, Bank Negara Malaysia, Monetary Authority of Singapore, and South African Reserve Bank with the BIS Innovation Hub to test the use of CBDCs for international settlements.

References

Reserve Bank of India. (2022, October 07). 'Concept Note on Central Bank Digital Currency'. Retrieved from https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/CONCEPTNOTEACB531172E0B4DFC9A6E506C2C24FFB6.PDF

Reserve Bank of India. (2022, October 07). 'Issuance of Concept Note on Central Bank Digital Currency'. Retrieved from https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=54510

Reserve Bank of India. (2022, August 29). 'The Reserve Bank of India Act, 1934'. Retrieved from https://rbi.org.in/Scripts/OccasionalPublications.aspx?head=Reserve%20Bank%20of%20India%20Act

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