ECONOMY

Central Bank Digital Currency: RBI Working Towards Phased Implementation Strategy

The Reserve Bank of India may conduct pilot projects for retail and wholesale central bank digital currencies in the near future, Deputy Governor T Rabi Sankar said on Thursday.

The comments mark the clearest indication yet that the Indian central bank is studying and hoping to move towards the introductions of CBDCs, even though a number of complex issues remain to be unbundled.

“RBI is currently working towards a phased implementation strategy and examining use cases which could be implemented with little or no disruption,” Sankar said in a speech hosted by the Vidhi Center of Legal Policy.

Ahead of that the central bank is examining a number of key issues.

These include:

  • The scope of CBDCs—whether they should be used in retail payments or also in wholesale payments.

  • The underlying technology—whether it should be a distributed ledger or a centralised ledger.

  • The validation mechanism—whether token based or account based.

  • The distribution architecture—whether direct issuance by the RBI or through banks.

  • The degree of anonymity.

  • Changes in legislation needed to ensure that a CBDC can be issued by the RBI.

Sankar, in his speech, said the use case for CBDCs in emerging markets is clear.

“CBDCs are desirable not just for the benefits they create in payments systems, but also might be necessary to protect the general public in an environment of volatile private virtual currencies,” he said.

According to Sankar, there are clear advantages of CBDCs over other digital payments systems. For one, payments using CBDCs are final and reduce settlement risk. “Imagine a UPI system where CBDC is transacted instead of bank balances, as if cash is handed over—the need for interbank settlement disappears.”

CBDCs could also enable more real-time and cost-effective payments across borders.

In addition, in a country like India, where the currency-to-GDP ratio is high, CBDCs can potentially help replace cash usage and reduce the cost of printing, transporting, storing and distributing currency, Sankar argued.

He said CBDCs may also become necessary due to the advent of private virtual currencies.

While, in theory, CBDCs offer many benefits, central banks globally are debating a number of design dilemmas.

The RBI’s no different.

Key among these questions is the disruption that banks may face.

“CBDCs, depending on the extent of its use, can cause a reduction in the transaction demand for bank deposits,” Sankar said. “In addition, by providing a genuinely risk-free alternative to bank deposits, they could cause a shift away from bank deposits which in turn might reduce the need for government guarantees on deposits.”

However, would this, in turn, hurt the ability of banks to give out credit? “Since central banks cannot provide credit to the private sector, the impact on the role of bank credit needs to be well understood,” Sankar said.

CBDCs could also come with the risk of a quicker flight of deposits, should these units be routed via banks. It could also have the reverse impact.

CBDC could also have a bearing on monetary policy. “If there’s overwhelming demand for CBDC, and CBDCs are issued largely through the banking system, as is likely, more liquidity may need to be injected to offset the currency leakage from the banking system,” said Sankar.

Technology and the level of anonymity associated with these units are issued are other issues being pondered by central banks over the world.

Still, Sankar suggested that the time for introducing a CBDC is getting closer.

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