CENTRAL BANK DIGITAL CURRANCY – A NEW
NORMAL IN NEAR FUTURE.
A
central bank digital currency (CBDC) uses an electronic record or digital token
to represent the virtual form of a fiat currency
of a particular nation (or region). A CBDC is centralized; it is issued and
regulated by the competent monetary authority of the country. A central bank
digital currency (CBDC) utilizes technology to represent a country's official
currency in digital form. Unlike decentralized crypto currency projects like
Bitcoin, a CBDC would be centralized and regulated by a country's monetary
authority.
Except as currency notes, all other use
of paper in the modern financial system, be it as bonds, securities,
transactions, communications, correspondences or messaging – has now been
replaced by their corresponding digital and electronic versions. On anecdotal
evidence, use of physical cash in transactions too has been on the decline in
recent years, a trend further reinforced by the ongoing Covid19 pandemic. These
developments have resulted in many central banks and governments stepping up
efforts towards exploring a digital version of fiat currency.
.CBDC is a digital or virtual currency
but it is not comparable to the private virtual currencies that have mushroomed
over the last decade. Private virtual currencies sit at substantial odds to the
historical concept of money. They are not commodities or claims on commodities
as they have no intrinsic value; some claims that they are akin to gold clearly
seem opportunistic. Usually, certainly for the most popular ones now, they do
not represent any person’s debt or liabilities.
To sum up, CBDC is the same as currency
issued by a central bank but takes a different form than paper (or polymer). It
is sovereign currency in an electronic form and it would appear as liability
(currency in circulation) on a central bank’s balance sheet. The underlying
technology, form and use of a CBDC can be moulded for specific requirements.
CBDCs should be exchangeable at par with cash.
Design Features
Availability
Currently, access to digital central bank
money is limited to central bank operating hours, traditionally less than 24
hours a day and usually five days a week.8 CBDCs could be available 24 hours a
day and seven days a week or only during certain specified times (such as the
operating hours of largevalue payment systems). CBDC could be available
permanently or for a limited duration (eg it could be created, issued and
redeemed on an intraday basis).
Anonymity
Token-based CBDC can, in principle, be
designed to provide different degrees of anonymity in a way that is similar to
private digital tokens.9 A key decision for society is the degree of anonymity
vis-à-vis the central bank, balancing, among other things, concerns relating to
money laundering, financing of terrorism and privacy.
Transfer mechanism.
The transfer of cash is conducted on a
peer-to-peer basis, while central bank deposits are transferred through the
central bank, which acts as an intermediary. CBDC may be transferred either on
a peer-to-peer basis or through an intermediary, which could be the central bank,
a commercial bank or a third-party agent.
Interest-bearing.
As with other forms of digital central bank
liabilities, it is technically feasible to pay interest (positive or negative)
on both token- and account-based CBDCs. The interest rate on CBDC can be set
equal to an existing policy rate or be set at a different level to either
encourage or discourage demand for CBDC.11 Both non-interest bearing and
interest bearing accounts could be used for retail or wholesale payment
transactions. The payment of (positive) interest would likely enhance the
attractiveness of an instrument that also serves as a store of value.
Limits or caps.
Different forms of quantitative limits or
caps on the use or holdings of CBDC are often mentioned as a way of controlling
potentially undesirable implications or to steer usage in a certain direction.
For example, limits or caps could make a CBDC less useful for wholesale rather
than retail payments. At present, such limits or caps on holdings/use are most
easily envisioned in non-anonymous account-based systems.
What is the need for a CBDC?
While interest in CBDCs is near
universal now, very few countries have reached even the pilot stage of
launching their CBDCs. The adoption of CBDC has been justified for the following
reasons:-
i.
Central banks, faced with dwindling usage of paper currency, seek to
popularize a more acceptable electronic form of currency (like Sweden);
ii.
Jurisdictions with significant physical cash usage seeking to make
issuance more efficient (like Denmark, Germany, or Japan or even the US);
iii.
Central banks seek to meet the public’s need for digital currencies,
manifested in the increasing use of private virtual currencies, and thereby
avoid the more damaging consequences of such private currencies.
In
addition, CBDCs have some clear advantages 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. CBDCs would also potentially enable a more real-time and
cost-effective globalization of payment systems. 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. Time zone difference would no
longer matter in currency settlements – there would be no ‘Herstatt’ risk.
A pilot survey conducted by the Reserve
Bank on retail payment habits of individuals in six cities between December
2018 and January 2019, results of which were published in April, 2021 RBI Bulletin
(please see charts below) indicates that cash remains the preferred mode of
payment and for receiving money for regular expenses. For small value
transactions (with amount up to ₹500) cash is used predominantly.
There is thus a unique scenario of increasing
proliferation of digital payments in the country coupled with sustained
interest in cash usage, especially for small value transactions. To the extent
the preference for cash represents a discomfort for digital modes of payment,
CBDC is unlikely to replace such cash usage. But preference for cash for its
anonymity, for instance, can be redirected to acceptance of CBDC, as long as
anonymity is assured.
CBDC and the Banking System
CBDCs, depending on the extent of its
use, can cause a reduction in the transaction demand for bank deposits. Since
transactions in CBDCs reduce settlement risk as well, they reduce the liquidity
needs for settlement of transactions (such as intra-day liquidity). 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 (Dyson and Hodgson, 2016).
21. At the same time reduced
disintermediation of banks carries its own risks. If banks begin to lose
deposits over time, their ability for credit creation gets constrained. Since
central banks cannot provide credit to the private sector, the impact on the
role of bank credit needs to be well understood. Plus, as banks lose
significant volume of low-cost transaction deposits their interest margin might
come under stress leading to an increase in cost of credit.
There is another risk of CBDCs that could be
material. Availability of CBDC makes it easy for depositors to withdraw
balances if there is stress on any bank. Flight of deposits can be much faster
compared to cash withdrawal. On the other hand, just the availability of CBDCs
might reduce panic ‘runs’ since depositors have knowledge that they can
withdraw quickly. One consequence could be that banks would be motivated to
hold a larger level of liquidity which could result in lower returns for
commercial banks.
CBDC and Technology Risk
CBDC ecosystems may be at similar risk
for cyber-attacks as the current payment systems are exposed to. Further, in
countries with lower financial literacy levels, the increase in digital payment
related frauds may also spread to CBDCs. Ensuring high standards of cyber security
and parallel efforts on financial literacy is therefore essential for any
country dealing with CBDC.
27. Absorption of CBDCs in the economy
is also subject to technology preparedness. The creation of population scale
digital currency system is contingent upon evolution of high speed internet and
telecommunication networks and ensuring the wider reach of appropriate
technology to the general public for storing and transacting in CBDCs.
Legal Framework
Although CBDCs are conceptually no
different from banknotes, introduction of CBDC would require an enabling legal
framework since the current legal provisions are made keeping in mind currency
in paper form. Under the Reserve Bank of India Act, 1934, the Bank is empowered
to “…regulate the issue of bank notes and the keeping of reserves with a view
to securing monetary stability in India and generally to operate the currency
and credit system of the country to its advantage” (Preamble). Even though CBDCs will be a primarily
technology driven product, it will be desirable to keep the legislation
technology neutral to enable coverage of a variety of technology choices.
Conclusion
There is new era will start in India
thereby the cost of printing money in paper form will vanish and Digital
currency and technology driven payment methods will stay and continue to grow.
The digital currency will also help in cross border transaction and trade
finance activity. The Pandemic on one hand helped us to think how to perform
all transaction though electronic form and digitally. Already there is
development seen in digitalisation of trade activity. I am of the view the day
is not too far to transfer cross border funds from my mobile though Fintech
instead of Banks.
2 https://law.stanford.edu/projects/central-bank-digital-currencies-a-transatlantic-perspective/
3 https://www.federalreserve.gov/newsevents/speech/quarles20210628a.htm
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