Everything you need to know about Central Bank Digital Currency (CBDC) by RBI

Everything you need to know about Central Bank Digital Currency (CBDC) by RBI

Why In News?

Reserve Bank of India is considering launching a central bank digital currency in a 'phased manner', informed T Rabi Sankar, the deputy governor of RBI, at a conference held by a think tank, Vidhi Centre for Legal Policy, on Thursday, 22 June.

Deputy Governor also listed key issues that the central bank is examining:

  • Should central bank digital currency be used only in retail or in wholesale payments too?
  • Can it be a distributed or a centralized ledger?
  • Should the validation mechanism be token-based or account based?
  • Should the distribution method be a direct issuance by the RBI or through other banks?
What is CBDC?

Central bank digital currency, also known as virtual currencies or digital currency, is the legal tender issued by a central bank in a digital form. “It is the same as a fiat currency (government printed currency whose value depends on the strength of the country’s economy) and is exchangeable one-to-one with the fiat currency” said Dy Governor T Rabi Sankar. “Only its form is different.”

  • In simple terms, it is equivalent to the current banknote but in electronic form and cannot be converted or drawn in paper form (cash) from a bank or an automated teller machine.
  • Like Credit card, internet banking and Digital Wallets, the CBDCs will be the part of the payments system, supplementing use of cash; its not alternative to Cash.
  • Certain economies such as the United Kingdom, the United States, Russia, China and South Korea have explored this domain but no country has successfully implemented it yet.
  • The Bank for International Settlements says 10% of central banks claim that they are likely to issue a CBDC within three years and 20% within six


Benefits of CBDC

Higher seigniorage: Since it supplement cash, the cost of printing money, distribution and mopping up soiled notes come down drastically as the use of CBDC grows. 

  • Seigniorage refers to the profit made by a government from minting currency. Seigniorage is determined by the difference between the face value of the currency and the cost of producing it.
  • For example, if the cost of printing a Rs 500 note in India is Rs 2, then Rs 498 is the profit made on the production of the note. Central Bank earn this profit by putting the note into circulation.

Reduced dependency on cash : While that's the benefit for the Central Bank, for the masses the transactions will be easy as they won't have to carry cash.

Reduced settlement risk : Payments using Central Bank Digital Currencies are final and can limit the settlement risk in the financial system


Challenges with CBDC

When one keeps money with the banks, they earn interest. If the CBDCs being Just a digital wallet doesn't offer Interest why will people shift from cash to CBDCs

A far more serious challenge will be if interest is paid and the RBI issues CBDCs, won't there be a flight of deposits from Banks as CBDCs being issued by RBI will be considered as safest assets.

Another Challenge is If the regulator ends up competing with the regulated entities, the banking system may see erosion in deposits, threatening the financial sector's stability.

Suggestions

Ideally, CBDCs should be issued by a set of banks, chosen by the RBI, with the regulator holding the mirror accounts, something on the line of a "Gilt Account".

This is a decentralized model but if the RBI adopts this, it will not end competing with banks and Financial sector stability will be maintained.

In other words, the CBDCs can be issued via a distributed ledger, synchronized between the banks and the RBI and not a centralized ledger held solely by the RBI.

Source : BS

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