By Palanisamy Saravanan & Sumit Banerjee

The fintech department of the Reserve Bank of India released a concept note on Central Bank Digital Currency (CBDC). The note is a deep-dive into the central bank’s deliberations on developing the digital rupee, or e₹. The concept note defines CBDC as the digital form of currency notes issued by the central bank. It will be similar to paper currency but in the digital form, and have the same utility as a medium of exchange, store of value, and legal tender. We present a few concerns regarding this project.

Improvement over existing options

The Indian financial system is one of the best in terms of real-time payment and cost-effective digital payment infrastructure. RBI’s Digital Payment Index shows that there has been a 3.5X growth in digital payments between 2018 and 2022. A large portion of the credit goes to the success of the Unified Payment Interface (UPI), which has made digital payments seamless. For a CBDC to become relevant in the retail space, it has to present an alternative that improves upon the ecosystem supported by UPI with its ubiquity and ease of operations. It also needs to have a critical mass of people opting for it, to be successful. UPI’s requirement for internet connection and the server downtime of connected banks sometimes stymies the ease of payment we associate with it. If the CBDC can provide an offline payment solution, it can be a viable alternative payment medium. However, it must be said that the issues associated with the UPI do not occur most of the time.

Limitations

The CBDC presents an option for people to have a central bank instrument for payment and settlement. The concept note states that this presents a choice for the users to hold the CBDC instead of having the money in their bank accounts. This presents an interesting dilemma for all the stakeholders. For individuals holding CBDC instead of keeping money in the bank account, the question of earning interest over it is still up in the air. None of the CBDCs deployed by foreign central banks currently provide for interest. Hence, it does not make economic sense for individuals to go for CBDCs. For banks, money held as CBDCs is the sum of money away from their precious CASA (current account- savings account) deposits. Suppose a large number of people opt for CBDCs. In that case, the asset-liability management has to be reworked considering the outflow of money from the low-cost CASA deposits. It is likely to increase the cost of borrowings as well. RBI has also mentioned that it wants CBDC to complement existing forms of money. Hence, it is expected that there will be a maximum limit up to which one can hold CBDC, which is again the norm in most of the economies with CBDCs present. However, if restrictions are put on the amount of CBDC that can be used for transactions, large monetary transactions between firms cannot be done through this. Therefore, it is worth considering the point that if UPI can facilitate transactions in smaller denominations and we have alternate methods for real-time settlement for large ticket-size transactions, what sweet spot does the CBDC aim to hold in this payment landscape?

International payments and financial inclusion

The one area where a CBDC can take giant strides is international payments. As we have seen, the global monetary transaction system is not bereft of politics. The recent ban on Russian banks from the SWIFT systems required those banks to move to other modes of secure communication with other banks. The alternatives, Chinese CIPS, Indian SFMS, and Russian SPFS, can work parallelly. Still, to transact with other banks on different platforms, these have to be integrated into the SWIFT network. CBDCs can bypass such restrictions for payments between two countries. However, it comes with its own challenges. The design of different CBDCs has to be done to allow easy convertibility into other currencies. However, in this case, the caveat is also the same as above: a large number of countries, or at least significant trading partners, need to have this feature embedded in their CBDC to make this a feasible option.

One of the stated aims of the CBDC is to help further financial inclusion. Ownership of bank accounts and digital payment solutions have helped bring many people into the net of formal financial channels. CBDC can only add to this inclusion exercise if it allows offline capabilities. However, it is likely to take a lot of awareness campaigns and education from the central bank to make people realise its benefits.

Privacy

The issue with CBDC that is most concerning is privacy. Banks and intelligence agencies can track financial transactions if they are recorded anywhere. However, cash allows people to make transactions anonymously. CBDC will invariably leave a digital trail. There has to be more clarity on the data protection of the users of CBDC. It can be argued that CBDC does not add more layers of tracking than digital payment does.

At this point, CBDC is only in the conceptual phase, and deliberations are being made on its design and public policy aspects. However, this exercise also entails a considerable cost to the public exchequer. It has to be considered that if there are no significant benefits of using CBDC over the current mode of payments and store of value, is this exercise even worth taking on?

(Palanisamy Saravanan & Sumit Banerjee are professor of finance, and doctoral student, Indian Institute of Management, Tiruchirappalli respectively. All views are personal.)