INTRODUCTION
The Government of India considering the increasing demand and rapid growth of digital payment mechanisms in India, with the help of its regulatory agencies have been looking at the viability and operationality of digital rupees in the country’s economic ecosystem.
Therefore, the Finance Minister of India carefully considering the huge growth potential of Digital Rupee, in the Union Budget 2022-2023 proposed that the Reserve Bank of India (“RBI”) will be introducing its own Digital Rupee named Central Bank Digital Currency (“CBDC”), which will help to provide a significant boost to the digital economy of the country.
The Government of India in furtherance of the achieving the desired goal has recently released a concept note on CBDC, laying down the fine blue print of CBDC with respect to its objectives, choices, benefits, the adoption of technological infrastructure, maintenance of privacy, use of a distributed ledger technology, its impact on economic metrics such as monetary policy and financial stability, showcasing how the CBDC is going to introduce the much needed reform in the economic sector of India.
WHAT IS CBDC
The RBI broadly explains CBDC as the legal tender issued by a Central Bank in a digital form. It is akin to sovereign paper currency but takes a different form. The CBDC will work similarly to the role of current fiat currency in way of acting as a medium for exchange, unit of account, store of value, and standard of deferred payment.
Furthermore, the user of CBDC will be able to exchange it at par for cash, which will make it convenient and secure for its user to carry transactions, as a result, the introduction of CBDC in India will provide benefits of both worlds together.
Although, CBDC will have features similar to crypto-currency, it will be far from the risks borne by it since, unlike crypto currency it would be used as a medium of exchange rather than as assets. Moreover, it will be issued by RBI alone, instead of being mined.
DESIGN CHOICES
The RBI in the concept note has also thrown light on the design choices which it has and what it intends to choose and implement for the country in recent future.
The RBI seeks to introduce CBDC as a complementary system to the already existing payment and settlement system, the main consideration for the design features of CBDCs should be the least disruptive.
1. Types of CBDC
CBDC can be classified into two broad types viz. general purpose or retail (CBDC-R) and wholesale (CBDC-W). Retail CBDC would be potentially available for use by all viz. private sector, non-financial consumers, and businesses while wholesale CBDC is designed for restricted access to select financial institutions.
The Wholesale CBDC is for the settlement of interbank transfers and related wholesale transactions. Whereas, the Retail CBDC is an electronic version of cash primarily meant for retail transactions.
The Retail CBDC is a more secure option for consumers as it is a direct liability of the RBI. Wholesale CBDC has the potential to transform settlement systems for financial transactions and make them more efficient and secure.
As per the potential offered by each of them, there may be merit in introducing both CBDC-W and CBDC-R. However, it is estimated that the RBI would first start with wholesale at the Pilot stage and then accordingly start the other.
2. Model for issuance and management of CBDC
There are two models for issuance and management of CBDCs viz. Direct model (Single Tier model) and Indirect model (Two-Tier model). A Direct model would be the one where the RBI would be responsible for managing all aspects of the CBDC system viz. issuance, account-keeping, and transaction verification.
In the Indirect model, the RBI , and other intermediaries (banks and any other service providers), each play their respective roles. In this model, the RBI issues CBDC to consumers indirectly through intermediaries and any claim by consumers is managed by the intermediary as the central bank only handles wholesale payments to intermediaries.
The Indirect model is similar to the current physical currency management system where the various banks manage activities like distribution of notes to the public, account-keeping, adherence to requirements related to know your-customer (KYC) and anti-money laundering and countering the terrorism of financing (AML/CFT) checks, transaction verification, etc.
3. Forms of CBDC
CBDC can be structured as ‘token-based’ or ‘account-based’. A token-based CBDC is a bearer instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them.
In contrast, an account-based system would require the maintenance of records of balances and transactions of all holders of the CBDC and indicate the ownership of the monetary balances.
Moreover, in the token-based CBDC, the person receiving a token will verify that his ownership of the token is genuine, whereas, in an account-based CBDC, an intermediary verifies the identity of an account holder.
The RBI considering the features offered by both the forms of CBDCs, a token-based CBDC is viewed as a preferred mode for CBDC-R as it would be closer to physical cash, while account-based CBDC may be considered for CBDC-W.
4. Degree of Anonymity
CBDC to play the role of a medium of exchange needs to incorporate all the features that physical currency represents including anonymity, universality, and finality. Ensuring anonymity for a digital currency particularly would be a challenge, as all digital transactions would leave some trail.
The RBI has emphasized that the degree of anonymity would be a key design decision for any CBDC. Reasonable anonymity for small-value transactions akin to anonymity associated with physical cash may be a desirable option for CBDC-R.
The Concept also discusses the offline presence of CBDC but it is yet to be seen how said technology would be implemented. If it gets successfully implemented then it would be a very big step for financial inclusion for those in remote areas to engage in transactions without the need for connectivity.
ADVANTAGES
The CBDC is a sovereign currency issued at par with the current fiat currency, its just it will be issued in Digital manner hence, it would get the same benefits, which current fiat currency has such as trust, safety, liquidity, settlement, finality, and integrity.
In addition to the above, the issuance of CBDC will further promote digital finance among the masses. The RBI has emphasized upon certain advantages and benefits of CBDC which has influenced it to explore the issuance of the same. They Include –
1. Reduction of Cost in Physical Cash Management
With RBI being the sole issuer of currency in India, it incurs huge expenses in the printing of currency and ensuring its security. The environment factor is also affected due to the increase in the mining of currency even in a minor way.
However, the issuance of CBDC, will help reduce the liabilities attached to paper currency, and the related cost and management, by setting up a robust technological infrastructure. It would further advance towards a cashless economy and would also ensure fair competition, efficiency, and innovation in payment.
2. Cross-Border Transactions
India is the world’s largest recipient of remittances as it received $87 billion in 2021 with the United States being the biggest source, accounting for over 20% of these funds. The cost of sending remittances to India, therefore, assumes critical relevance, especially in view of the large Indian diaspora spread across the world and from the point of view of the potential (mis)use of informal/illegal channels. With the existence of a currency which is digital as well as sovereign, the costs involved in the transfer of such money and the other issues involved with it can be avoided. Moreover,
3. Financial Inclusion and Innovation of Payment Systems
CBDC will facilitate entry of unbanked population and support financial inclusion by making available easy credit to the citizens and also with the proposed offline usage feature it would allow people in remote areas without connectivity to be financially included and also secure their transactions and wealth. With the currency being in a digital mode, newer technologies can be developed and provided by third-party apps to innovate and facilitate this upcoming currency. This will also ensure better infrastructural facilities and include innovation in the payment systems.
CHALLENGES
There are many shortcomings that would be faced by CBDC, as it is just a plan on paper. The first and foremost criticism is the paucity or poor quality of digital infrastructure and inaccessibility to the majority of the population would render the CBDC ineffective. Hence, the infrastructure shall be innovated and developed before the issuance of CBDC.
Moreover, the CBDC issued by the RBI to the customer would involve verification for its transfer, the privacy, and anonymity which is provided by the paper currency would be diluted.
Furthermore, the various legal compliances shall be properly formed and a legal framework shall be set up in order to supervise and ensure no illegality exists. Hence, a clear framework is required for governance.
AMLEGAL REMARKS
India is witnessing exponential growth in the use of digital payment systems in India and therefore, in view of the increasing demand and rapid growth of digital payment mechanisms, there is an urgent need for the development of a new digital currency ecosystem and infrastructure, so that when and how the RBI Digital Rupee is introduced, it is able to flourish and survive the harsh modalities of the financial market in India.
Although the CBDC, seems like the way forward for revolutionizing the economic sector of India, the growing dependence of customers on digital payment systems calls for an adequate legal framework, as the existing regulations which govern and regulate the payment system in India were enacted with the intention to accommodate paper currency, and therefore, there is a need to amend the existing legislature to issue currency in digital form and allow it to be used as legal tender.
Recently the RBI has launched a pilot CBDC program for wholesale sector. However, in the absence of a robust legal framework, the RBI there are several factors, which the RBI should consider while taking further action of CBDC, which include developing a robust technological infrastructure to prevent cyber attacks, privacy issues and other customer-related issues which may occur in its usage.
– Team AMLEGALS assisted by Mr. Niloy Ghosh (Intern)
For any queries or feedback, please feel free to get in touch with tanmay.banthia@amlegals.com or himanshi.patwa@amlegals.com.
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