Banking Article, Banking Finance 2021, Banking Finance November 2021

Central Bank Digital Currency – The Future of Money


The world has witnessed number of civilizations like Indus Valley, Mohenjo-Daro etc. Apart of its magnificent architecture the one thing that amazes the world is the discovery of coins casted in different metals thus adding to its monetary value which hints that along with the barter system the business of that era ran on currencies too. With the advent of modernization and globalization there has been massive transition in financial and economic sector. Crypto currency marks the beginning of a new era.  The Reserve Bank of India in 2018 came out strongly against crypto currencies in India but in 2020, the Supreme Court of India reversed the RBI ban. That move was welcomed by the crypto exchanges and investors throughout the country. After this, Indian banks have tried to curtail transactions with crypto-exchanges as, in their view, they are governed by RBI. But later, RBI mentioned that banks cannot quote its 2018 ban to customers as it was overruled by the Supreme Court, paving the way for crypto trading to continue in India. Around 15 million Indians are believed to have made investments in private crypto currency holdings. Crypto currency investments in the nation increased from $923 million in April 2020 to almost $6.6 billion by May 2021, a growth of about 400% in only one year. In concurrence, Central Bank, the country’s banking regulator, has arrived at an amicable update to its implementation of a digital currency, which is expected to materialize by end of 2021. The central bank-authorized digital or electronic currency will be a legal tender unlike crypto-currency. However, the Central Bank also clarified that the CBDC, as a legal tender, is different from other private digital/virtual currencies like bitcoin, dogecoin, ethereum etc. that have mushroomed over the last decade. It is interesting to note that central banks across the world, including in the US, European Union, and China, have been working towards issuing their own digital currency ever since the spectacular rise in the value of privately issued crypto-currency. Indian central bank’s digital rupee could pave the way ahead for country’s crypto ecosystem.

Central Bank Digital Currency or CBDC:

On July 22, Reserve Bank of India (RBI) Deputy Governor said the regulatory body is considering introducing a central bank digital currency (CBDC) in a phased manner. It is sovereign currency in an electronic form, and it will appear as liability (currency in circulation) on a central bank’s balance sheet. A CBDC is the legal tender issued by a central bank in a digital form. It is the same as a fiat currency and is exchangeable one-to-one with the fiat currency except its form. The underlying technology, form, and use of a CBDC can be moulded for specific requirements. CBDCs should be exchangeable at par with cash.

Status on Central Bank Digital Currencies Globally:

On July 14, the European Central Bank launched its digital euro project, approving an “investigation phase” that could ultimately lead to a virtual currency being implemented later in this decade.

Most major central banks have followed China where the digital Yuan has already been in circulation in several cities. The US Federal Reserve and the Bank of England are also looking into the possibilities of digital currency for their economies.

According to a survey by the Bank for International Settlements, Around 86% of global central banks were actively researching the potential for central bank digital currency, while 60% were experimenting with the technology and 14% were launching pilot projects.

Need for a CBDC:

The adoption of CBDC has been justified for the following reasons:

  1. Central banks, faced with dwindling usage of paper currency, seek to popularize a more acceptable electronic form of currency like Sweden.
  2. Jurisdictions with significant physical cash usage seeking to make issuance more efficient like Denmark, Germany, or Japan or even the US.
  • Central banks seek to meet the public’s need for digital currencies. As the virtual currency is the entering in the market so to overcome the dire consequences CBDC is the only option.
  1. It is conceivable for an Indian importer to pay its American exporter on a real time basis in digital dollars, without the need of a middleman.
  2. As the circulation of currency is more in our country. The arrival of CBDC will lessen the circulation. In this way expenditure in form of printing, transportation and distribution will be reduced.

Role of CBDC in Banking System:

  1. CBDC will play the important role in settling down the settlement and liquidity risk.
  2. 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.
  • 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.
  1. On the other hand, just the availability of CBDCs might reduce panic ‘runs’ since depositors have knowledge that they can withdraw quickly.
  2. 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.
  3. CBDCs are currency and therefore do not pay interest, their impact on bank deposits may actually be rather limited. Depositors that require CBDCs for transactional purposes are likely to sweep day end balances to interest-earning deposit accounts.

CBDC and Technology Risk:

  1. CBDC ecosystems may be at similar risk for cyber-attacks as the current payment systems. In countries with lower financial literacy levels, the increase in digital payment related frauds may also spread to CBDCs.
  2. The country which is dealing with the CBDC must have high label of cyber security and financial literacy.
  • Absorption of CBDCs in the economy is also subject to technology preparedness.
  1. 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.
  2. In developing countries, lower level of technology adoption may limit the reach of CBDCs and add to existing inequalities in terms of accessing financial products and services.

RBI’s approach on CBDC:

  1. The High Level Inter-Ministerial Committee constituted by Ministry of Finance, Government of India to examine the policy and legal framework for regulation of virtual / crypto currencies had recommended the introduction of CBDCs as a digital form of fiat money in India.
  2. RBI has also been exploring the pros and cons of introduction of CBDCs since quite some time.
  • RBI is currently working towards a phased implementation strategy and examining use cases which could be implemented with little or no disruption. Some key issues under examination are as under:
  1. The scope of CBDCs – whether they should be used in retail payments or also in wholesale payments.
  2. The underlying technology – whether it should be a distributed ledger or a centralized ledger.
  3. The validation mechanism – whether token based or account based.
  4. Distribution architecture – whether direct issuance by the RBI or through banks

Legal Framework:

  1. The introduction of CBDC would require a legal framework as current legal provisions are made keeping in mind currency in paper form. However CBDCs are conceptually similar to bank note.
  2. 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. This will also help to operate the currency and credit system of the Bank.
  • The Reserve Bank derives the necessary statutory powers from various sections of the RBI Act – with respect to denomination (Section 24), form of banknotes (Section 25), status as legal tender (Sec 26(1)) etc.
  1. There is a need to examine consequential amendments to other Acts like The Coinage Act, 2011, FEMA, 1999, Information Technology Act, 2000 etc. 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.


The emergence of CBDC is laced with numerous benefits with far reaching positive effects. This may be less reliance on cash, lower transaction cost and lower settlement risk. Also the introduction of CBDC will likely to lead the more robust, efficient, reliable, regulated and legal tender-based payment option. However the risk is associated with the CBDC show there is a need of evaluation for the potential benefits. If India moves towards CBDC naturally it will get the leadership position in payment system.

CBDCs are not only desirable in payment systems benefits, but also protect the general public from the dire consequence of private virtual currency. Off course this would require the careful calibration and a nuanced approach in implementation. For the implementation of CBDC we require board views and stakeholder consultations along with technical challenges. Technical challenges also have their own importance. As the saying goes, every idea has to wait for its time. Perhaps the time has come to introduce CBDC in a larger scale.

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