Banking Article, Banking Finance 2023, Banking Finance February 2023



Currency is a form of money that is issued exclusively by the sovereign (or a central bank as its representative). It is a liability of the issuing central bank (and sovereign) and an asset of the holding public. Currency is fiat, it is legal tender. Currency is usually issued in paper form, but the form of currency is not its defining characteristic.

Functions of Money

  • A medium of exchange.
  • A standard of deferred payment.
  • A store of wealth.
  • A measure of value.

Reasons for Demand of Money:

  • A transactions-relatedreason:  People need money on a regular basis to pay bills and finance their discretionary consumption.
  • A precautionaryreason: People also need money for an unexpected needs in future like medical bill etc.
  • A speculativereason:  if they expect the value of such money to increase versus other asset classes.

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modern financial system, be it as bonds, securities, transactions, communications, correspondences or messaging has now been replaced by their corresponding digital and electronic versions. Only the currencies are left in paper format. Taking advantage of this, rapid mushrooming of private crypto currencies in the last few years has attempted to challenge the fundamental notion of money. To counter it and take other advantage of digital currency, Central Bank of all over the world including Reserve Bank of India is working on to roll out their own digital currency.

A Central Bank Digital Currency (E-rupee in case of India) 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. Only its form is different.

As per RBI Concept note “e-₹ or digital rupee will provide an additional option to the currently available forms of money. It is substantially not different from banknotes, but being digital it is likely to be easier, faster, and cheaper,”

Features of Central Bank Digital Currency (CBDC):

The features of Central Bank Digital Currency include but not limited to:

  • CBDC is sovereign currency issued by Central Banks in alignment with their monetary policy.
  • It appears as a liability on the central bank’s balance sheet.
  • Must be accepted as a medium of payment, legal tender, and a safe store of value by all citizens, enterprises, and government agencies.
  • Freely convertible against commercial bank money and cash.
  • Legal tender for which holders need not have a bank account.
  • Expected to lower the cost of issuance of money and transactions.

Difference between crypto currencies and E-rupee

Central Bank Digital Currency is a digital or virtual currency but it is not comparable to the private virtual currencies like Crypto Currency that have mushroomed over the last decade.

  • RBI’ Central Bank Digital Currency (CBDC) will be issued and controlled by the Central Bank itself, Unlike Crypto Currencies, which are private in nature.
  • Crypto Currencies are not commodities or claims on commodities as they have no intrinsic value whereasCentral Bank Digital Currency have as issued by Central Bank.
  • Crypto Currencies do not represent any person’s debt or liabilities. There is no ISSUER. They are not money as the word has come to be understood historically.
  • Cryptocurrencies focus on decentralisation. They remove the need for a central authority to facilitate transactions. On the other hand, a CBDC, while utilising the transparency and security that block chains provide, is still entirely centralised. A central bank oversees and facilitates the transactions with the help of other third-party organisations.
  • Unlike crypto currencies, CBDCs act only as a means of transferring value.
  • CBDCs use a private permissioned block chain network, while crypto currencies use a permissionless open network.
  • Users that use cryptocurrency have anonymity when they make transactions on the network. However, CBDCs will be attached to a person’s existing bank account, which will contain their personal information.

Why Central Banks of all the countries is exploring Central Bank Digital Currency?

As per survey conducted by Bank of International Settlement in 2021, 86% of Central Banks were actively researching the potential for Central Bank Digital Currency, 60% were experimenting with the technology and 14% were deploying pilot projects. Followings are the reason why Central Bank of all over the world including RBI is focused on Central Bank Digital Currency.

Main Driver is to provide the public with virtual currencies that carry the legitimate benefits of private virtual currencies while avoiding the damaging social and economic consequences of private currencies (Crypto Currencies).

  • Central banks, faced with declining usage of paper currency, seek to popularize a more acceptable electronic form of currency.
  • Handling of physical cash is less cost and time efficient in comparison with digital currency and it is vary Intricate.
  • 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.
  • Payments using Central Bank Digital Currencies are final and thus reduce settlement risk in the financial system.
  • In UPI system if Central Bank Digital Currency is transacted instead of bank balances, the need for interbank settlement disappears.
  • Central Bank Digital Currency would also potentially enable a more real-time and cost-effective globalization of payment systems.
  • Time zone difference would no longer matter in currency settlements – there would be no ‘Herstatt’ risk.


If the Central Bank Digital Currency will be used in transaction, it can cause a reduction in the transaction demand for bank deposits. Since transactions in Central Bank Digital Currency 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, Central Bank Digital Currency could cause reduction in bank deposits.

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.

 Not only that, Banks will lose significant volume of low-cost transaction deposits known as CASA.

Due to less CASA deposit, their interest margin might come under stress leading to an increase in cost of credit.

Availability of Central Bank Digital Currency 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.

This is the reason that the e-rupee is unlikely to earn interest as the central bank is worried about the impact of mass withdrawals on India’s financial and banking system.

There is possibility of increasing of P2P lending and further disintermediation of banks.

Central Bank Digital Currency: The way ahead in India.

Central Bank Digital Currency (CBDC) will be known as E-rupees in India.

Central Bank Digital Currency can be classified into two broad types’ viz. general purpose or retail and wholesale. Retail Central Bank Digital Currency would be potentially available for use by all, while wholesale Central Bank Digital Currency is designed for restricted access to select financial institutions. Wholesale Central Bank Digital Currency is intended for the settlement of interbank transfers and related wholesale transactions, Retail Central Bank Digital Currency is an electronic version of cash primarily meant for retail transactions.

Central Bank Digital Currency can be structured as ‘token-based’ or ‘account-based’. A token-based Central Bank Digital Currency 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 maintenance of record of balances and transactions of all holders of the Central Bank Digital Currency and indicate the ownership of the monetary balances. Also, in a token-based Central Bank Digital Currency, the person receiving a token will verify that his ownership of the token is genuine, whereas in an account-based Central Bank Digital Currency, an intermediary verifies the identity of an account holder. Considering the features offered by both the forms of CBDCs, a token-based CBDC is viewed as a preferred mode for CBDC-Retails as it would be closer to physical cash, while account-based CBDC may be considered for CBDC-Wholesale.

There are two models for issuance and management of Central Bank Digital Currency viz. direct model (Single Tier model) and indirect model (Two-Tier model). A Direct model would be the one where the central bank is responsible for managing all aspects of the Central Bank Digital Currency system viz. issuance, account-keeping and transaction verification. In an Indirect model, central bank and other intermediaries (banks and any other service providers), each play their respective role. In this model central bank issues Central Bank Digital Currency 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. RBI Yet to take final decision on this matter.

CBDCs being digital in nature, technological consideration will always remain at its core. The infrastructure of CBDCs can be on a conventional centrally controlled database or on Distributed Ledger Technology. Reserve Bank of India has to decide on the matter considering the available infrastructure.

As per recommendations of the internal Working Group (WG) set up by Reserve Bank in October 2020, RBI is exploring the option of implementation of account-based Central Bank Digital Currency in Wholesale segment and token-based Central Bank Digital Currency in Retail segment vide a graded approach.

The payment of positive interest would likely enhance the attractiveness of CBDCs that also serves as a store of value. But, designing a CBDC that moves away from cash-like to a “deposit-like” it may have a potential for disintermediation in the financial system. It will be resulting from loss of deposits by banks, reducing their credit creation capacity in the country. Also considering that physical cash does not carry any interest, it would be more logical to offer non-interest bearing Central Bank Digital Currency. Reserve Bank of India should take decision after detail study of the interest of the nation in general and all stack holder in particular.

For CBDC to play the role as a medium of exchange, it needs to incorporate all the features that physical currency represents including anonymity, universality, and finality. RBI has to develop such a system in which all these features can be associated with Central Bank Digital Currency.


There are associated risks, no doubt, but they need to be carefully evaluated against the potential benefits.

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