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In October 2020, the Reserve Bank of India (RBI) had set up an Internal Working Group to undertake a study on the appropriate design and implementation architecture for introducing a ‘Central Bank Digital Currency’ (CBDC) in India. In a report released in February 2021, the working group made certain recommendations. On 7 October 2022, the Fintech Department of RBI issued its much-awaited Concept Note on CBDCs.

The Concept Note provides deep insights into RBI’s motivations for the introduction of CBDCs in India. It also outlines potential design features, policy issues and implications, and possible technology platforms. It articulates a policy preference for indirect/hybrid CBDCs issued by RBI and distributed by banks and other intermediaries. It envisages a token-based (akin to fiat currency) model for a retail CBDC and a separate account-based model for a wholesale CBDC. In opting for non-interest bearing architecture, RBI considers its CBDC a swap for paper cash (an RBI liability that does not bear interest). The Concept Note’s proposal of limited anonymity (similar to European Central Bank-led ‘anonymity vouchers’) for use in small transactions and complete visibility to intermediaries and authorities for large transactions strikes a balance between privacy and regulation.

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The guiding principles reflected in the Concept Note view CBDCs as an additional payment avenue that does not replace existing payment systems. Being the liability of RBI rather than commercial banks, a CBDC insulates users from insolvency risks in the financial system. The central bank has reiterated its concerns about private virtual currencies (cryptocurrencies) and proposed CBDC adoption as a tool for monetary and financial stability, reducing risks arising from settlement (given no central counterparty) and physical cash management. This will result in the creation of core payment systems outside India’s commercial banking system, resulting in diversification of payment options, mitigate credit and liquidity risks, and provide a hedge against payment system and bank failures. It can also reduce cross-border payment friction, promote financial inclusion, given its offline feature, and deliver a digital footprint of retail users that may enable easy credit.

The Concept Note also considers various technology and cyber-security risks, governance and system stability factors, integration with existing payment systems and interoperability.

While recognizing the legal implications of CBDCs, given that the existing legal framework governing money was enacted in a pre-digital age, the Concept Note stops short of hard-wired recommendations, leaving this assessment to the final CBDC architecture adopted (after trials) in terms of its operational and technological design features, including legal amendments required to provide for the right of CBDC issuance, legal tender status and criminal law protection from counterfeits, anti-money laundering and terrorism financing (AML/CFT) considerations, apart from other safeguards.

Participants in the financial system will have to assess CBDCs and adapt themselves to their advent. From ceding conventional roles to developing new roles, there is a lot to be done in the financial and payment system. The implications of a CBDC to banks, payment intermediaries and other participants in the financial services ecosystem is likely to be profound. The role of banks and other intermediaries in the distribution of a retail CBDC may lead to new partnerships between banks, fintech firms and technology companies. The proposed two-tier model would require technology and infrastructure investment by banks and other financial intermediaries. The acceptance and exchange of an e-rupee in a one-to-one ratio for fiat currency will require systemic interoperability. On the legal front, the RBI Act, Foreign Exchange Management Laws, Payment System and Settlement Act, Coinage Laws and the Prevention of Money Laundering Laws (including AML/CFT reporting and monitoring) may all need further adaptation to a CBDC.

A CBDC presents an opportunity for banks and fintech firms to reinvent parts of their traditional business. Several financial intermediaries (payment processors and aggregators, card networks and e-wallet service providers) are expected to play a significant role in the onward march of an e-rupee, as an altogether new payment use-case will be created. The potential impact on India’s growing e-commerce landscape will also be material.

The introduction of CBDCs is likely to have a positive impact on India’s formal economy and could also strengthen our fiscal system. There would be both challenges and opportunities for the banking system and non-bank intermediaries. For agile financial system players with an appetite for investment and growth led by modern technology, the opportunities are immense.

A CBDC launch would be a positive move and is likely to have a far-reaching impact on both our domestic payment systems and cross-border payment architecture. From a public policy standpoint, the potential for financial inclusion, given India’s demographic advantage, a digital currency issued as legal tender is a compelling proposition.

Globally, central banks and governments are seized of technological advancements and their impact on financial stability. Whilst innovation will lead to efficiency and faster services, central banks must guard against risks to financial system’s robustness. Both demography and geography place India particularly well to use technology for financial intermediation. A CBDC launch will present an opportunity for India’s advancement by digital means to achieve its policy objectives.

L. Viswanathan & Anu Tiwari are partners at Cyril Amarchand Mangaldas.

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