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Recently, a deputy governor of the Reserve Bank of India (RBI) announced that RBI is working on a “phased implementation strategy" for the issuance of a central bank digital currency (CBDC), including a possible pilot project in the retail segment. A retail CBDC is a digital version of a fiat currency that’s available to the general public. It will be part of the payments ecosystem, which already consists of banks and payment service providers (PSPs). One significant issue in the design of a retail CBDC is the role of the private sector.

A retail CBDC issuance will include the introduction of public services needed for customer on-boarding, apart from systems for due diligence, compliance with anti-money laundering laws, transaction authorization and maintenance of cyber security. Such activities would mark a departure from existing central bank functions that focus on monetary stability and do not envisage direct interaction with retail users. A recent report by the Vidhi Centre for Legal Policy, titled A Central Bank Digital Currency for India: Proceeding with Cautious Optimism, notes that globally many central banks are exploring a retail CBDC that involves private-sector participation through a two-tiered model.

Under this model, a central bank develops the core CBDC system and the private sector takes up operational tasks. This is in contrast with a direct model, where the central bank is responsible for all aspects of CBDC issuance and its access to end-users.

Under both models, a CBDC remains a direct central bank liability. While a direct model will allow the central bank to exercise more control over the CBDC design, it will also require the bank to assume a more active role in payment services for CBDC transactions, raising questions over the institutional capacity of a central bank to undertake such activities. In economies like India’s that have well developed digital-payment markets, this may lead to the central bank competing with PSPs, which would raise concerns of disintermediation.

The two-tiered model seeks to address these concerns. It has been adopted by the central bank of the Bahamas that launched its CBDC (Sand Dollar) in 2020. Financial intermediaries in the private sector (banks, money-transmission businesses, PSPs, etc) provide wallet services for holding and using the Sand Dollar issued by the central bank. A CBDC pilot project launched by the People’s Bank of China in 2020 relied on a similar model, whereby it issued its e-CNY (China’s CBDC) through ‘authorized operators’ such as commercial banks and licensed non-bank payment institutions. These authorized operators manage wallets, authenticate e-CNY, and develop ‘platforms’ to enable operator-specific features. Such operators undertake customer due diligence and on-boarding services. In the UK, the Bank of England envisages private sector intermediaries as developers of ‘overlay services’ that can meet future payment needs by enabling programmable money, smart contracts and micro-payments. Proponents of this model argue that private-sector PSPs are “best placed to use their expertise" to promote innovation and integrate payment services with other financial products and platforms.

In India, to leverage the potential of the country’s payments sector, RBI ought to consider a two-tiered model for its retail CBDC; that is, it should provide the core system and leave operational and consumer-facing activities to regulated entities in the private sector (CBDC intermediaries). This will enable RBI to focus on core activities such as guaranteeing the stability of the digital currency’s value, regulating its intermediaries, and overseeing the overall security of the system.

Some issues, however, require special consideration. RBI will have to develop oversight and risk management functions vis-à-vis CBDC intermediaries, and establish systems to respond to potential CBDC disruptions that could result from operational failures or cybersecurity breaches. Further, since a CBDC will represent a direct claim on RBI, some form of an operational role for it will have to be planned. The Bank for International Settlements notes that an important aspect of CBDC design is the role of the central bank and private sector in the maintenance of a digital ledger for recording transactions. The central bank can opt to either run the core infrastructure that supports record-keeping and related tasks or delegate these to CBDC intermediaries. Both these approaches will have to take into account prudential risk management, data governance, security-risk mitigation and the impact on competition in India’s payments market. The adoption of a two-tiered model would also call for appropriate regulatory architecture designed to empower RBI to regulate CBDC intermediaries and oversee the soundness and operational resilience of such private entities, while ensuring overall financial stability and the safety of customer funds. Issues related to the interoperability of CBDC services with other payment solutions will have to be examined closely, as also the implications of data protection laws.

A two-tiered model based on public-private partnerships would present us an opportunity to leverage our private-sector potential to engage customers while promoting CBDC-oriented innovation in the payments sector. At the same time, it would rely on RBI to regulate and supervise this digital currency in a way that will generate the trust that underpins the transactional function of money.

Shehnaz Ahmed is fintech lead at the Vidhi Centre for Legal Policy. These are the author’s personal views

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