CENTRAL BANK DIGITAL CURRANCY – A NEW NORMAL IN NEAR FUTURE
Sathyamurthy Subramanian
Banking & Payment Professional (SWIFT, RTP, ACH, FEDWIRE, ISO20022, SEPA, TARGET 2), FX treasury management, and trade finance. Trainer in Banking and Soft skills. Registered Independent Director (IICA)
A central bank digital currency (CBDC) uses an electronic record or digital token to represent the virtual form of a?fiat?currency of a particular nation (or region). A CBDC is centralized; it is issued and regulated by the competent monetary authority of the country. A central bank digital currency (CBDC) utilizes technology to represent a country's official currency in digital form. Unlike decentralized crypto currency projects like Bitcoin, a CBDC would be centralized and regulated by a country's monetary authority.
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financial system, be it as bonds, securities, transactions, communications, correspondences or messaging – has now been replaced by their corresponding digital and electronic versions. On anecdotal evidence, use of physical cash in transactions too has been on the decline in recent years, a trend further reinforced by the ongoing Covid19 pandemic. These developments have resulted in many central banks and governments stepping up efforts towards exploring a digital version of fiat currency.
.CBDC is a digital or virtual currency but it is not comparable to the private virtual currencies that have mushroomed over the last decade. Private virtual currencies sit at substantial odds to the historical concept of money. They are not commodities or claims on commodities as they have no intrinsic value; some claims that they are akin to gold clearly seem opportunistic. Usually, certainly for the most popular ones now, they do not represent any person’s debt or liabilities.
To sum up, CBDC is the same as currency issued by a central bank but takes a different form than paper (or polymer). It is sovereign currency in an electronic form and it would appear as liability (currency in circulation) on a central bank’s balance sheet. The underlying technology, form and use of a CBDC can be moulded for specific requirements. CBDCs should be exchangeable at par with cash.
Design Features
Availability
Currently, access to digital central bank money is limited to central bank operating hours, traditionally less than 24 hours a day and usually five days a week.8 CBDCs could be available 24 hours a day and seven days a week or only during certain specified times (such as the operating hours of largevalue payment systems). CBDC could be available permanently or for a limited duration (eg it could be created, issued and redeemed on an intraday basis).
?Anonymity
Token-based CBDC can, in principle, be designed to provide different degrees of anonymity in a way that is similar to private digital tokens.9 A key decision for society is the degree of anonymity vis-à-vis the central bank, balancing, among other things, concerns relating to money laundering, financing of terrorism and privacy.
Transfer mechanism.
The transfer of cash is conducted on a peer-to-peer basis, while central bank deposits are transferred through the central bank, which acts as an intermediary. CBDC may be transferred either on a peer-to-peer basis or through an intermediary, which could be the central bank, a commercial bank or a third-party agent.
?Interest-bearing.
As with other forms of digital central bank liabilities, it is technically feasible to pay interest (positive or negative) on both token- and account-based CBDCs. The interest rate on CBDC can be set equal to an existing policy rate or be set at a different level to either encourage or discourage demand for CBDC.11 Both non-interest bearing and interest bearing accounts could be used for retail or wholesale payment transactions. The payment of (positive) interest would likely enhance the attractiveness of an instrument that also serves as a store of value.
Limits or caps.
Different forms of quantitative limits or caps on the use or holdings of CBDC are often mentioned as a way of controlling potentially undesirable implications or to steer usage in a certain direction. For example, limits or caps could make a CBDC less useful for wholesale rather than retail payments. At present, such limits or caps on holdings/use are most easily envisioned in non-anonymous account-based systems.
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What is the need for a CBDC?
While interest in CBDCs is near universal now, very few countries have reached even the pilot stage of launching their CBDCs. The adoption of CBDC has been justified for the following reasons:-
i.???????Central banks, faced with dwindling usage of paper currency, seek to popularize a more acceptable electronic form of currency (like Sweden);
ii.???????Jurisdictions with significant physical cash usage seeking to make issuance more efficient (like Denmark, Germany, or Japan or even the US);
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iii.???????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.
?In addition, CBDCs have some clear advantages over other digital payments systems – payments using CBDCs are final and thus reduce settlement risk in the financial system. Imagine a UPI system where CBDC is transacted instead of bank balances, as if cash is handed over – the need for interbank settlement disappears. CBDCs would also potentially enable a more real-time and cost-effective globalization of payment systems. It is conceivable for an Indian importer to pay its American exporter on a real time basis in digital Dollars, without the need of an intermediary. This transaction would be final, as if cash dollars are handed over, and would not even require that the US Federal Reserve system is open for settlement. Time zone difference would no longer matter in currency settlements – there would be no ‘Herstatt’ risk.
A pilot survey conducted by the Reserve Bank on retail payment habits of individuals in six cities between December 2018 and January 2019, results of which were published in April, 2021 RBI Bulletin (please see charts below) indicates that cash remains the preferred mode of payment and for receiving money for regular expenses. For small value transactions (with amount up to ?500) cash is used predominantly.
There is thus a unique scenario of increasing proliferation of digital payments in the country coupled with sustained interest in cash usage, especially for small value transactions. To the extent the preference for cash represents a discomfort for digital modes of payment, CBDC is unlikely to replace such cash usage. But preference for cash for its anonymity, for instance, can be redirected to acceptance of CBDC, as long as anonymity is assured.
CBDC and the Banking System
CBDCs, depending on the extent of its use, can cause a reduction in the transaction demand for bank deposits. Since transactions in CBDCs 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, they could cause a shift away from bank deposits which in turn might reduce the need for government guarantees on deposits (Dyson and Hodgson, 2016).
21. 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. Since central banks cannot provide credit to the private sector, the impact on the role of bank credit needs to be well understood. Plus, as banks lose significant volume of low-cost transaction deposits their interest margin might come under stress leading to an increase in cost of credit.
?There is another risk of CBDCs that could be material. 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. 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.
CBDC and Technology Risk
CBDC ecosystems may be at similar risk for cyber-attacks as the current payment systems are exposed to. Further, in countries with lower financial literacy levels, the increase in digital payment related frauds may also spread to CBDCs. Ensuring high standards of cyber security and parallel efforts on financial literacy is therefore essential for any country dealing with CBDC.
Absorption of CBDCs in the economy is also subject to technology preparedness. 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.
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Legal Framework
Although CBDCs are conceptually no different from banknotes, introduction of CBDC would require an enabling legal framework since the current legal provisions are made keeping in mind currency in paper form. 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 and generally to operate the currency and credit system of the country to its advantage” (Preamble).?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.
Conclusion
There is new era will start in India thereby the cost of printing money in paper form will vanish and Digital currency and technology driven payment methods will stay and continue to grow. The digital currency will also help in cross border transaction and trade finance activity. The Pandemic on one hand helped us to think how to perform all transaction though electronic form and digitally. Already there is development seen in digitalisation of trade activity. I am of the view the day is not too far to transfer cross border funds from my mobile though Fintech instead of Banks.
Retired Manager - Indian bank
3 年A well explained note