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RBI Hints At The Potential Use-Case and Design Of Its Digital Currency

The Reserve Bank of India (RBI) believes that a Central Bank-backed Digital Currency (CBDC) could aid in direct benefit transfers and with its capital management practices. However if not designed right it poses risks to the banking system, it said in its Report on Currency and Finance for 2020-21.

Last week, RBI Governor Shaktikanta Das said that the RBI was working on guidelines and a policy policy would be published shortly for the proposed CBDC or Digital Rupee. Das hinted that that RBI’s guideline and proposed policy paper could address two aspects, one on how to capitalise from the benefits of blockchain technology and the second on operations of the CBDC. Over the last month the crypto-currency industry in India has been thrown into a tizzy, ever since the government said it would introduce a new law which would ban “private” crypto-currencies, while creating a national digital currency. As very little information about the bill is available, speculation surrounding what the government and RBI is planning has grown over the past few weeks.

Direct Benefit Transfers

In its report, the RBI says that a CBDC can be used to directly improve welfare delivery to individuals.

“Several countries have been toying with the idea of launching central bank digital currency (CBDC) in some form or the other. The attractiveness of CBDC stems from its digital feature as well as from being a sovereign liability. CBDC can be designed to promote non-anonymity at the individual level, monitor transactions, promote financial inclusion by direct benefit fiscal transfer, pumping central bank ‘helicopter money’ and even direct public consumption to a select basket of goods and services to increase aggregate demand and social welfare, thereby acting as a direct instrument of monetary transmission”— Report on Currency and Finance

Helicopter Money is essentially a monetary policy tool to increase the flow of money and credit in an economy to stimulate consumption and growth. Traditionally, to increase the flow of credit and money increase or decrease, central banks decrease the rate that banks can borrow liquidity overnight from them and vice versa. Since this model relies on the banking system to pass on the benefits of a lower interest rate to consumers, there are frictions and delays. Helicopter money essentially allows the RBI to directly provide liquidity to individuals or for specific goods and services.

Bolstering Central Bank Balance Sheet

Most central banks around the world are pursuing an non-interest bearing CBDC, which means that the value of the Digital Currency is pegged to the Indian Rupee and does not rise. However, the RBI does point out to some benefits of an interest bearing CBDC. The RBI says that a CBDC can be used by institutions to settle payments and pay their liabilities if they have issues with liquid assets like cash or government securities.

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“An interest-bearing CBDC can increase the economy’s response to changes in the policy rate. In advanced economies with low growth and inflation and facing the constraint of “zero lower bound”, CBDC can help countries overcome the constraint with the monetary authority offering negative nominal interest rates to its holders. In emerging markets facing large scale capital inflows, CBDC can act as an instrument of sterilisation, alleviating the constraint that a finite stock of government securities in central bank balance sheet poses. A standing deposit facility (SDF) can also play a similar role, but CBDC, if designed to cater to not only wholesale institutions, but also retail individuals, can directly improve and fasten transmission”—Report on Currency and Finance

CBDCs Can Threaten Banking Model

Through a digital interest-bearing currency, the RBI can either pass on interest rate benefits to all consumers or specific beneficiaries directly. It can also reduce or increase the rate offered on the CBDC to increase or decrease the money supply in an economy thereby, controlling inflation. However, there are risks to a CBDC tat is an interest-bearing CBDC since it can threaten the role banks play in terms of providing deposits and loans and other market instruments.

“CBDC is, however, not an unmixed blessing – it poses a risk of disintermediation of the banking system, more so if the commercial banking system is perceived to be fragile. The public can convert their CASA [Current and Savings Accounts] deposits with banks into CBDC, thereby raising the cost of bank-based financial intermediation with implications for growth and financial stability. In countries with significant credit markets, commercial banks may lose their primacy as the major conduit of monetary policy transmission”—Report on Currency and Finance

The financial system is depenedent on central banks printing or reducing the availability of money in an economy. The banking industry depends on the availability of funds every day from the RBI, at a low interest rate, in order to manage its operations. The more liquidity a central bank provides to the banking system, the more money is available for lending to consumers and businesses, and vice versa. If the use and reliance of CBDCs grows significantly, beyond cash and traditional assets and payment instruments, it could threaten banks and financial companies that today play an intermediary role. If there is a reliance on the availability of cheap funds directly from the RBI through CBDCs, individuals and institutions will avoid traditional financial companies.

CBDCs With Limitations

To limit the risks of consumers and institutions relying on CBDCs to such a large extent that it threatens the balance sheets of traditional banks and financial institutions, the RBI said that certain limitations can be placed on the issuance of Digital Currencies.

“One recently proposed solution to limit disintermediation is the introduction of a 2-tier remuneration system for CBDCs, whereby transaction balances held by an individual remain interest free and is subject to a ceiling; while CBDC balances of the individual over and above the ceiling are subject to a penal negative interest rate. CBDCs providing anonymity may also have implications for cross border payments in violation of extant acts; appropriate safeguards against AML/CFT [Anti-Money Laundering/Combating the Financing of Terrorism] would need to be laid down”—Report on Currency and Finance


MediaNama has prepared a guide on crypto-currency regulations in India, listing the government’s position over the last few years and various policy recommendations; read it here: A complete low-down on crypto-currency regulation in India

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