DIGITAL RUPEE - ECONOMY

News: RBI Digital Rupee pilot for wholesale segment from November 1

What's in the news?

       The first pilot in the Digital Rupee, Wholesale segment (e₹-W) will commence on November 1, 2022, the Reserve Bank of India (RBI) said in a circular.

 Key takeaways:

       The use case for this pilot is settlement of secondary market transactions in government securities.

       Use of e₹-W is expected to make the inter-bank market more efficient.

       Settlement in central bank money would reduce transaction costs by pre- empting the need for settlement guarantee infrastructure or for collateral to mitigate settlement risk.

       Going forward, other wholesale transactions, and cross-border payments will be the focus of future pilots, based on the learnings from this pilot.

       Nine banks namely State Bank of India, Bank of Baroda, Union Bank of India, HDFC Bank, ICICI Bank, Kotak Mahindra Bank, Yes Bank, IDFC First Bank and HSBC have been identified for participation in the pilot.

       The first pilot in Digital Rupee - Retail segment (e₹-R) is planned for roll out within a month in select locations in closed user groups comprising customers and merchants.

       The details regarding operationalization of e₹-R pilot will be communicated in due course.

Concept Note:

       The RBI also released a Concept Note on Central Bank Digital Currency (CBDC) for India.

       The purpose behind the issue of this Concept Note is to create awareness about CBDCs in general and the planned features of the Digital Rupee (e₹), in particular.

       It explains the objectives, choices, benefits, and risks of issuing a CBDC in India. The Note also seeks to explain Reserve Bank’s approach towards introduction of the CBDC.

       The Concept Note also discusses key considerations such as technology and design choices, possible uses of Digital Rupee, issuance mechanisms, etc.

       It examines the implications of introduction of CBDC on the banking system, monetary policy, financial stability, and analyses privacy issues.

Go back to basics:

       The central bank said that the development of CBDC could provide the public a risk-free virtual currency that will give them legitimate benefits without the risks of dealing in private virtual currencies.

       The approach for issuance of CBDC will be governed by two basic considerations such as follows.

       To create a digital rupee that is as close as possible to a paper currency.

       To manage the process of introducing digital rupee in a seamless manner.

       The central bank also feels that it is desirable for CBDCs to have offline capabilities to make it a more attractive and accessible medium of payment for a wide category of users.

 Types of CBDC:

       Based on the usage and the functions performed by the digital rupee and considering the different levels of accessibility, CBDC can be demarcated into two broad categories.

a.       General purpose (retail) (CBDC-R)

b.      Wholesale (CBDC-W).

 1. CBDC - R:

       Retail CBDC is an electronic version of cash primarily meant for retail transactions.

       It will be potentially available for use by all such as private sector, non-financial consumers and businesses and can provide access to safe money for payment and settlement as it is a direct liability of the central bank.

       However, the RBI has not explained how e-rupee can be used in merchant transactions in the retail trade.

 2. CBDC - W:

       Wholesale CBDC is designed for restricted access to select financial institutions.

       It has the potential to transform the settlement systems for financial transactions undertaken by banks in the government securities (G-Sec) segment, inter-bank market and capital market more efficiently and securely in terms of operational costs, use of collateral and liquidity management.

Forms of CBDC:

The central bank says e-rupee, or CBDC, can be structured as token-based or account-based.

1. Token-based CBDC:

       A token based CBDC would be a bearer instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them.

       In a token based CBDC, the person receiving a token will verify that his ownership of the token is genuine.

       A token-based CBDC is viewed as a preferred mode for CBDC-R as it would be closer to physical cash.

 2. Account-based CBDC:

       An account-based system would require maintenance of record of balances and transactions of all holders of the CBDC and indicate the ownership of the monetary balances.

       In this case, an intermediary will verify the identity of an account holder.

       This system can be considered for CBDC-W, the RBI said. 

What is the model for issuance?

There are two models for issuance and management of CBDCs under the RBI’s consideration such as

       Direct model (single tier model)

       Indirect model (two-tier model).

1. Direct Model:

       In the direct model, the central bank will be responsible for managing all aspects of the digital rupee system such as issuance, account-keeping and transaction verification.

2. Indirect Model:

 An indirect model would be one where the central bank and other intermediaries (banks and any other service providers), each play their respective role.

In this model, the central bank will issue CBDC to consumers indirectly through intermediaries and any claim by consumers will be managed by the intermediary.

Advantages of e-rupee:

The RBI said the key motivations for exploring the issuance of CBDC in India among others include

       Reduction in operational costs involved in physical cash management.

       Fostering financial inclusion.

       Bringing resilience.

       Efficiency and innovation in the payments system.

Can e-rupee be transacted in offline mode?

       The offline functionality as an option will allow CBDC to be transacted without the internet and thus enable access in regions with poor or no internet connectivity.

       It will also create digital footprints of the unbanked population in the financial system, which will facilitate the easy availability of credit to them.

       However, the RBI feels in the offline mode, the risk of ‘double-spending’ will exist because it will be technically possible to use a CBDC unit more than once without updating the common ledger of CBDC. But it can be mitigated to a larger extent by technical solutions and appropriate business rules including monetary limits on offline transactions, the central bank says.