DATE: Date : 07 Oct 2022

Preface

Central Bank Digital Currency (CBDC) is a digital form of currency notes issued by a central bank. While most central banks across the globe are exploring the issuance of CBDC, the key motivations for its issuance are specific to each country’s unique requirements.

This Concept Note explains the objectives, choices, benefits and risks of issuing a CBDC in India, referred to as e₹ (digital Rupee). The e₹ will provide an additional option to the currently available forms of money. It is substantially not different from banknotes, but being digital it is likely to be easier, faster and cheaper. It also has all the transactional benefits of other forms of digital money.

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, in particular. The Note also seeks to explain Reserve Bank’s approach towards introduction of the digital Rupee. Reserve Bank’s approach is governed by two basic considerations – to create a digital Rupee that is as close as possible to a paper currency and to manage the process of introducing digital Rupee in a seamless manner.

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.

The Reserve Bank will soon commence limited pilot launches of e₹ for specific use cases. It is expected that this note would facilitate a deeper appreciation and understanding of digital Rupee and help members of public prepare for its use.

Summary

Management of currency is one of the core central banking functions of the Reserve Bank for which it derives the necessary statutory powers from Section 22 of the RBI Act, 1934. Along with the Government of India, the Reserve Bank is responsible for the design, production and overall management of the nation’s currency, with the goal of ensuring an adequate supply of clean and genuine notes in the economy.

The history of money is fascinating and goes back thousands of years. From the early days of bartering to the first metal coins and eventually the first paper money, it has always had an important impact on the way we function as a society. The innovations in money and finance go hand in hand with the shifts in monetary history. In its evolution till date, currency has taken several different forms. It has traversed its path from barter, to valuable metal coins made up of bronze and copper which later evolved to be made up of silver and gold. Use of coins was a huge milestone in the history of money because they were one of the first currencies that allowed people to pay by count (number of coins) rather than weight. Somewhere along the way, people improvised by using claims on goods and a bill of exchange.

Money either has intrinsic value or represents title to commodities that have intrinsic value or title to other debt instruments. In modern economies, currency is a form of money that is issued exclusively by the sovereign (or a central bank as its representative) and is legal tender. Paper currency is such a representative money, and it is essentially a debt instrument. It is a liability of the issuing central bank (and sovereign) and an asset of the holding public.

Irrespective of the form of money, in any economy, money performs three primary functions – medium of exchange, a unit of account and a store of value. Money as a medium of exchange may be used for any transactions wherein goods or services are purchased or sold. Money as a unit of account can be used to value goods or services and express it in monetary terms. Money can also be stored or conserved for future purposes.

India has made impressive progress towards innovation in digital payments. India has enacted a separate law for Payment and Settlement Systems which has enabled an orderly development of the payment eco-system in the country. The present state-of-the-art payment systems that are affordable, accessible, convenient, efficient, safe, secure and available 24x7x365 days a year are a matter of pride for the nation. This striking shift in payment preference has been due to the creation of robust round the clock electronic payment systems such as Real Time Gross Settlement (RTGS) and National Electronic Funds Transfer (NEFT) that has facilitated seamless real time or near real time fund transfers. In addition, the launch of Immediate Payment Service (IMPS) and Unified Payments Interface (UPI) for instant payment settlement, the introduction of mobile based payment systems such as Bharat Bill Payment System (BBPS), and National Electronic Toll Collection (NETC) to facilitate electronic toll payments have been the defining moments that has transformed the payments ecosystem of the country and attracted international recognition. The convenience of these payment systems ensured rapid acceptance as they provided consumers an alternative to the use of cash and paper for making payments. The facilitation of non-bank FinTech firms in the payment ecosystem as PPI issuers, Bharat Bill Payment Operating Units (BBPOUs) and third-party application providers in the UPI platform have furthered the adoption of digital payments in the country. Throughout this journey, the Reserve Bank has played the role of a catalyst towards achieving its public policy objective of developing and promoting a safe, secure, sound, efficient and interoperable payment system.

With the developments in the economy and the evolution of the payments system, the form and functions of money has changed over time, and it will continue to influence the future course of currency. The concept of money has experienced evolution from Commodity to Metallic Currency to Paper Currency to Digital Currency. The changing features of money are defining new financial landscape of the economy. Further, with the advent of cutting-edge technologies, digitalization of money is the next milestone in the monetary history. Advancement in technology has made it possible for the development of new form of money viz. Central Bank Digital Currencies (CBDCs).

Recent innovations in technology-based payments solutions have led central banks around the globe to explore the potential benefits and risks of issuing a CBDC so as to maintain the continuum with the current trend in innovations. RBI has also been exploring the pros and cons of introduction of CBDCs for some time and is currently engaged in working towards a phased implementation strategy, going step by step through various stages of pilots followed by the final launch, and simultaneously examining use cases for the issuance of its own CBDC (Digital Rupee (e₹)), with minimal or no disruption to the financial system. Currently, we are at the forefront of a watershed movement in the evolution of currency that will decisively change the very nature of money and its functions.

Reserve Bank broadly defines CBDC as the legal tender issued by a central bank in a digital form. It is akin to sovereign paper currency but takes a different form, exchangeable at par with the existing currency and shall be accepted as a medium of payment, legal tender and a safe store of value. CBDCs would appear as liability on a central bank’s balance sheet.

Bank for International Settlement has laid down “foundational principles” and “core features” of a CBDC, to guide exploration and support public policy objectives, as per the need of existing mandate of Central Banks. The foundational principles emphasise that, authorities would first need to be confident that issuance would not compromise monetary or financial stability and that a CBDC could coexist with and complement existing forms of money, promoting innovation and efficiency.

Key Motivations

CBDC, being a sovereign currency, holds unique advantages of central bank money viz. trust, safety, liquidity, settlement finality and integrity. 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 payments system, adding efficiency to the settlement system, boosting innovation in cross-border payments space and providing public with uses that any private virtual currencies can provide, without the associated risks. The use of offline feature in CBDC would also be beneficial in remote locations and offer availability and resilience benefits when electrical power or mobile network is not available.

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. The rapid mushrooming of private cryptocurrencies in the last few years has attempted to challenge the fundamental notion of money as we know it. Claiming the benefits of de-centralisation, cryptocurrencies are being hailed as innovation that would usher in de-centralised finance and disrupt the traditional financial system. However, the inherent design of cryptocurrencies is more geared to bypass the established and regulated intermediation and control arrangements that play a crucial role of ensuring integrity and stability of monetary and financial eco-system.

As the custodian of monetary policy framework and with the mandate to ensure financial stability in the country, the Reserve Bank of India has been consistent in highlighting various risks related to the cryptocurrencies. These digital assets undermine India’s financial and macroeconomic stability because of their negative consequences for the financial sector. Further, a wider proliferation of cryptocurrencies has the potential to diminish monetary authorities’ potential to determine and regulate monetary policy and the monetary system of the country which could pose serious challenge to the stability of the financial system of the country.

In this context, it is the responsibility of central bank to provide its citizens with a risk free central bank digital money which will provide the users the same experience of dealing in currency in digital form, without any risks associated with private cryptocurrencies. Therefore, CBDCs will provide the public with benefits of virtual currencies while ensuring consumer protection by avoiding the damaging social and economic consequences of private virtual currencies.

Design Choices

As CBDCs are electronic form of sovereign currency, it should imbibe all the possible features of physical currency. The design of CBDC is dependent on the functions it is expected to perform, and the design determines its implications for payment systems, monetary policy as well as the structure and stability of the financial system. One of the main considerations is that the design features of CBDCs should be least disruptive.

The key design choices to be considered for issuing CBDCs include (i) Type of CBDC to be issued (Wholesale CBDC and/or Retail CBDC), (ii) Models for issuance and management of CBDCs (Direct, Indirect or Hybrid model), (iii) Form of CBDC (Token-based or Account-based), (iv) Instrument Design (Remunerated or Non-remunerated) and (v) Degree of Anonymity.

Type of CBDC to be issued

CBDC can be classified into two broad types viz. general purpose or retail (CBDC-R) and wholesale (CBDC-W). Retail CBDC would be potentially available for use by all viz. private sector, non-financial consumers and businesses while wholesale CBDC is designed for restricted access to select financial institutions. While Wholesale CBDC is intended for the settlement of interbank transfers and related wholesale transactions, Retail CBDC is an electronic version of cash primarily meant for retail transactions.

It is believed that Retail CBDC can provide access to safe money for payment and settlement as it is a direct liability of the Central Bank. Wholesale CBDC has the potential to transform the settlement systems for financial transactions and make them more efficient and secure. Going by the potential offered by each of them, there may be merit in introducing both CBDC-W and CBDC-R.

Model for issuance and management of CBDC

There are two models for issuance and management of CBDCs viz. Direct model (Single Tier model) and Indirect model (Two-Tier model). A Direct model would be the one where the central bank is responsible for managing all aspects of the CBDC system viz. issuance, account-keeping and transaction verification.

In an Indirect model, central bank and other intermediaries (banks and any other service providers), each play their respective role. In this model central bank issues CBDC to consumers indirectly through intermediaries and any claim by consumers is managed by the intermediary as the central bank only handles wholesale payments to intermediaries.

The Indirect model is akin to the current physical currency management system wherein banks manage activities like distribution of notes to public, account-keeping, adherence of requirement related to know-your-customer (KYC) and anti-money laundering and countering the terrorism of financing (AML/CFT) checks, transaction verification etc.

Forms of CBDC

CBDC can be structured as ‘token-based’ or ‘account-based’. A token-based CBDC is a bearer-instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them. In contrast, 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. Also, in a token-based CBDC, the person receiving a token will verify that his ownership of the token is genuine, whereas in an account-based CBDC, an intermediary verifies the identity of an account holder. Considering the features offered by both the forms of CBDCs, a token-based CBDC is viewed as a preferred mode for CBDC-R as it would be closer to physical cash, while account-based CBDC may be considered for CBDC-W.

Technology choice

CBDCs being digital in nature, technological consideration will always remain at its core. The infrastructure of CBDCs can be on a conventional centrally controlled database or on Distributed Ledger Technology. The two technologies differ in terms of efficiency and degree of protection from single point of failure. The technology considerations underlying the deployment of CBDC needs to be forward looking and must have strong cybersecurity, technical stability, resilience and sound technical governance standards. While crystallising the design choices in the initial stages, the technological considerations may be kept flexible and open-ended in order to incorporate the changing needs based on the evolution of the technological aspects of CBDCs.

Instrument Design

The payment of (positive) interest would likely enhance the attractiveness of CBDCs that also serves as a store of value. But, designing a CBDC that moves away from cash-like attributes to a “deposit-like” CBDC may have a potential for disintermediation in the financial system resulting from loss of deposits by banks, impeding their credit creation capacity in the economy. Also considering that physical cash does not carry any interest, it would be more logical to offer non-interest bearing CBDCs.

Degree of Anonymity

For CBDC to play the role as a medium of exchange, it needs to incorporate all the features that physical currency represents including anonymity, universality, and finality. Ensuring anonymity for a digital currency particularly represents a challenge, as all digital transactions would leave some trail. Clearly, the degree of anonymity would be a key design decision for any CBDC. In this regard, reasonable anonymity for small value transactions akin to anonymity associated with physical cash may be a desirable option for CBDC-R.

While the intent of CBDC and the expected benefits are well understood, it is important that the issuance of CBDC needs to follow a calibrated and nuanced approach with adequate safeguards to address potential difficulties and risks in order to build a system which is inclusive, competitive and responsive to innovation and technological changes. CBDC, across the world, is mostly in conceptual, developmental, or at pilot stages. Therefore, in the absence of a precedence, extensive stakeholder consultation along with iterative technology design may be the requirement, to develop a solution that meets the requirements of all stakeholders.

CBDC is aimed to complement, rather than replace, current forms of money and is envisaged to provide an additional payment avenue to users, not to replace the existing payment systems. Supported by state-of-the-art payment systems of India that are affordable, accessible, convenient, efficient, safe and secure, the Digital Rupee (e₹) system will further bolster India’s digital economy, make the monetary and payment systems more efficient and contribute to furthering financial inclusion.

Chapter 1: Introduction

1.1 Maintaining monetary and financial stability and explicitly or implicitly promoting broad access to safe and efficient payments, have been among the main objectives of the RBI. Monetary stability is secured by virtue of the statutory responsibility of currency management conferred on the Reserve Bank in the Preamble of the Reserve Bank of India Act, 1934, which mandates the Reserve Bank to regulate the issue of Bank notes and keeping of reserves. A core instrument by which central banks carry out their public policy objectives is by providing central bank money, which is the safest form of money to banks, businesses, and the public.

1.2 The history of money is fascinating and goes back thousands of years. From the early days of bartering to the first metal coins and eventually the first paper money, it has always had an important impact on the way we function as a society. The innovations in money and finance go hand in hand with the shifts in monetary history. In its evolution till date, currency has taken several different forms. It has traversed its path from barter to valuable metal coins made up of bronze and copper which later evolved to be made up of silver and gold. Somewhere along the way, people improvised and instead of actual goods for barter they started using claims on goods, a bill of exchange.

1.3 Money either has intrinsic value or represents title to commodities that have intrinsic value or title to other debt instruments. In modern economies, currency is a form of money that is issued exclusively by the sovereign (or a central bank as its representative) and is legal tender. Paper currency is such a representative money, and it is essentially a debt instrument. It is a liability of the issuing central bank (and sovereign) and an asset of the holding public. Central Bank Money acts as medium of payment, a unit of account and a store of value for a jurisdiction.

1.4 Payment systems are changing at an accelerating pace. Today, users expect faster, easier payments anywhere and at any time, mirroring the digitalisation and convenience of other aspects of life (Bech et al,2017). Systems that offer near instant person-to-person retail payments are becoming increasingly prevalent around the world. India has always been a country that has fostered innovation and development in the area of payment and settlement systems. The past decades have witnessed the blossoming of a myriad of payment systems, all for the convenience of the common man. Reserve Bank of India has taken several initiatives since the mid-eighties to bring in technology-based solutions to the banking system. 

1.5 India has made impressive progress towards innovation in digital payments. India has enacted a separate law for Payment and Settlement Systems which has enabled an orderly development of the payment eco-system in the country. The present state-of-the-art payment systems that are affordable, accessible, convenient, efficient, safe, secure and available 24x7x365 days a year are a matter of pride for the nation. This striking shift in payment preference has been due to the creation of robust round the clock electronic payment systems such as RTGS and NEFT that has facilitated seamless real time or near real time fund transfers. In addition, the launch of IMPS and UPI for instant payment settlement, the introduction of mobile based payment systems such as BBPS, and National Electronic Toll Collection (NETC) to facilitate electronic toll payments have been the defining moments that has transformed the payments ecosystem of the country and attracted international recognition. The convenience of these payment systems ensured rapid acceptance as they provided consumers an alternative to the use of cash and paper for making payments. The facilitation of non-bank FinTech firms in the payment ecosystem as PPI issuers, BBPOUs and third-party application providers in the UPI platform have furthered the adoption of digital payments in the country. Throughout this journey, the Reserve Bank has played the role of a catalyst towards achieving its public policy objective of developing and promoting a safe, secure, sound, efficient and interoperable payment system.

1.6 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. The rapid mushrooming of private cryptocurrencies in the last few years has attempted to challenge the fundamental notion of money as we know it. Claiming the benefits of de-centralisation, cryptocurrencies are being hailed as innovation that would usher in de-centralised finance and disrupt the traditional financial system. However, the inherent design of cryptocurrencies is more geared to bypass the established and regulated intermediation and control arrangements that play a crucial role of ensuring integrity and stability of monetary and financial eco-system.

1.7 As the custodian of monetary policy framework and with the mandate to ensure financial stability in the country, the Reserve Bank of India has been consistent in highlighting various risks related to the cryptocurrencies. These digital assets undermine India’s financial and macroeconomic stability because of their negative consequences for the financial sector. Further, a wider proliferation of cryptocurrencies has the potential to diminish monetary authorities’ potential to determine and regulate monetary policy and the monetary system of the country which could pose serious challenge to the stability of the financial system of the country.

1.8 In addition to the process of making payments, even the types of money being used for making payments are undergoing change. The Central Banks provide money to the public through physical cash and to banks and other financial entities through reserve and settlement accounts. Recent technological advances have ushered in a wave of new private-sector financial products and services, including digital wallets, mobile payment apps, and new digital assets. While cash is still the king (Bech et al (2018)), innovations are pushing Central Banks to think about how new central bank digital currencies (CBDCs) could complement or replace traditional money (Committee on Payments and Market Infrastructures and the Markets Committee (CPMI-MC) (2018)). CBDC is a third form of base money, and central banks around the globe are exploring its feasibility, potential benefits, and the risks involved. As per the results of 2021 Bank for International Settlements (BIS) survey on CBDCs conducted on 81 central banks, 90% of central banks are engaged in some form of CBDC work and more than half are now developing them or running concrete experiments.

1.9 Recognising the global developments in the field of CBDC, the Reserve Bank had set up an Internal Working Group (WG) in October 2020 to undertake a study on appropriate design / implementation architecture for introducing CBDCs in India. The WG in their February 2021 report made the following major recommendations:

Need for a robust legal framework to back the issuance of e₹ (Digital Rupee)2 as another form of currency. It was recommended to amend the RBI Act to cover e₹ in the definition of the term ‘bank note’ and also insert a new section in the RBI Act covering features pertaining to e₹ and necessary exemptions.

The design of e₹ may be decided depending on the circumstances and the need of the country. It recommended that the design of e₹ should be compatible with the objectives of monetary and financial stability.

The most widespread use and advantage of e₹ was expected to emerge from the token-based variant in the retail segment. Keeping this in mind, the WG recommended undertaking some pilot projects with phased implementation to serve as a learning experience.

Implementation of a specific purpose e₹, one each in the wholesale and retail segments to begin with. The proposed models could be implemented with little or no disruption to the market and help unravel the benefits of CBDC. For Wholesale CBDC (CBDC-W), a phased implementation strategy for wholesale account-based CBDC3 model, in securities settlement (outright), was proposed. For Retail CBDC (CBDC-R), a token-based CBDC4 with tiered architecture model was proposed wherein the Reserve Bank shall only issue and redeem e₹ while the distribution and payment services will be delegated to the banks.

As traceability, privacy and transaction costs vary for each CBDC type resulting in different cost implications for each stakeholder, the need to conduct more research on the technological aspects of CBDC implementation on a national scale was recommended.

The WG was of the view that finalising a model for implementation of e₹ within a short duration may not be desirable and re-iterated that the initial models proposed be simple models that could be considered to commence work in this connection. The WG proposed to continue deliberations on CBDC over a longer period to refine and crystallise requirements for the implementation of other models of e₹ in future.

1.10 Earlier, in November 2017, a High Level Inter-ministerial committee was constituted under the chairmanship of the Secretary, Department of Economic Affairs (DEA), Ministry of Finance, Government of India (GoI) to examine the policy and legal framework for regulation of virtual / crypto currencies and recommend appropriate measures to address concerns arising from their use. The committee had recommended the introduction of CBDCs as a digital form of sovereign currency in India.

1.11 Across the globe, more than 60 central banks5 have expressed interest in CBDC with a few implementations already under pilot across both Retail6 and Wholesale7 categories and many others are researching, testing, and/or launching their own CBDC framework. As of July 2022, there are 105 countries8 in the process of exploring CBDC, a number that covers 95% of global Gross Domestic Product (GDP). 10 countries have launched a CBDC, the first of which was the Bahamian Sand Dollar in 2020 and the latest was Jamaica’s JAM-DEX. Currently, 17 other countries, including major economies like China and South Korea, are in the pilot stage and preparing for possible launches. China was the first large economy to pilot a CBDC in April 2020 and it aims for widespread domestic use of the e-CNY by 2023. Increasingly, CBDCs are being seen as a promising invention and as the next step in the evolutionary progression of sovereign currency.

1.12 Like other central banks, RBI has been exploring the pros and cons of introduction of CBDCs for some time. The introduction of CBDC in India is expected to offer a range of benefits, such as reduced dependency on cash, lesser overall currency management cost, and reduced settlement risk. It could provide general public and businesses with a convenient, electronic form of central bank money with safety and liquidity and provide entrepreneurs a platform to create new products and services. The introduction of CBDC, would possibly lead to a more robust, efficient, trusted, regulated and legal tender-based payments option (including cross-border payments).

1.13 However, CBDC could also pose certain risks that may have a bearing on important public policy issues, such as risk to financial stability, monetary policy, financial market structure and the cost and availability of credit. They need to be carefully evaluated against the potential benefits.

1.14 Government of India announced the launch of the Digital Rupee — a Central Bank Digital Currency (CBDC) from FY 2022-23 onwards in the Union Budget placed in the Parliament on February 01, 2022. In the budget announcement it was stated that the introduction of CBDC will give a big boost to the digital economy. The broad objectives to be achieved by the introduction of CBDC using blockchain and other technologies as a ‘more efficient and cheaper currency management system’ were also laid down in the budget.

1.15 The Government of India vide gazette notification dated March 30, 2022 notified the necessary amendments in the Reserve Bank of India Act, 1934, which enables running the pilot and subsequent issuance of CBDC.

1.16 An internal high-level committee on CBDC under the chairmanship of Shri Ajay Kumar Choudhary, Executive Director, RBI was constituted in February 2022 by the Reserve Bank to brainstorm and undertake an extensive study on various aspects of CBDC and explore the motivation for the introduction of CBDC, its design features and its implications on policy issues, choice of technology platforms and accordingly suggest measures for its successful introduction.

1.17 Based on the deliberations in the Committee, the Reserve Bank hereby releases this Concept Note to present the background, motivation, choices of design features and other policy frameworks for e₹ system for the country. The aim is to build an open, inclusive, inter-operable and innovative CBDC system which will meet the aspirations of the modern digital economy of India.

Chapter 2: CBDC – Conceptual Framework

2.1 What is CBDC?

The report by the CPMI-MC published in 2018 defines CBDCs as new variants of central bank money different from physical cash or central bank reserve/settlement accounts. That is, a central bank liability, denominated in an existing unit of account, which serves both as a medium of exchange and a store of value. The four different properties of money are: (i) issuer (central bank or not); (ii) form (digital or physical); (iii) accessibility (wide or narrow); and (iv) technology (peer-to-peer tokens, or accounts) (Bech and Garratt (2017)). Based on these four properties, the CPMI-MC report provides a taxonomy of money (‘The Money Flower’), which delineates two broad types of CBDC: general purpose and wholesale – with the former type coming in two varieties (Figure 1).

(Figure 2. The money flower: a taxonomy of money. CB = central bank. Source: CPMI-MC (2018); Bech and Garratt (2017))
Reserve Bank defines CBDC as the legal tender issued by a central bank in a digital form. It is the same as a sovereign currency and is exchangeable one-to-one at par (1:1) with the fiat currency9. While money in digital form is predominant in India—for example in bank accounts recorded as book entries on commercial bank ledgers—a CBDC would differ from existing digital money available to the public because a CBDC would be a liability of the Reserve Bank, and not of a commercial bank.

2.2 Features of CBDC

The features of CBDC include:

CBDC is sovereign currency issued by Central Banks in alignment with their monetary policy

It appears as a liability on the central bank’s balance sheet

Must be accepted as a medium of payment, legal tender, and a safe store of value by all citizens, enterprises, and government agencies.

Freely convertible against commercial bank money and cash

Fungible legal tender for which holders need not have a bank account

Expected to lower the cost of issuance of money and transactions

Chapter 3 – Motivations for issuance of CBDCs

3.1 Different jurisdictions have justified the adoption of CBDC for very diverse reasons. Some of them are enumerated below:

Central Banks, faced with dwindling usage of paper currency, seek to popularise a more acceptable electronic form of currency (like Sweden);

Jurisdictions with significant physical cash usage seeking to make issuance more efficient (like Denmark, Germany, Japan or even the US);

Countries with geographical barriers restricting the physical movement of cash had motivation to go for CBDC (e.g. The Bahamas and the Caribbean with small and large numbers of islands spread out);

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.

3.2 Further, CBDCs have some clear advantages over other digital payments systems, as it being a sovereign currency, ensures settlement finality and thus reduces settlement risk in the financial system. CBDCs could also potentially enable a more real-time, cost-effective seamless integration of cross border payment systems. India has made impressive progress in innovation in digital payments. The payment systems are available 24X7, 365 days a year to both retail and wholesale customers, they are largely real-time, the cost of transaction is perhaps the lowest in the world, users have a wide array of options for doing transactions and digital payments have grown at an impressive CAGR of 55% over the last five years.

3.3 Supported by the state-of-the-art payment systems of India that are affordable, accessible, convenient, efficient, safe and secure, the e₹ system will bolster India’s digital economy, enhance financial inclusion, and make the monetary and payment systems more efficient. There are a large and diverse number of motivations for India to consider CBDC. Some of the important motivations for India to consider issuing CBDC are given below.

3.3.1 Reduction in cost associated with physical cash management

Cost of cash management in India has continued to be significant. The total expenditure incurred on security printing during April 1, 2021 to March 31, 2022 was ₹4,984.80 crore as against ₹4,012.10 crore in the previous year (July 1, 2020 to March 31, 2021)10. This cost, which does not include the Environmental, Social, and Governance (ESG) cost of printing money, is predominantly borne by four stakeholders –general public, businesses, banks, and the Central Bank. CBDC affects the overall value of the money issuing function to the extent that it reduces operational costs e.g. costs related to printing, storage, transportation and replacement of banknotes, and costs associated with delay in reconciliation and settlement. Though, at the outset, establishing a CBDC creation/issuance may entail significant fixed infrastructure costs but subsequent marginal operating costs shall be very low. Cost-effectiveness of cash management using CBDC vis-à-vis physical currency provides an additional motivation for introduction of CBDC, which may be also perceived to be environment friendly. Complementing the higher cash requirement of the country, CBDC will lead to lowering of cost as it would obviate the need of many processes associated with distribution of physical currency across the country. Further, given the geographical spread and pockets where making physical cash available is a challenge, CBDC is expected to facilitate seamless transactions.

3.3.2 To further the cause of digitisation to achieve a less cash economy.

India has a unique case where the cash in the economy has shot up despite rapid digitisation in the payments space. The growing use of electronic medium of payment has not yet resulted in a reduction in the demand for cash. The percentage increase in value of banknotes during 2020-21 and 2021-22 was 16.8 per cent and 9.9 per cent respectively and the percentage increase in volume of banknotes during 2020-21 and 2021-22 was 7.2 per cent and 5.0 per cent respectively. (Source: RBI Annual Report for the year 2021-22)

The year (2021-22) witnessed a higher than average increase in banknotes in circulation primarily due to precautionary holding of cash by the public induced by the second wave of COVID-19 pandemic. Further, a pilot survey conducted by the Reserve Bank on retail payment habits of individuals in six cities between December 2018 and January 2019, indicated that cash remains the most preferred mode of payment and for receiving money for regular expenses; it was followed by digital mode. For small value transactions (with amount up to ₹500) cash is used predominantly.

CBDC can be a preferred mode of holding central bank money rather than cash in any uncertain situation like the one of pandemic COVID-19. Further, the preference for cash transactions for regular expenses and small payments for its anonymity, may be redirected to acceptance of CBDC, if reasonable anonymity is assured. This shall further the digitisation process in the country.

The Reserve Bank Digital Payment index (RBI-DPI) demonstrates significant growth in adoption and deepening of digital payments across the country since its inception.

This increase indicates that the digital payments are further deepening and expanding in the country and is an indication that, Indian citizens have an appetite for digital payments. Therefore, the digital currency issued by the central bank shall provide yet another option for furthering the cause of digital payment, apart from the range of other digital payment instruments available, given its ease of usage coupled with sovereign guarantee.

3.3.3 Supporting competition, efficiency and innovation in payments

The digital revolution is taking the world by storm and no other area has witnessed such metamorphosis as payment and settlement systems, resulting in an array of digital options for the common man. Consumers now have a range of options to choose from when selecting a payment method to complete a transaction. They make this selection based on the value they attribute to a payment method in a certain situation as each payment mode has its own use and purpose. The shift from cash to electronic payments increases the reliance on electronic payment systems, which has implications for the diversity and resilience of the payments landscape.

CBDC could further enhance resilience in payments and provide core payment services outside of the commercial banking system. It can provide a new way to make payments and also diversify the range of payment options, particularly for e-commerce (where cash cannot be used, except for the Cash on Delivery (COD) option). The CBDC based payment system is not expected to substitute other modes of existing payment options rather it will supplement by providing another payment avenue to the larger public. As has been the experience with many payment products, once CBDC is introduced, innovations around the product would only expand the choices available and healthy competition will help bringing about both cost and time efficiencies.

Most payments in a modern economy are made with private money maintained by commercial banks, which are in the form of demand deposits and therefore liabilities of these banks. A key feature of bank deposits is that commercial banks guarantee convertibility on demand to central bank money at a fixed price, namely, at par, thereby maintaining the value of their money. Nevertheless, in a fractional reserve system, a commercial bank—even if solvent— may face a challenge to meet with any sudden spurt in demand to convert substantial amount of bank deposits to central bank money. A significant difference between the central bank money and commercial bank money is that central bank can meet its obligations using its own nonredeemable money, while the latter entails counterparty risk. Central Bank money is the only monetary asset in a domestic economy without credit and liquidity risk. Therefore, it is preferred asset to settle payments in financial market infrastructures (see CPMI-IOSCO Principles for Financial Market Infrastructures (2012)).

Therefore, an e₹ would offer the public broad access to digital money free from credit risk and liquidity risk. As such, it could provide a safe foundation for private-sector innovations to meet current and future needs and demands for payment services. It shall also help in levelling the playing field in payment innovation for firms of all sizes. For some smaller firms, the costs and risks of issuing a safe and robust form of private tender may be prohibitive. A CBDC could overcome this barrier and allow private-sector innovators to focus on new access services, distribution methods, and related service offerings. Finally, a CBDC might generate new capabilities to meet the evolving speed and efficiency requirements of the digital economy.

Further, payments using CBDCs are final and thus reduce settlement risk in the financial system. CBDC will eliminate the need for interbank settlement by giving choices to market participants to choose among the various settlement options such as settlement in Central Bank / commercial bank accounts with / without using clearing corporations; or settlement on a bilateral basis without use of central counterparty by directly using CBDC accounts. It can be compared to a cash-based transaction, where instead of banknotes, CBDC is handed over leading to instant settlement. This is expected to bring in further efficiency in the payment system.

3.3.4 To explore the use of CBDC for improvement in cross-border transactions

The present state-of-the-art payment systems of India are affordable, accessible, convenient, efficient, safe and secure and are a matter of pride for the nation. However, ‘Cross Border Payments’ is an area especially ripe for change and could benefit from new technologies. As per the World Bank, India is the world’s largest recipient of remittances as it received $87 billion in 2021 with the United States being the biggest source, accounting for over 20 per cent of these funds. The cost of sending remittances to India, therefore, assumes critical relevance, especially in view of the large Indian diaspora spread across the world and from the point of view of the potential (mis)use of informal / illegal channels.

The G20 has also made enhancing cross-border payments a priority and endorsed a comprehensive programme to address the key challenges to cross border payment, namely high costs, low speed, limited access and insufficient transparency and frictions that contributed to these challenges. Faster, cheaper, more transparent, and more inclusive cross-border payment services would deliver widespread benefits for citizens and economies worldwide, supporting economic growth, international trade, global development and financial inclusion. BIS has published the results from a survey of Central Banks in June, 2021, which notes that CBDCs could ease current frictions in cross-border payments – and particularly so if central banks factor an international dimension into CBDC design from the outset.

As noted by BIS, the potential benefits will be difficult to achieve unless central banks incorporate cross-border considerations in their CBDC design from the start and coordinate internationally. Many central banks are currently investigating risks, benefits and various designs of CBDC, mainly with a strong focus on domestic needs. Implications of CBDCs, even if only intended for domestic use, are expected to go beyond borders, making it crucial to coordinate work and find common ground among CBDCs of various jurisdictions. If coordinated successfully, the ‘clean slate’ presented by CBDCs may be leveraged to enhance cross-border payments. According to BIS survey among central banks in late 2020, cross-border payments efficiency is an important motivation for CBDC issuance, especially with regards to wholesale CBDC projects. CBDCs can boost innovation in cross-border payments, making these transactions instantaneous and help overcome key challenges relating to time zone, exchange rate differences as well as legal and regulatory requirements across jurisdictions. Additionally, the interoperability of CBDCs presents means to mitigate cross-border and cross-currency risks and frictions while reinforcing the role of central bank money as an anchor for the payment system. Therefore, the potential use of CBDC in alleviating challenges in cross-border payment is one of the major motivations for exploring issuance of CBDC.

3.3.5 Support financial inclusion

The annual FI-Index for India for March 2022 is 56.4 vis-à-vis 53.9 in March 2021. It demonstrates the fact that despite various measures undertaken by various stakeholders in strengthening financial inclusion in the country, further coordinated effort is required by the policy makers to achieve the desired goal.

Some of the existing challenges to financial inclusion include limited physical infrastructure – especially in remote areas, poor connectivity, non-availability of customized products, socio-cultural barriers, lack of integration of credit with livelihood activities or other financial services across insurance, pension etc. With suitable design choices, CBDC may provide the public a safe sovereign digital money for meeting various transaction needs. It shall make financial services more accessible to the unbanked and underbanked population. The offline functionality as an option will allow CBDCs to be transacted without the internet and thus enable access in regions with poor or no internet connectivity. It shall also create digital footprints of the unbanked population in the financial system, which shall facilitate the easy availability of credit to them.

Universal access attributes of a CBDC including offline functionality, provision of universal access devices and compatibility across multiple devices, shall prove to be a gamechanger by improving the overall CBDC system for reasons of resilience, reach and financial inclusion.

3.3.6 Safeguard the trust of the common man in the national currency vis-à-vis proliferation of crypto assets

Christine Lagarde, President of the European Central Bank (ECB), chair of the group of central bank governors responsible for the report titled ‘Central bank digital currencies: foundational principles and core features’, while releasing the report stated that “… central banks have a duty to safeguard people’s trust in our money. Central banks must complement their domestic efforts with close cooperation to guide the exploration of central bank digital currencies to identify reliable principles and encourage innovation.” The proliferation of crypto assets can pose significant risks related to Money Laundering & Financing of Terrorism. Further, the unabated use of crypto assets can be a threat to the monetary policy objectives as it may lead to creation of a parallel economy and will likely undermine the monetary policy transmission and stability of the domestic currency. It will also adversely affect the enforcement of foreign exchange regulations, especially, the circumvention of capital flow measures.

Further, developing CBDC could provide the public a risk free virtual currency that will provide them legitimate benefits without the risks of dealing in private virtual currencies. It may, therefore, fulfil demand for secured digital currency besides protecting the public from the abnormal level of volatility which some of these virtual digital assets experience. Thus, safeguarding the trust of the common man in the Indian Rupee vis-à-vis proliferation of crypto asset is another important motivation for introducing CBDC.