Why India Needs To Restrict CBDCs To A Fewer Applications


When India already has a popular mobile payments solution that is cost-effective and scalable, what purpose does the CBDC-R solve, ask experts

CBDC could be an effective instrument for government transactions and cross-border payments solution

Launching CBDC-R to counter cryptocurrencies is a misplaced priority

Expanding its central bank digital currency (CBDC) pilot, the Reserve Bank of India (RBI) is looking to join hands with five more banks — Axis bank, Federal bank, Punjab National Bank, Canara Bank and IndusInd Bank. Up until now, eight banks have boarded more than 50,000 users and 5,000 merchants in the retail digital rupee space.

Not only this, the RBI recently signed an MoU with the Central Bank of UAE to jointly explore opportunities around facilitating cross-border CBDC transactions of remittances and trade.

At a time when the RBI is slowly making headway with its CBDC pilot, it is probably time to reanalyse such an initiative, especially when the country is already fostering a vibrant digital payment ecosystem.

To do this, we will have to understand the pros and cons attached to the digital currency, thereby jumping onto more crucial aspects like how the mass adoption of CBDCs could be a possible threat to the Indian banking system, and the future of India’s UPI (Unified Payments Interface), among other things.

As of now, some of the major challenges eclipsing the country’s ambitious CBDC project are as follows:

A Costly Affair And Threat To RBI’s Reputation?

In its concept, the central bank noted that the total expenditure incurred on security printing of bank notes from April 1, 2021, to March 31, 2022, was INR 4,984.80 Cr as against INR 4,012.10 Cr between July 1, 2020, and March 31, 2021.

While it noted that CBDC reduces operational costs related to printing, storage, transportation and the replacement of banknotes, it added that establishing a CBDC and its issuance entail significant fixed infrastructure costs and constant upgradation.

The International Monetary Fund, too, has raised the same issue. In a report, the financial agency of the United Nations has observed that offering CBDC could be very costly for the central banks, and could pose risks to their reputations.

According to the report, offering a full-fledged CBDC requires central banks “to be active along several steps of the payments value chain, potentially including interfacing with customers, building front-end wallets, picking and maintaining technology, monitoring transactions, and being responsible for anti-money laundering and countering the financing of terrorism.”

A failure in any of these functions, due to technical glitches, cyberattacks, or human errors, could undermine a central bank’s reputation.

CBDCs Could Adversely Impact The Conventional Banking System

Token-based CBDCs don’t need bank accounts. This may shift people’s focus from banks to fintech applications for financial services. The more a CBDC gets popular, the lesser deposits banks may record.

According to a study by Duke University, “The introduction of a CBDC does impact bank deposits with an overall 10% drop in the level of bank deposits. However, only a third of the impact on deposits is passed through to lending. The attenuated impact on bank lending happens because banks can replace deposits with wholesale funding.”

The RBI raised this issue in its concept note too. It observed, a non-interest bearing CBDC can avoid a major disruption to banking services and a possible disintermediation of banks.

However, there is still a concern expressed in some quarters that there could be a possibility of shifting of some of the current accounts maintained by corporates and business entities with banks in favour of CBDC to gain access to the central bank money.

A Lopsided Financial Inclusion

According to the RBI, the digital rupee can make financial services more accessible to the unbanked and underbanked population of the country.

Further, the offline functionality will allow CBDC transactions to take place without the internet, enabling access to regions with poor or no internet connectivity.

The apex bank believes this will also create digital footprints of the unbanked population in the financial system.

Contrary to the RBI’s belief, experts are of the view that Indians who do not hold a bank account are the ones that do not have a smartphone as well, so the idea of a lock, stock, and barrel financial inclusion takes a back seat here.

“One may not need a bank account to operate in CBDC, but one needs a smartphone. Today, around 700 Mn Indians have bank accounts, and the population with smartphones hovers around the same number. There is a high probability that the Indians who don’t have bank accounts are the ones who don’t own a smartphone. So, the idea that CBDCs will cater to those who don’t have bank accounts is misleading,” a banker argued.

He added that it is a good idea to have an offline feature; however, people who own smartphones also have access to online transactions. Further, NPCI has already enabled offline transactions on UPI by dialling *99# USSD code. However, the feature has not been that popular.

The offline transactions in CBDC will be simpler and easier in comparison to offline UPI, however, the TAM could be too small to focus on and could now be addressed by UPI Lite, which was rolled out recently, experts believe.

Launching CBDC To Counter Crypto Is Not A Good Idea, Say Experts 

The RBI has been pitching that e₹-R will provide the public with virtual currencies that carry the ‘legitimate benefits of private virtual currencies while avoiding the damaging social and economic consequences of private currencies’.

However, most of the crypto experts Inc42 spoke with believe that comparing CBDCs with cryptocurrencies is like comparing apples and oranges.

“Cryptocurrencies at best act as digital assets and hence there’s no question of them competing with fiat currencies. If at all, we need to draw a comparison, it could be stablecoins, which are backed by collaterals and hence are dependent on fiat currency,” a crypto startup cofounder said, requesting anonymity.

What’s Happening Globally?

Responding to a query related to applications and technologies, an RBI official had earlier told Inc42 that the apex bank was neither in a hurry to launch CBDC nor had set any particular deadline.

“The effort is to test every aspect of the CBDC whether it is technology, application areas or its possible impact on the banking sector or the cost aspect, in the pilot before launching the full-fledged CBDC,” the official had said.

For now, it seems that India’s vision is abreast of many who are exploring the potential of digital currency, but steadily.

Take China and South Korea for instance, who are currently in the advanced phase of their CBDC pilot.

Launched in April 2020, the Chinese CBDC (Digital Yuan e-CNY) concluded transactions to the tune of $14 Bn until October 2021, with more than 260 Mn wallet users.

Despite having entered into phase II, the People’s Bank of China has no preset timetable for the final launch, as it intends to “forge ahead with the pilot R&D projects; improve relevant institutional arrangements and rules; deepen the analysis of the impact on financial and other related systems, and participate in international exchanges of view.”

Similar is the case with the Bank of Korea, which in its CBDC report notes, “While there is no immediate need to issue CBDC in Korea, we believe that there is a strong case for us to be prepared for the potential introduction of CBDC in the future.”

The Bank of Korea has already completed the second phase of its CBDC pilot. It observes that a CBDC could process up to 2,000 transactions per second. Further, the DLT does not yet have the scalability needed for a retail CBDC.

In the case of India, the RBI is exploring all key probable features of CBDCs such as scalability, offline functionality, recoverability, programmability, traceability, privacy and transaction costs by using both DLT and non-DLT mechanisms.

Countries like Denmark, Finland and Ecuador are also going slow on their CBDC projects, making sure that no stone is left unturned.

Danmarks Nationalbank had earlier observed that it was difficult to see what a central bank digital currency would contribute that is not already covered by the payment solutions that exist today.

Highlighting they already have an effective payments infrastructure in place, the bank noted that the CBDC would fundamentally change Danmarks National bank´s role in the financial system and make it a direct competitor to the commercial banks. The introduction would lead to risks of financial instability, for example, by increasing the risk of systemic bank runs.

Why Should RBI Restrict CBDC To A Few Applications?

While the Indian government has already been spending over INR 2,500 Cr annually on UPI, spending more on CBDC-R may not be the right approach at this point in time.

“UPI transactions are aimed to serve the poor. With UPI Lite, it will further extend deeper to the underserved sections of society. At this stage, when UPI is just getting global, the focus should be on UPI, while CBDC-R may wait for the next few years,” said the banker quoted earlier.

He added, “We need to weigh the pros and cons. India already has a popular mobile payments system that is scalable and cost-effective. Is there any particular problem that Indians are facing with regard to retail payments? No. Then, why the rush. The RBI wants to promote CBDC-R to counter crypto which is not good. The central bank needs to rethink this, especially when banks are facing existential crises.”

Experts are of the opinion that a central bank digital currency could be an effective instrument in the wholesale and cross-border remittance market.

Speaking with Inc42, the CFO of Infosys and a partner at Aarin Capital, Mohandas Pai, said, “The CBDC is a fantastic development by the RBI and it should be used for government transactions. It brings safety, reduces the risk and the need for any margin funds.”

“Today the stock market is a T+1 market, while the mutual fund market follows a T+2 approach. Now is the time that we must have the government security market moved to T+0, and with CBDC behind the scenes, we could achieve this easily,” Pai added.

The Road Ahead

There is no doubt about the fact that digital currency is the future of money and solves a plethora of challenges that come with fiat currency. CBDCs not only have the potential to make cross-border remittances more efficient but also significantly reduce the cost of cash management, including costs incurred on security printing of fiat money.

Although there are many visible benefits of having a digital currency, it may not be the right time to make headway in this direction, especially when the country is spending a fortune on supporting the UPI?

Further, has the RBI found a sizable TAM for its CBDC-R, and, if not, won’t a premature CBDC-R become an extra burden on the country, given the significant costs associated with building the infra CBDC needs to survive? Well, these are the blazing questions that still remain to be answered.



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