A large part of transactions in India’s economy are still carried out using untraceable cash. Currency in circulation formed about 15 percent of the total money supply as of mid-January. It is a straight, logical conclusion that a digital rupee will replace physical cash.
A digital version of fiat currency is, by definition, an online token and has no physical presence. In that, it is a perfect replacement of cash for an economy. Therefore the introduction and adoption of a CBDC is most compatible with a state that intends to bring its population under the formal economy and the tax net. This was one of the stated motivations for Nigeria in adopting the eNaira. Financial inclusion plays a big part in the introduction to the eNaira.
But if cash was so easy to replace, why are other countries not taking a headlong plunge into CBDCs of their own?
Replacement of cash invariably leads to other instruments getting booted out as well when it comes to store of value or safety. While cash is the most convenient and opaque medium of exchange, it requires a visit to the bank or an automated teller machine (ATM). A digital rupee would need neither. That’s a mixed blessing that the adoption of a CBDC would entail.
A digital fiat currency would serve as a safety valve against the risk of a bank collapse. Note that cash is also a counterbalance to all the risks associated with financial instruments including a bank deposit. Ergo, during times of crisis involving a bank, depositors can seek refuge in a CBDC.
The convenience of digital transfers would reduce public anxiety, unlike in unfortunate cases such as the one involving Punjab and Maharashtra Cooperative Bank. Researcher Bhargavi Zaveri has highlighted this counterbalance to banking risk.
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“In the last few years, depositors of about 21 banks were restricted from withdrawing their funds from their bank accounts due to bank distress (excluding the demonetisation exercise, which triggered caps on withdrawals),” she pointed out in a post on the blog IndiaCorpLaw. “A CBDC, which is a liability of the RBI, will mitigate the risk of losses that Indian depositors face when dealing with commercial banks in India.”
In short, imagine withdrawing deposits in case of doubts over the bank’s wellbeing, but doing it digitally instead.
Mi CASA, su CASA
So will a CBDC replace bank deposits?
Since a CBDC is a currency, all Indians will get to hold it in their wallets – the same as cash. When there is digital cash, there is no need for a current account for online payments and by extension, no need for the various digital payment options that spring from bank current and savings accounts (CASA). This has the potential to upset the banks’ calculations of low-cost deposits that they have come to rely on.
The CASA ratio could come under threat, especially during episodes of anxiety around the health of a bank. After all, a CBDC is a store of value, albeit without a return. Unlike in the case of cash, which gets converted into a financial product called bank account, a CBDC would remain a liability on the balance sheet of the Reserve Bank of India. To that extent, CBDC balances resting in wallets at banks may not be lendable by banks, Zaveri told Moneycontrol.
Credit creation would need to be revisited. To be sure, the central bank has flagged this point.
“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,” deputy governor T Rabi Shankar said in a speech in July.
For a country like India, which has just begun to bring every nook and corner into the fold of basic infrastructure that now includes mobile phones, a digital rupee should be rolled out after careful consideration.For banks in India, a CBDC may be the jolt they need to come out of their lethargy of taking sticky public deposits for granted. But perhaps the RBI could wait for them to fix their balance sheets first.