MC Explains | RBI kicks off digital rupee pilot: 12 Questions answered

The Reserve Bank of India (RBI) said on November 29 that it has identified eight banks to participate in the launch of the first pilot for retail digital rupee.

Earlier, the RBI had identified nine banks to participate in the launch of the first pilot of digital rupee in the wholesale segment on November 1.

Eight banks have been identified for phase-wise participation in the latest pilot, the RBI said, adding that the first phase will begin with four banks -- State Bank of India, ICICI Bank, Yes Bank and IDFC First Bank in four cities across the country.

Four more banks -- Bank of Baroda, Union Bank of India, HDFC Bank and Kotak Mahindra Bank will join this pilot subsequently, a media release issued by the central bank noted.

Here’s an explainer to better understand the rolling out of the Central Bank Digital Currency (CBDC).

What is CBDC?

A central bank digital currency is a legal tender issued in the digital form. It is the same as a fiat currency but the form is different and is exchangeable one-to-one with the government-issued money. In other words, CBDC is the same as the legal currency we use. Just that it's in a digital form.

What is the RBI pilot project focused on?

According to the RBI release issued on October 31, the use case for the wholesale pilot is settlement of secondary market transactions in government securities. Use of e₹-W, or wholesale, is expected to make the inter-bank market more efficient, the RBI said.

And, how is it going to play out?

The RBI expects that 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, it said.

When was the concept of CBDC first introduced in India?

Union Finance Minister Nirmala Sitharaman had on February 1 said the RBI would roll out its own central bank digital currency (CBDC) in 2022-23, marking the first official statement from the Union government on the launch of the much-awaited digital currency.

What are the expected benefits of CBDC for the broader economy?

The government expects that the introduction of CBDC will boost the digital economy and it will be based on the blockchain technology. The Reserve Bank had earlier indicated that CBDC was on the cards even as the central bank was against the idea of permitting private virtual currencies.

The finance minister had said that the introduction of CBDC would further enhance India's status as a digital economy given its world-class digital payments system.

How does the Digital Rupee work?

A CBDC is the digital form of fiat currency and will ease transactions. An RBI report had earlier described CBDC as something that will provide a safe, robust, and convenient alternative to physical cash. Depending on various design choices, it can also assume the complex form of a financial instrument, the RBI report said.

Is CBDC a cryptocurrency like Bitcoin?

No. A CBDC is not a private crypto currency. It is a digital form of legal tender and private virtual currencies are entirely different. Private virtual currencies are at substantial odds with the historical concept of money. They are not commodities or claims on commodities as they have no intrinsic value.

How does the RBI respond to claims that private cryptos are assets like gold?

The RBI had said that private virtual currencies do not represent any person’s debt or liabilities. "There is no issuer. They are not money (certainly not currency) as the word has come to be understood historically," said RBI Deputy Governor T Rabi Sankar on July 22. What this effectively means is that, according to the RBI, no banking entity can treat private virtual currencies as assets or liabilities for transactions.

What is the RBI view on CBDC’s future potential?

Sankar said CBDC has the potential to provide significant benefits, such as reduced dependency on cash, higher seigniorage due to lower transaction costs and reduced settlement risk.

It will also possibly lead to a more robust, efficient, trusted, regulated and legal tender-based payments option, Sankar said.

What is RBI's take on CBDC vis-à-vis private cryptocurrencies?

Sankar said the advent of private virtual currencies may well be another reason why CBDCs may be necessary. “It is not clear what specific need is met by these private virtual currencies that official money cannot meet as efficiently, but that may in itself not come in the way of their adoption. If these virtual currencies gain recognition, national currencies with limited convertibility are likely to come under threat,” Sankar said.

What are the risks associated with CBDCs, according to the RBI?

Sankar outlined certain risks associated with CBDCs, saying the availability of these currencies will make it easy for depositors to withdraw balances if there is stress on any bank. "Flight of deposits can be much faster compared to cash withdrawal," Sankar said.

On the other hand, just the availability of CBDCs might reduce panic “runs” since depositors have knowledge that they can withdraw quickly. One consequence could be that banks would be motivated to hold a larger level of liquidity, which could result in lower returns for commercial banks, the deputy governor said.

What is the future of private virtual currencies in India?

There is no clarity yet on this. Until the government comes clear on regulation, the central bank is likely to remain in a wait-and-watch mode as far as private virtual currencies are concerned.