Trying to understand CBDC

CBDC eR-R and eR-W: 

Do they transform ‘physical cash carry’ concept?

Introduction: Only recently, I went through the 'Concept note on Central Bank Digital Currency (CBDC)' published by RBI. That was the time, when the regulator announced its pilot-launch of Digital Rupee retail, "eR-R". (The pilot-launch of Digital Rupee-Wholesale - "eR-W" commenced earlier, on 1st November 2022). In a nutshell, RBI conveys that CBDC is a replica of physical currency in a digital format, with denomination-wise-split currency balances available in an e-wallet on users’ mobiles(eR-R) /CBDC accounts with RBI (eR-W). The currencies in the wallet/ account continue to retain their character as a legal tender, even though they are digitalised, and the value is equivalent to the physical value of the currency they represent. There is no fluctuation to their value, unlike a crypto currency. Since the balances in the wallet (eR-R), is deemed a legal liability from the issuer of currency and not a deposit with RBI/designated bank, it will not earn any interest.  

Liability: CBDCs would appear as liability on a central bank’s balance sheet

eR-W : The liability is direct on RBI in the case of eR-W (now introduced on pilot for secondary market transactions in G-Sec among 9 banks. (3 PSBs and 6 Pvt banks). 

eR-R: The liability is indirect as the transactions will be conducted through a digital wallet offered by the participating banks (introduced from 1st Dec 22 with 4 banks for now, 1 PSB, 3 private banks available in four cities under closed user group (CUG) basis ). 

How digital rupee operates?

As per the concept note, 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 is considered for CBDC-W 

eR-W: In the pilot phase, settlement of secondary market transactions in government securities, among 9 identified banks, are brought under eR-W. The said banks have opened CBDC accounts with RBI and transfer funds from their rupee accounts with RBI at the beginning of the day, taking into account the sales/purchases completed/likely to be completed during the day. As and when sale of  government securities is concluded, money from the purchaser bank's CBDC account with RBI is transferred to the CBDC account of the selling bank (CCIL screens and CBDC server with RBI are connected) and CCIL settles the securities in question, with the purchasing bank immediately. The settlement under eR-W is a gross settlement carried out for each transaction, instead of a net-settlement arrangement, that was happening so far, through the intermediary CCIL (Clearing Corporation of India Ltd.). Since the CCIL had to match the trades between the players to arrive at net settlement by each player at the end of the day, the settlement happened on a T+1 basis. With gross settlement introduced between the seller and purchaser directly on a real time basis and the intermediary CCIL is required only for transfer of securities, settlement in eR-W is T+0.  At the end of the day, the credit balances in the CBDC account of the banks gets transferred to the rupee account balances held with RBI.

eR-R: Working of eR-R appears to be less complex. Digital tokens, representing legal tender - denomination wise, will be distributed by RBI through the identified banks to the users, who apply for digital currency. The customer should download CBDC app., which are bank specific. (available in android phone only for now). In the app, SIM details needs authentication; link the bank account to be debited and enter details of debit card for verification purposes. Then the customer can select the denominations needed and authorise the bank to debit his account with the total amount for transfer of the said currencies by way of digital tokens into his wallet. He can transact with another person (P2P) or a merchant (P2M), having a similar e-wallets with any designated bank. Instead of carrying physical cash in his wallet, the user carries a pre-loaded e-wallet in his mobile phone. At the end of the day/ any time he chooses, the user can transfer the funds back to his account by carrying out necessary authentications in his digital app. In case, the mobile phone carrying the digital wallet is lost, the wallet can be accessed and transferred to a new mobile number/ mobile phone. Formalities can be completed in touch with the bank, the app of which is being used. 

Benefits: 
1. Every year, RBI incurs app. Rs.5000 cr. for printing physical notes. If digital currency is popularised, much of this cost can be reduced
2. Digital Currency is environment friendly, as it helps in preservation of trees, which are cut in huge quantities for paper and ink requirements.
3. To the user, the fear of counterfeit/ fake currency associated with a physical currency or losing through theft is eliminated.

My views:
Both eR-W and eR-R are pilot launches only. RBI itself says it is an experiment and the ultimate aim is to spread CBDC, so that physical carry of cash is reduced. I give my views, with the understanding that the scheme will evolve over time, based on the experience and success gained in these pilot launches.

1. Cash and Gold are two idle assets that do not earn any money unless deployed profitably. However, time immemorial, these two are close to the chest of the public, for sentimental and safety reasons. The government introduced Sovereign Gold Bonds (SGB) in 2016, which guarantees redemption of guaranteed gold at current market rates plus periodical interest at 2.5% on balance outstanding. But so far, the government could mobilise 90 tonnes of gold only (Rs.38,693 cr.) as against estimated public holding in India at about 23000 tonnes of gold (World Gold Council estimates). Availability of cash 24x7 through ATMs have increased the cash holding with the public, instead of bringing down the currency in circulation. So CBDC may become another instrument like SGB, with all salient features representing the original instrument (gold/currency), but poor response from the public, if not popularised effectively. 

2. eR-R: The settlement through eR-R depends on, whether the receiver of a payment has a wallet and is willing to get the settlement this way.  The issues that need attention are:

·   Broadly, by payment behaviour, the bank customers can be categorised into (i) having bank accounts with debit cards, however, there is no record of internet transactions  (ii) account holders with record of on-line/off-line internet transactions but not yet into UPI transfers and (iii) those who transact through internet and UPI modes. 

    Category (i) above include significant number of senior citizens as well as persons in rural/semi urban areas, who have not availed internet banking facilities (even for view purposes), as they are apprehensive due to lack of awareness of the availability, safety and seamless features. 

    Category (ii) covers sizeable number of customers, who are used to operate their debit/credit cards for merchant payments and transact through internet but still chose not to migrate to UPI system of payments, since they fear hacking possibilities in transacting through mobile phones. 

    These two categories have the tendency to carry more cash to the debit of their account by visiting the branch/ATM. eR-R should be popularised among them first, explaining the  security and safety features and that the transactions in the wallet are independent of  the linked account.

·     In the UPI mode, one need not disclose his account details . Gross settlement from a user's account takes place in a fraction of seconds after selecting the phone number/QR code of the beneficiary and authenticating the debit using the PIN. Interoperability among various payment modes are also in vogue. Though use of UPI results in number of transactions appearing in statement of accounts, unduly high, the customers transacting through UPI modes might still not find it attractive to add one more wallet, which is at present restricted among persons/merchants having eR-R wallets.

·       Pre-paid wallets, which are popular mode of payment with payment banks, are not so with the other commercial banks.  Bulk of the UPI volume happens between accounts with the banks only, though the transfer is enabled through mobile phone/QR Codes. The main issue is the mental discomfort with the customers and also that the balances in the instrument do not attract interest. (since it is not part of any deposit account held by the customer).

·     ATMs are available 24/7 for cash withdrawals (3-5 free transactions in a month). Recently a major PSB has increased the per day ATM withdrawal limit from Rs.40,000 to Rs.75,000

·    Inter-operability with other payment modes are not yet available. This may deter UPI payment users to have eR-R wallet, as they have to carry two wallets, one for UPI payments and the other for transfer of cash among eR-R users. 

RBI stated in the concept note that it is against creating a mechanism (interest payment) that may move bank deposits to CBDC. But it should factor that the aim of CBDC is to reduce the currency with the public, which stands at Rs.30.93 lac cr. , much more than the demand deposits with the banks at Rs.21.93 lac cr. (as on 18 Nov 22). If the currency with the public is brought back to the banking system by popularising CBDC, which offers digital rupee for payments and settlement, the banks are likely to be benefitted with more deposits in the long run. Considering the constraints (as stated above) in creating acceptance about CBDC among users of cash for their expenses and the benefit of more liquidity into the financial system in due course, I suggest that an incentive or a token interest payment (say 0.50% on daily balances)  may be thought of in the initial period, when eR-R is launched across all over India.  

3. eR-W eR-W appears to be another digital mode added to the existing digital payments happening amongst banks through other modes. Though the settlement in bank money would reduce transaction costs as settlement guarantee infrastructure or collateral to mitigate settlement risk, are eliminated, transactions in eR-W add up to the already voluminous interbank transfers happening through RTGS and NEFT. RBI, from the experience gained in the pilot launch, may think of integrating the advantages of CBDC (like reduction in costs, T+0 settlements, etc.) in the existing RTGS circuit.

4. Digital Banking: CBDC is definitely a feather in the cap of digital payments happening in India. However, digital banking (e-debiting/crediting/transacting through an account) appears to be a more sure way of reducing ‘physical cash transactions’ volume. 

Hence, 
(a) efforts to open more bank accounts in banked/unbanked areas, 
(b) bringing more and more merchants into the online network and UPI, 
(c) making more government payments (state governments still lack) to public under direct transfers and  
(d) reducing cash payments through banks and ATMs in particular 
are to be continued as vigorously as ever, in order to reduce physical carry of cash with the public.

Regards 

Viswanathan

10^th December 2022.