CBDCs — Part 2: Implications and Current Global Status

Source: Forbes

Part 2 in a 2-part series. A look at the implications of CBDCs for various stakeholders and what countries around the world are doing currently…

In my previous piece, I looked at what CBDCs are and how they differ from other digital payment modes. Indeed, CBDCs are metamorphosing into prominent focus areas for Central Banks around the world. It’s no more just a quixotic idea. But, what would be the implication of CBDCs for the various stakeholders — the Government, people, banks and fintech players?

In this piece, I explore the potential impact of CBDCs and how Governments world-over are progressing in their CBDC programme.

Now, CBDCs can be of many types. Some classifications were mentioned in part 1 of this series. For the purpose of this article, I’m not introducing the additional layers of tokenisation, blockchain technology, interest-bearing nature etc. These additional features can be incorporated into CBDCs as well and their corresponding impacts are also briefly mentioned here.

Implications to Stakeholders

1. Government

• Greater Access to Data: Under a centralised CBDC system, the Central Bank would have access to finer data on transactions which could help in policymaking. The quantum and quality of data would, of course, depend on the level of privacy afforded by the particular country’s CBDC model.
• Better Distribution of Taxes Between Centre and State: With digital transactions, automatic splitting of taxes between centre and state can be ensured.
• Fraud Prevention: A CBDC model would sound the death knell for the shadow economy and black money transactions. Fraud and money laundering prevention would get a fillip.
• Lower Cost of Printing and Vending: The banking entities would no longer have to bear the financial and logistical burden of transportation and handling associated with safe money transfer. However, the net impact must take into account the greater spending on tech for the generation of digital coins.
• Better Distribution of Funds to Specific Groups: A significant proportion of India’s population is unbanked and the current mechanism of funds transfer to beneficiaries is highly inefficient. Corruption, high operational costs, data discrepancies and cash-heavy models hinder the smooth transfer of benefits and relief to those who most need them. CBDCs would allow the Government to directly transfer money to individuals, even to those who don’t have bank accounts.
• Countering Risk from Private Cryptocurrencies and Stablecoins: People are gaining interest in cryptocurrencies and with players like Facebook seeking to enter the space, there is a chance that fiat currency as we know it would witness a decline in prominence. Governments greatly feel the need to tap into the space to avoid large-scale financial disruptions and prevent loss of control in monetary policy matters.
• Keeping Up with Other CBDCs: China is progressing rapidly with its digital yuan project and many countries are exploring their versions of CBDCs. It’s important that India’s in the race as well.
• Monetary Policy Implications: Overall monetary policy implications are hard to predict, as it depends on the propensity to hold CBDCs. Monetary policy implementation could get easier with interest-bearing CBDCs. For example, a negative-rates regime is easier to implement in a near-complete CBDC system since people cannot hoard physical cash anymore. Programmable monetary policy and helicopter drops are some other interesting monetary policy phenomena. Further, the impact of large international CBDC movements cannot be ignored.
• Cybersecurity and Data Privacy: Of course, with the introduction of CBDCs, Governments and Central Banks must invest heavily in electronic vaults and fail-safe cybersecurity measures to safeguard against hackers and cybercriminals. Developing appropriate privacy protocols and safeguarding them also becomes important.
• Backups and Contingencies: It’s extremely important to ensure that people are able to make payments 24*7. Robust servers and maintenance protocols along with ample backups must be in place to avoid operational failure.
• Regulatory Environment: With countries venturing into new territory here, cogent rules and regulations must be put in place to avoid undesirable outcomes.

2. People

• Contactless Option: With the pandemic stoking concerns around the hygiene of physical currency notes and directing a shift towards digital payments, CBDCs fall in line with the booming trend.
• Convenience and Safety: CBDCs are insulated from the risks of thievery, loss and damage that cash in physical wallets is exposed to. It becomes much easier to hold and transfer money via digital means. But, there are cybersecurity risks that cannot be ignored.
• Precise Accuracy: Stepped into a vegetable mart with a single ₹2000 note? Brace yourself for some heavy eye-rolling as you attempt to make your ₹50 purchase. CBDCs would help in tackling the ‘I have no change’ issue, like the other digital payment apps.
• Cheaper Cross-Border Payments: As opposed to the current expensive and slow system, CBDCs can greatly expedite economical cross-border payments.
• Better Accessibility for the Unbanked: In India, there are around 1.2 billion mobile phone connections. In contrast, there are only 582 million bank accounts. In such an environment of low bank penetration, CBDCs offer digital payments access to the unbanked. Benefit also abound from the improvement in targeted benefits transfer.
• Consistent Access and Connectivity Challenges: While overall accessibility could improve, consistent access could be a challenge if the CBDC wallets and transfer mechanisms require internet facilities. A significant proportion of the country doesn’t have access to high-quality internet and, while the situation is improving, offline models and NFC should be put in place.
• Privacy Concerns: The anonymity afforded by cash transactions would be lacking in CBDC payments. This may stir up concerns among people, though strong privacy laws and protocols may help alleviate the fear.
• Merchant Acceptance: With acceptance being a core tenet of any successful medium of exchange, merchants’ willingness to use CBDCs would play a key role in widespread adoption.

3. Banks

• Bank Runs: A legitimately concerning situation is one where people rush to move their deposits to CBDCs, resulting in bank runs. That could greatly disrupt the country’s financial system.
• Investments in Technology: Banks would need to invest in electronic vaults for CBDC storage and electronic wallets as their product offerings change.
• The Relevance of Deposits: In the current model, banks hold accounts at the RBI. With a CBDC, everyone would liaise with the Central Bank, reducing the need to hold deposits with commercial banks. Without retail deposits, banks would have to avail of costlier wholesale funding to provide loans. According to Gavin Smith, chief executive of Panxora, “Banks could still offer a service to lend money if owners move some of their CBDC into a central pool that banks lend out…Margins would become much more transparent. Lending would become a service.” So, conducting KYC procedures for wallet issuance would be one of the key new tasks for banks in the new environment.

4. Cryptocurrencies and Crypto e-Wallets

• Competition: Cryptocurrencies would be faced with heavy competition from the sovereign-backed CBDC. However, features like anonymity and blockchain tech and their positioning as asset classes would still hold appeal.

5. Fintechs

• Prominence: The role played by fintech would become even more prominent, as they facilitate retail CBDC transfer and offer tech support to the system.

CBDCs Around the World

CBDC development is happening at a brisk pace around the world. A significant proportion of central banks are involved in exploring this new instrument.

Source: Atlantic Council

Source: Ready, steady, go? — Results of the third BIS survey on central bank digital currency

• China: Organising digital renminbi trials at a rapid pace in the cities of Shenzhen, Suzhou, Beijing and Chengdu
• Cambodia: Launched the blockchain-based digital currency Bakong
• Sweden: Testing the eKrona
• Turkey: Would pilot its CBDC in the second half of 2021
• ECB: Exploring the digital euro
• Japan: Engaging in active research. The Bank of Japan launched Project Stella along with the ECB in December 2016 to explore the uses of DLT for financial market infrastructures
• US: Exploring the digital dollar which has been classified as a ‘high priority project’
• Bahamas: Launched the CBDC Sand Dollar in October 2020

CBDCs in India

The Cryptocurrency and Regulation of Official Digital Currency Bill 2021, to be introduced in the ongoing Parliament session, would ban holding and trading private cryptocurrencies and create a legitimate framework for an RBI-backed digital currency. However, in a recent interview, FM Nirmala Sitharaman did mention that the ‘Government wants to ensure there’s a window for experiments in cryptocurrency space’ and that ‘there will be a very calibrated position taken on cryptocurrency.’ This does amplify the confusion on the Government’s stance on private cryptocurrencies.

CBDCs in India, on the other hand, are currently in an incipient stage. According to RBI Governor Shaktikanta Das, “On CBDCs, a lot of work is going on internally in the Reserve Bank of India and we will be coming out with some broad guidelines and approach paper very shortly. There are a few issues to be sorted out internally and it’s very much work in progress.”

So, one can expect a digital rupee in the coming years.

CBDCs are indeed gaining prominence with central banks the world over. The exact structure and operation need to be excogitated but there’s no doubt that in the next few years, CBDCs would play a significant role in the day-to-day finances of people.