How CBDC can help banks and fintech firms reinvent themselves

The concept note provides deep insight into the RBI’s motivations for the introduction of CBDCs in India. It also outlines potential design features, policy issues and implications, and possible technology platforms. It articulates a policy preference for indirect/hybrid CBDCs issued by the RBI and distributed by banks and other intermediaries. It envisions a token-based (akin to fiat currency) model for a retail CBDC and a separate account-based model for a wholesale CBDC. By opting for non-interest-bearing architecture, the RBI considers its CBDC as a swap for paper cash (an RBI obligation that does not bear interest). The concept note’s proposal for limited anonymity (similar to European Central Bank-led “anonymity vouchers”) for use in small transactions and full visibility to intermediaries and authorities for large transactions strikes a balance between privacy and regulation.

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The guiding principles reflected in the concept note see CBDC as an additional payment method that does not replace existing payment systems. As a responsibility of the RBI rather than commercial banks, a CBDC insulates users from insolvency risks in the financial system. The central bank has reiterated its concerns about private virtual currencies (cryptocurrencies) and proposed CBDC adoption as a tool for monetary and financial stability, reducing risks arising from settlement (given no central counterparty) and physical cash handling. This will result in the establishment of core payment systems outside of India’s commercial banking system, resulting in diversification of payment options, reducing credit and liquidity risk and providing a hedge against payment system and bank failure. It can also reduce cross-border payment friction, promote financial inclusion, given the offline functionality, and deliver a digital footprint of retail users that can enable easy credit.

The concept note also considers various technology and cyber security risks, governance and system stability factors, integration with existing payment systems and interoperability.

While acknowledging the legal implications of CBDCs, given that the existing legal framework for money was adopted in a pre-digital age, the Concept Note stops short of firm recommendations, leaving this assessment to the final CBDC architecture adopted ( after trials) in terms of its operational and technological design features, including legal changes required to ensure the right to CBDC issuance, legal tender status and criminal law protection against counterfeiting, anti-money laundering and financing of terrorism (AML/CFT), apart from other safeguards. .

Participants in the financial system must assess CBDCs and adapt to their emergence. From shedding conventional roles to developing new roles, there is much to be done in the finance and payment system. The implications of a CBDC for banks, payment intermediaries and other participants in the financial services ecosystem are likely to be profound. The role of banks and other intermediaries in the deployment of a retail CBDC could lead to new partnerships between banks, fintech firms and technology companies. The proposed two-tier model will require technology and infrastructure investments from banks and other financial intermediaries. Acceptance and exchange of an e-rupee at a one-to-one ratio for fiat currency will require systemic interoperability. On the legal front, the RBI Act, Foreign Exchange Management Laws, Payment System and Settlement Act, Coin Laws and Prevention of Money Laundering Laws (including AML/CFT reporting and monitoring) may all need further alignment with a CBDC.

A CBDC provides an opportunity for banks and fintech firms to reinvent parts of their traditional business. Several financial intermediaries (payment intermediaries and aggregators, card networks and e-wallet providers) are expected to play a significant role in the further march of an e-rupee, as a whole new use case for payment will be created. The potential impact on India’s growing e-commerce landscape will also be significant.

The introduction of CBDCs is likely to have a positive impact on India’s formal economy and may also strengthen our financial system. There will be both challenges and opportunities for the banking system and non-bank intermediaries. For nimble financial system players with an appetite for investment and growth led by modern technology, the opportunities are enormous.

A CBDC launch will be a positive move and is likely to have a far-reaching impact on both our domestic payment systems and cross-border payment architecture. From a public policy standpoint, the potential for financial inclusion, given India’s demographic advantage, a digital currency issued as legal tender is a compelling proposition.

Globally, central banks and governments are gripped by technological advances and their impact on financial stability. While innovation will lead to efficiency and faster services, central banks must guard against risks to the robustness of the financial system. Both demographics and geography place India particularly well to use technology for financial intermediation. A CBDC launch will present an opportunity for India’s advancement of digital means to achieve its policy goals.

L. Viswanathan & Anu Tiwari are partners in Cyril Amarchand Mangaldas.

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