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The retail release of the Central Bank Digital Currency (CBDC), the digital rupee, is allegedly nearing completion at the Reserve Bank of India (RBI). The retail CBDC (CBDC-R) will be able to communicate with the current payment systems.
Impact of CBDC-R on Existing Payment Channels
The success of a CBDC-R launch will depend heavily on public-private partnerships, which will allow central banks to take use of already-existing infrastructure and client connections. Such partnerships will fill up the gaps in central banks' capacities and understanding of consumer behaviour, particularly in a retail setting, and enable them to execute use cases that are in line with end-user expectations. The likelihood of a successful adoption will rise if commercial banks and other private players (technology enablers, merchants, and users) are included in the launch process. RBI will also develop a greater feeling of ownership, manage anxieties of displacement, and control these fears.
Impact and Possibilities for Commercial Banks
Views of CBDCs for domestic banks aren't quite as favourable. Domestic banks' functions as deposit takers and crucial intermediaries are compromised when central banks create digital currencies directly and provide interest on them. As a result of having fewer resources available due to decreased deposit taking, domestic banks' capacity to extend credit to clients is constrained. In this regard, the development of CBDCs poses a serious challenge to the current domestic banking business models. Since their clientele is heavily cash-oriented and will take some time to become used to utilising CBDCs as their principal currency, credit unions and cooperative banks, in particular, are likely to struggle with this transition. These banks will have to adapt to the change by working with new digital ledger types, joining new networks, and collaborating with FinTechs. In the short term, building the infrastructure required to facilitate large-scale CBDC transfers entails a tremendous resource and innovation load.
Another significant issue can develop as a result of the conversion of fiat currency into CBDC. The interest rates offered for bank deposits and CBDC would have a significant impact on the conversion of fiat currency into CBDC. The likelihood of such increased withdrawals from banks and conversions to CBDC will rise as more people convert all or a portion of their deposits into CBDC and as CBDC interests rise. Commercial banks would suffer if these deposits stopped coming in because they would need to find another source of funding for their lending operations, which would limit their capacity to extend loans to the general population. Commercial banks may benefit from regulations imposing caps on the size of CBDC deposits and offering no interest on such digital wallets. However, zero interest or limits on CBDC will disincentivize the adoption of CBDC and would hamper its implementation.
The RBI's use of a two-tier issuance architecture for CBDC-R is a wise decision since it prevents a run on the bank. According to this design, the commercial banks issue CBDC and distribute it to the general public on the basis of securities or cash deposits maintained with the RBI. As RBI is already in talks with 10 scheduled commercial banks for the pilot launch of CBDC-R, engagement models may include “first movers” who co-create an emerging CBDC ecosystem and “selective adopters” who incrementally adjust existing capabilities to accommodate CBDCs. Players must identify the primary risks and benefits associated with this position, assess their likelihood and impact, and determine potential mitigation levers.
Impact and Possibilities for FinTech Platforms
CBDCs are giving FinTechs new chances to innovate on all levels. The move toward cashless digital finance is the biggest potential FinTechs have seen to date, with opportunities ranging from developing user-friendly transaction services for consumers to assist in constructing a robust and scalable platform for cross-currency transactions. Financial firms specializing in DeFi or Web 3.0-based services have a bright future ahead of them.
Impact and Possibilities for Financial Network Players
Domestic and international CBDC transactions necessitate the establishment of new, undefined norms. To develop a strong distributed ledger infrastructure and choose the finest standards for their currencies, banks will probably want to collaborate with seasoned innovators. The current big financial network companies like RuPay, Visa, and Mastercard will need to think about their position in this growing arena and assure them if they want to remain significant players in the CBDC-driven global economy.
We will see a number of mergers and acquisitions within the payment ecosystem with the launch of CBDC-R. Traditional players will likely collaborate with new tech-driven finance start-ups to leverage the implementation of CBDC-R.
How CBDC-R will impact Digital Payments
Over the past five years, the volume of digital payments in India has increased at a rate of about 50% annually on average. Even though that growth rate is among the fastest in the world, India's unique real-time, mobile-enabled system, the Unified Payments Interface, has seen an expansion rate of about 160 percent annually. Now, with the launch of CBDC-R, India will see the next boom in digital payments if properly implemented, incentivizing the general population.
Security and Reliability
The CBDC reduces depositors' exposure to their bank because it is a central bank liability. It is currently improbable that a central bank will fail to fulfil its duty to honour a payment or settle a transaction. A CBDC is a risk-free settlement asset as a result. CBDC would result in more reliable and effective legal tender-based payments.
Additionally, it will stop private counterparts from controlling the flow of transaction data. The introduction of digital currency would decrease reliance on cash, offer more seigniorage because of decreased transaction costs, and decrease settlement risk. The rupee is slowly but surely gaining popularity as India's economic integration with the rest of the world deepens. Given how much easier it is to track and interact with digital currencies across borders, a CBDC may help these efforts.
Cross-border Payments
Cross-border payments represent the second use case for CBDC-R. Cross-border transfers cost more than domestic payments since numerous banks are involved, sometimes even from the same country. Cross-border remittance settlement takes longer and costs more money than domestic payment transactions since foreign banks often operate via "correspondent banks" that have their settlement accounts with the central bank.
Due to their prospective ability to function without correspondent banks, CBDCs have the potential to reduce the expenses associated with sending money internationally. A CBDC can be paid in the central bank's digital ledger directly as it was issued by the institution, bypassing the chain of banks that would normally be engaged in a cross-border transaction. A cross-border payment made through CBDC will operate similarly. However, a CBDC's capacity to operate across borders is related to this. India has G20 obligations to make the e-rupee interoperable.
Lending
At first, Retail CBDC will let RBI users create wallets directly. As a result, customers will be able to establish a history with the RBI, which would eventually make it easier for them to obtain loans and access other financial products directly from the Central Bank. Additionally, CBDC will let MSMEs receive rapid loans. As more MSMEs choose CBDC, banks will be better able to determine the borrower's risk profile with more accuracy, helping MSMEs with their financial needs. Additionally, the Federal Bank may use CBDC as a tool for stimulus distribution during times of crisis or ambiguity. Furthermore, MSMEs may demonstrate their creditworthiness with the use of CBDC monitoring. But it would be interesting to see whether RBI would take this course and risk disintermediating legacy banking channels.
Offline Payments
Another option that CBDC may provide is offline payment. Near-field communication (NFC) technology may be the foundation of the offline wallet, which would generally be a separate wallet. The digital wallet/application may be used on either a feature phone or a smartphone that supports NFC. It will be a very safe and convenient alternative for peer-to-peer payments in places with unstable networks or without the Internet. Without requiring an internet connection, account-neutral identity verification, transaction confirmation, and payment will all take place over the offline wallet.
In conclusion
The greatest obstacle that CBDC must overcome is the fear of exclusion. It's critical to make sure that CBDC is accessible to everyone in a place like India, where more than 500 million people still use Numpad phones. RBI should give a few incentives to roll our CBDC-R for general consumers. Additionally, the involvement of individuals from lower socioeconomic levels in the nation is essential for CBDC's success. We need to solve a number of problems and make the CBDC function as an inclusion tool if we want the CBDC ecosystem to be sustainable. We must innovate to find solutions to issues, including offline payments.
