CBDC more environment friendly than other cashless modes: RBI report

Context: Central bank digital currency (CBDC) or e-rupee, if designed keeping in mind the environment, social and governance (ESG) objectives, can be more environment friendly compared to alternative cashless methods, according to the RBI report.

CBDC and environment

  • CBDCs are significantly more energy efficient than current credit card processing centres, in part because the latter involve energy-inefficient legacy systems.
  • CBDC helps curb emissions by nullifying operations such as printing, storage, transportation, and replacement of physical currency.
  • Results of a climate stress-test revealed that public sector banks (PSBs) may be more vulnerable than private sector banks (PVBs) in India.

Climate-stress tests are scenario based exercises that assess the loss to the financial systems/entities due to climate related risks by adopting the methodology of traditional stress tests to climate related exigencies.

All about Central Bank Digital Currency

  • Central Bank Digital Currency (CBDC) is a digital form of currency notes issued by a central bank. The e₹ will provide an additional option to the currently available forms of money. 
  • It is akin to sovereign paper currency but takes a different form, exchangeable at par with the existing currency and shall be accepted as a medium of payment, legal tender and a safe store of value. CBDCs would appear as liability on a central bank’s balance sheet. That is, a central bank liability, denominated in an existing unit of account, which serves both as a medium of exchange and a store of value.
  • It is substantially not different from banknotes, but being digital it is likely to be easier, faster and cheaper. It also has all the transactional benefits of other forms of digital money.
  • CBDC, being a sovereign currency, holds unique advantages of central bank money viz. trust, safety, liquidity, settlement finality and integrity.

The features of CBDC include

  • CBDC is sovereign currency issued by Central Banks in alignment with their monetary policy
  • It appears as a liability on the central bank’s balance sheet
  • Must be accepted as a medium of payment, legal tender, and a safe store of value by all citizens, enterprises, and government agencies.
  • Freely convertible against commercial bank money and cash
  • Fungible legal tender for which holders need not have a bank account
  • Expected to lower the cost of issuance of money and transactions

Type of CBDC to be issued

  • CBDC can be classified into two broad types viz. general purpose or retail (CBDC-R) and wholesale (CBDC-W). Retail CBDC would be potentially available for use by all viz. private sector, non-financial consumers and businesses while wholesale CBDC is designed for restricted access to select financial institutions. While Wholesale CBDC is intended for the settlement of interbank transfers and related wholesale transactions, Retail CBDC is an electronic version of cash primarily meant for retail transactions.
  • It is believed that Retail CBDC can provide access to safe money for payment and settlement as it is a direct liability of the Central Bank. Wholesale CBDC has the potential to transform the settlement systems for financial transactions and make them more efficient and secure. Going by the potential offered by each of them, there may be merit in introducing both CBDC-W and CBDC-R.

Model for issuance and management of CBDC

  • There are two models for issuance and management of CBDCs viz. Direct model (Single Tier model) and Indirect model (Two-Tier model). A Direct model would be the one where the central bank is responsible for managing all aspects of the CBDC system viz. issuance, account-keeping and transaction verification.
  • In an Indirect model, central bank and other intermediaries (banks and any other service providers), each play their respective role. In this model central bank issues CBDC to consumers indirectly through intermediaries and any claim by consumers is managed by the intermediary as the central bank only handles wholesale payments to intermediaries.
  • The Indirect model is akin to the current physical currency management system wherein banks manage activities like distribution of notes to public, account-keeping, adherence of requirement related to know-your-customer (KYC) and anti-money laundering and countering the terrorism of financing (AML/CFT) checks, transaction verification etc.

Forms of CBDC

  • CBDC can be structured as ‘token-based’ or ‘account-based’. 
  • A token-based CBDC is a bearer-instrument like banknotes, meaning whosoever holds the tokens at a given point in time would be presumed to own them. 
  • In contrast, an account-based system would require maintenance of record of balances and transactions of all holders of the CBDC and indicate the ownership of the monetary balances. 
  • Also, in a token-based CBDC, the person receiving a token will verify that his ownership of the token is genuine, whereas in an account-based CBDC, an intermediary verifies the identity of an account holder. 
  • 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 may be considered for CBDC-W.

Advantages of CBDC over other digital payments systems

  • As it being a sovereign currency, ensures settlement finality and thus reduces settlement risk in the financial system. 
  • CBDCs could also potentially enable a more real-time, cost-effective seamless integration of cross border payment systems. 
  • The payment systems are available 24X7, 365 days a year to both retail and wholesale customers. 
  • They are largely real-time, the cost of transaction is perhaps the lowest in the world, users have a wide array of options for doing transactions and digital payments have grown at an impressive CAGR of 55% over the last five years.
  • The e₹ system will bolster India’s digital economy, cashless economy, enhance financial inclusion, and make the monetary and payment systems more efficient.
  • CBDCs could ease current frictions in cross-border payments.
  • Traceability of transactions would crack down on corruption and money laundering.
  • Counter the monopoly of private sector issued cryptocurrencies.

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