Payment and settlement systems and services have become vital components of the economic life of contemporary societies. Due to several reforms in the recent past, the landscape of NPS (National Payment Systems) has been changed globally. The issuance of CBDC is a highly debated topic among nations, and global financial groups and communities are studying several aspects of the CBDC issuance, such as design, implementation, and impact on the financial policy, systems, and the broader economy. Against the backdrop of the development of new forms of private money, Crypto-assets and stable coins over the last few years, the issuance of Central Bank Digital Currency (CBDC) has become a highly debated financial-sector topic worldwide.

With rapidly evolving technology and its application to practically all areas of finance, in particular, the issuance of value in electronic form, the possibility for central banks to issue their digital currency to the broad public has raised the attention of the international financial community.

This has attracted conspicuous resources to study the various aspects of CBDC, from design to implementation, and the implications of CBDC for the financial system, including its policy, regulation, oversight and the economy more broadly.

CBDC Vs cryptocurrencies

The private cryptocurrencies were designed to avoid regulation by any authority and to restrict the power of governments in manipulating the currency valuation. The supporters of cryptocurrencies often condemn the excessive printing of money and believe the same is the cause of inflation, and CBDC cannot provide a solution to this criticism. On the contrary, CBDC has sovereign backing and is issued by the central banks of various nations and claims to protect the citizens from cryptocurrencies, while cryptocurrency enthusiasts believe that they provide relief to the people from the inflation which may be caused by the monetary policies of different central banks.

CBDC Vs banking system

CBDCs can significantly impact the monetary policies, existing banking system, and macroeconomic policies if the model of the CBDC is not carefully calibrated. They can mitigate the payment default risk faced by the depositors of commercial banks in case of a financial crisis which is triggered by fraud or an increase of stressed assets. Withdrawal limits imposed by RBI in the cases of PMC Bank and Yes Bank are examples. On the other hand, CBDCs being legal tender, will not be an interest-bearing instrument. Furthermore, this will force the banks to increase the deposit interest rates to attract depositors from RBI-issued CBDC. This will have an impact on the profitability of the banks.

SWOT analysis of CBDC

CBDCs are a digital form of paper currency, and unlike cryptocurrencies that operate in a regulatory vacuum, these are legal tender issued and backed by the central bank. Many countries have decided to have their own CBDC to provide more reliable digital currencies to work as legal tender, prompting the displacement of private digital currencies.

1. The Bahamas has been the first economy to launch its nationwide CBDC-Sand Dollar.
2. Nigeria rolled out the e-Naira in 2020.
3. China has become the world's first major economy to pilot a digital currency, i.e. e-CNY.
4. Korea, Sweden, Jamaica, and Ukraine are some of the countries to have begun testing their digital currency, and many more may soon follow.

The main objective of the same is to mitigate the risks and also to trim the cost of handling physical currency as well as the cost of phasing out soiled notes. It will also wean people away from cryptocurrencies as a means of money transfer.

Strengths of CBDC

1. Combination of traditional and innovative - CBDC can gradually bring a cultural shift towards virtual currency by reducing currency handling costs.
   a. CBDC is envisaged to bring in the best from crypto and money circulation of the traditional financial system i.e., the convenience and security of digital forms.
   b. Easier cross-border payments - CBDC can provide easy means to speed up a reliable sovereign-backed domestic payment and settlement system, partly replacing paper currency. It can also be useful to eliminate the need for an expensive network of correspondent banks for settling cross-border payments.
2. Financial Inclusion - The increased use of CBDC could be explored for pushing the informal economy into the formal zone to ensure better regulatory and tax law compliance and also lay the way to strengthen financial inclusion.
3. There is a need to enforce strict compliance with know your customer (KYC) norms to prevent the currency’s use for terror financing or money laundering.

Weakness of CBDC: -

1. Privacy concerns - The first issue to tackle is the heightened risk to the privacy of users, given that the central bank could potentially end up handling an enormous amount of data regarding user transactions. This has serious implications, given that digital currencies will not offer users the level of privacy and anonymity offered by transacting in cash.
   a. In case of another major issue, there is a chance of compromise of credentials.
2. The shift to CBDC can have a negative effect on the bank’s ability to plough back funds into credit intermediation.
   a. If e-cash becomes more popular and successful for payments and the RBI places no limit on the amount that can be stored in mobile wallets, then the small and weaker banks will struggle to retain low-cost deposits.
3. Other risks are:
   a. The dynamic developments in technology may lead to higher upgradation costs and pose a greater threat to the ecosystem of CBDC.
   b. There can be a rise in operational risks caused by intermediaries because the staff has to be retrained to work in the CBDC environment.
   c. There would be elevated cyber security risks and cyber security costs for the protection of firewalls and for vulnerability testing.
   d. Financial and operation burden on the central banks which is managing the CBDC would increase.

Opportunities of CBDC

1. Decrease in currency chests of the Reserve Bank of India, thereby no need to print the currency by the regulator. The revenue expenditure and capital expenditure in this regard can be minimised to a large extent.
2. Cash transactions at the bank branches will be reduced; thereby, bank branch staff (Cashiers / Tellers) can be utilised by the banks for other transactions or other productive jobs.
3. Decreased use of Automated Teller Machines, thereby reduction of the huge amount of recurring and capital expenditure to the banks.
4. Merchant Cash Transactions - No Cash Transactions - All are online transactions, thereby quick disposal of customers at merchant establishments / retail stores.
5. Government Revenue (GST) and Income Tax will improve due to all transactions being accounted for.
6. Black money / unaccounted will be reduced in the economy.

Threats of CBDC

1. Cyber-crimes will increase, particularly in rural / semi-urban areas, where public awareness and literacy rates are poor.
2. Square one of the ‘Barter System’ - Instead of exchanging goods for digital currency, the public will prefer the exchange of goods with other goods; thereby, the Barter System will be re-originated, particularly in rural areas of the country.
3. The usage should be payment-focused to improve the payment and settlement system to reduce or remove the weaknesses of CBDCs. Then it can steer away from serving as a store of value to avoid the risks of disintermediation and its major monetary policy implications.
4. The data stored with the central bank in a centralised system will hold grave security risks, and robust data security systems will have to be set up to prevent data breaches. Thus, it is important to employ the right technology that will back the issue of CBDCs.
5. The sizing for the infrastructure required for the CBDC will remain tricky if payment transactions are carried out using the same system. The RBI will have to map the technology landscape thoroughly and proceed cautiously with picking the correct technology for introducing CBDCs.
6. The financial data collected on digital currency transactions will be sensitive, and the government will have to carefully think through the regulatory design. This would require close interaction between the data protection regulators and the banking system

Conclusion

To conclude, the adoption of CBDC has been justified for the following reasons:

1. Central banks should seek to popularise a more acceptable form of electronic currency.
2. Jurisdictions with more physical cash usage should seek to make the issuance more efficient.
3. Central banks sought to meet the need for digital currencies, which manifested in the increasing use of private virtual currencies. Thus, it seeks to avoid the severe consequences of such private currencies.
4. Since many of the securities traded in the market have been digitised in the last decade, the next in the pipeline is the Central Bank Digital Currency (CBDC). The rapid progress of private cryptocurrencies is considered a threat to the stability of the financial system.

With the increased appetite and interest for CBDC across the countries and with the rapid progress of private cryptocurrencies, governments of several countries are acting swiftly to manage such risks with Central Bank Digital Currency.

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