Digitalisation has reformed the financial sector. It has brought about a lot of changes in the way transactions take place and money is handled. These days, payments are being made via digital wallets, UPI accounts, credit cards, debit cards, and other online modes of payment. Digitising payments has reduced the use of physical cash. Furthermore, the launch of e₹ or Central Bank Digital Currency (CBDC) by the Reserve Bank of India (RBI) is another feather in the hat.

What is Central Bank Digital Currency (CBDC)?

CBDC is a legal tender in digital form, that is issued and managed by the central bank, i.e. RBI. Also known as digital rupee, CBDCs can be exchanged at par with the prevailing currencies. CBDCs have been designed to create awareness of this form of currency.

CBDC is classified into Retail (CBDC-R) and Wholesale (CBDC-W). CBDC-R would be available for use by the private sector, non-financial consumers, as well as business entities and would be clearing retail transactions of the general public. On the other hand, only specific financial institutions will be granted access to CBDC-W and will cater to interbank transfers and interconnected wholesale transactions.

Objectives of CBDCs

CBDCs have been launched with the following objectives:

• It aims at offering enhanced privacy and anonymity without any compromise on the regulatory aspect of the central bank.
• It plans to make use of robust encryption methods to ensure the high security of transactions and to reduce unauthorised access and fraud.
• It aims at revamping and innovating the payment landscape. 
• It aims at fostering financial inclusion by offering a digital payment system that is secure and accessible.

Federal Bank has made it easy for its customers to get their hands on CBDCs. Check out their CDBC section to know more about the joining process.

Need for a Digital Currency in India's Financial Landscape

In today's rapidly digitising economy, the integration of a digital currency holds the potential to significantly reduce reliance on physical cash.  As a digital currency, CBDC-R can turn around the financial ecosystem of India, foster financial inclusion, and improve transaction security and efficiency. 

Let us look at the potential benefits and challenges associated with the implementation of CBDC-R.

The Benefits of CBDC-R

CBDC-R has the following benefits over other digital payment systems:

1. CBDC-R, a sovereign currency could help in reducing settlement risk.
2. It could also lead to a cost-effective, real-time, and smooth integration of international payment systems.
3. This system supported by highly-advanced technology will boost India’s digital economy,  foster financial inclusion, and lead to more affordable and efficient financial payment systems.
4. CBDC-R offers a solution for reducing operational costs across various areas of the banking system such as printing and storage costs, transportation of banknotes and replacement costs.
5. It supports efficiency, innovation, and competition in payments which would benefit businesses of all sizes.
6. It would help strengthen financial inclusion.
7. It would offer the general public a virtual currency free of risks.

The Challenges Faced by CBDC-R

The introduction of CBDCs posed the following challenges:

1. Creating awareness and making people shift to this mode of payment.
2. Key issues in security like counterfeiting and cybersecurity.
3. The regulation of this system by the central bank could be a matter of concern in terms of privacy and anonymity.
4. A hybrid model might be essential as the account-based system would be perfect for wholesale CBDC applications, whereas the token-based approach would be apt for retail applications.
5. In India, connectivity issues still prevail in rural areas. This could be a challenge for CBDC-R to ensure the smooth functioning of transactions.

Analysing how CBDC-R can Impact Financial Inclusion, Payment Systems and Monetary Policy

The reason behind the launch of CBDC is to ensure India moves ahead in the area of digital payments and virtual currency.  With CBDCs, the RBI aims at addressing issues related to physical currencies and international transactions in terms of costs, efficiency, and seamless systems. CBDCs will be powered by universal access features inclusive of offline functionality, universal access devices as well as compatibility across various devices. This would help enhance the overall CBDC system and help foster financial inclusion.

As CBDCs would be issued and controlled by the RBI, the transitions could help the bank gain insight into economic trends and consumer behaviour that could help in formulating monetary policies. To harness the true potential of CBDC-R it is crucial to strike a balance between security, privacy, innovation, and financial stability. Visit Federal Bank to know more about how to join the CBDC ecosystem.