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Picture Courtesy: The Hindu

Context:

The Reserve Bank of India (RBI) has recommended that a proposal to link Central Bank Digital Currencies (CBDCs) of BRICS countries be included in the agenda of the 2026 BRICS Summit, which India will host.

What is Central Bank Digital Currency?

A Central Bank Digital Currency (CBDC) is a digital form of a country’s sovereign currency, issued and regulated by the central bank, and recognized as legal tender, just like physical cash.

CBDC is known as the Digital Rupee (e₹) and is issued by the Reserve Bank of India (RBI). 

Functioning of CBDC:

CBDC functions through a centralised issuance system where the central bank issues digital currency that is distributed via banks or authorised intermediaries, stored in digital wallets, and transferred through secure cryptographic systems with real-time settlement.

Objectives of CBDC:

The primary objectives of CBDC are to provide a safe digital alternative to cash, enhance payment system efficiency, promote financial inclusion, reduce dependence on private digital money, strengthen monetary sovereignty, and enable faster and cheaper cross-border transactions.

Types of CBDC

CBDCs are classified into Retail CBDC, which is designed for use by the general public as a digital substitute for cash, and Wholesale CBDC, which is intended for interbank settlements and financial market transactions. 

Benefits of CBDC:

CBDCs help improve financial stability by offering risk-free digital money, enhance payment efficiency through instant settlement and lower costs, promote financial inclusion via offline functionality, reduce illicit financial activities through traceability, and support cross-border trade by minimising intermediary dependence.

CBDC vs Cryptocurrency:

Key Features of CBDC:

CBDCs possess features such as legal tender status, sovereign backing, high security, interoperability with existing payment systems, offline usability, programmability for targeted transfers, and absence of credit or liquidity risk.

India’s Approach to CBDC

India’s Digital Rupee (e₹) is being piloted by the Reserve Bank of India with features such as offline payments, programmable subsidies, and fintech wallet integration, while positioning it as a safe alternative to private stablecoins. 

Challenges Associated with Central Bank Digital Currency (CBDC):

• Cybersecurity and operational risks: CBDCs are vulnerable to cyberattacks, hacking, malware, and system outages, and given that they represent sovereign money, any breach can undermine trust in the entire monetary system, with the BIS (Bank for International Settlements) identifying cyber risk as one of the top three threats to CBDC implementation globally. 

• Privacy and data protection concerns: CBDCs require transaction traceability to prevent money laundering and terror financing, but excessive surveillance can violate individual privacy, creating tension between financial transparency and civil liberties, especially in the absence of robust data protection laws in many developing economies. 

• Risk of bank disintermediation: If individuals shift large deposits from commercial banks to CBDC wallets, banks may face deposit erosion, affecting their ability to lend, which the IMF (2023) warned could increase financial instability, especially during crises when CBDCs may be perceived as safer than bank deposits. 

• Impact on monetary policy transmission: While CBDCs can improve policy transmission, poorly designed CBDCs could lead to unintended tightening of liquidity, complicate interest rate management, and increase volatility in money markets, particularly if CBDCs are interest-bearing. 

• Digital divide and financial exclusion: Despite inclusion goals, CBDCs may exclude populations lacking smartphones, internet access, or digital literacy, with the World Bank (2024) noting that nearly 1 billion adults globally still lack reliable digital access, making over-reliance on digital currency risky. 

Way Forward:

• Phased and pilot-based implementation: Countries should follow a gradual rollout strategy, as adopted by India’s e₹ pilot, allowing regulators to test cybersecurity, scalability, and user behaviour before full-scale adoption. 

• Strong cybersecurity architecture: CBDC systems must adopt multi-layered cybersecurity frameworks, including encryption, redundancy, real-time monitoring, and regular stress testing, aligned with BIS and ISO standards. 

• Privacy-by-design framework: A calibrated approach combining low-value anonymity with high-value traceability should be adopted, ensuring compliance with AML/CFT norms while protecting individual privacy through strong data governance laws. 

• Two-tier distribution model: Maintaining a central bank–commercial bank partnership model can prevent bank disintermediation, preserve credit creation, and ensure that CBDCs complement rather than replace the existing banking system. 

• Financial inclusion measures: Offline CBDC functionality, feature-phone compatibility, and digital literacy campaigns are essential, especially in developing economies, as demonstrated by India’s focus on offline e₹ payments. 

Conclusion:

Central Bank Digital Currency has the potential to modernise payment systems, strengthen monetary sovereignty, and enhance financial inclusion, but its success will depend on addressing cybersecurity, privacy, banking stability, and interoperability challenges through a cautious, phased, and well-regulated approach supported by strong domestic and international coordination.

Source: The Hindu