Note4Students
From UPSC perspective, the following things are important :
Prelims level: Central Bank Digital Currency (CBDC)
Mains level: CBDC used for foreign payments
Central Idea: RBI Deputy Governor T. Rabi Shankar commented on CBDC platforms and their potential impact on cross-border payments during the G20 TechSprint.
About Central Bank Digital Currency (CBDC)
- CBDC is a central bank-issued digital currency which is backed by some kind of assets in the form of either gold, currency reserves, bonds and other assets, recognised by the central banks as a monetary asset.
- The present concept of CBDCs was directly inspired by Bitcoin, but a CBDC is different from virtual currency and cryptocurrency.
- Cryptocurrencies are not issued by a state and lack the legal tender status declared by the government.
Hurdles in Cross-Border Payments
- Fragmented and truncated data formats: Lack of standardization in data formats creates inefficiencies in cross-border payments. Fragmented and truncated data formats create additional costs and delays in the processing of transactions.
- Complex processing of compliance checks: Cross-border payments require compliance with different regulatory frameworks in different jurisdictions. Compliance checks can be complex and time-consuming, causing delays and additional costs.
- Limited operating hours: Traditional banking systems have limited operating hours, which can cause delays in cross-border payments. International time zone differences also contribute to these challenges.
- Legacy technology platforms: Traditional banking systems still rely on legacy technology platforms, which can be slow and outdated. This can lead to inefficiencies and delays in cross-border payments.
- Long transaction chains: Cross-border payments often involve multiple intermediaries, which can lead to long transaction chains. Each intermediary adds additional costs and can increase the time it takes for a transaction to be completed.
- Funding costs: Cross-border payments require funding in multiple currencies, which can lead to additional costs. Exchange rate fluctuations can also impact the cost of cross-border payments.
- Weak competition: The lack of competition in the cross-border payments industry can contribute to inefficiencies and high costs. The dominance of a few large players can limit innovation and hinder the development of more efficient solutions.
Potential benefits with CBDC
- Less intermediaries: CBDC can reduce the need for multiple intermediaries in cross-border payments, leading to a faster and more efficient process.
- Enhanced efficiency: It can increase the speed and efficiency of cross-border payments by reducing processing times and delays.
- Enhanced integration: It can enable better integration between different payment systems, reducing fragmentation and increasing interoperability.
- Enhanced technical compatibility: It can be designed to work with existing payment infrastructure, making it easier to adopt and integrate into the current system.
- Enhanced safety: It can provide enhanced security measures that can help mitigate the risk of fraud and cyber-attacks in cross-border payments.
- Mitigation of cross-currency risks: CBDC can help mitigate risks associated with cross-border and cross-currency transactions, such as exchange rate fluctuations, currency conversion fees, and transaction processing delays.
How can this be implemented to practice?
| Description | Examples | |
| Model 1 | Enhancing Compatibility Among Domestic CBDC Systems | Many central banks are working to enhance the compatibility of domestic CBDC systems. Common international standards are required, which require regulatory coordination and market practices. |
| Model 2 | Interlinking CBDC Systems | CBDC networks are linked up by synchronizing payment actions without the need for a trusted third party or a common platform. |
| Model 3 | Establishing a Single mCBDC System | Cross-border payments are processed through a jointly operated “corridor network”. |
RBI’s push for CBDC adoption @ G20
- RBI emphasized the need for increased adoption of CBDCs across countries for them to play a role in the cross-border payments arena.
- Countries need to decide to create CBDCs and create an infrastructure for various CBDCs to interface for CBDCs to be effective in cross-border payments.
- RBI suggested India’s model of digitization, where the basic infrastructure was created by the public sector and the fintech/financial/start-up ecosystem was allowed to create innovative solutions, could also be successful with CBDCs globally
Conclusion
- CBDCs could bring about a significant change in the sphere of cross-border payments, but coordination across countries and between the public and private sectors is essential for that to happen
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