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The Reserve Bank of India’s Digital Rupee Pilot Program Commences in the Wholesale Segment

The Reserve Bank of India’s Digital Rupee Pilot Program Commences in the Wholesale Segment

On 1st November 2022, the Reserve Bank of India (“RBI”) commenced its pilot program on Digital Rupee in the wholesale segment. The use case for this pilot programme is “settlement of secondary market transactions in government securities”. As per RBI’s Press Release, “settlement in central bank money would reduce transaction costs by pre-empting the need for settlement guarantee infrastructure or for collateral to mitigate settlement risk”, making the inter-bank market more efficient. Nine banks have been identified by the RBI for the pilot programme for the wholesale segment.

The RBI had announced the launch of the pilot programme at the time of issuing the Concept Note on Central Bank Digital Currency (“CBDC”). As the name suggests, CBDC is virtual money created by a central bank of a country and is recognised as legal tender by the central bank of that country. On 7th October 2022, the RBI had issued the Concept Note with the objective of creating awareness about CBDCs in general, and the e₹ (Digital Rupee), in particular. In the Concept Note, the RBI has defined CBDC as the legal tender issued by a central bank in a digital form which is the same as sovereign currency and is exchangeable with fiat currency.

As per the RBI, technological innovations are pushing the central banks, globally, to think about how the CBDCs could complement or replace traditional money. In light of the developments, the RBI had set up an Internal Working Group in October 2020 to study appropriate implementation architecture for introduction of CBDCs in India. This Internal Working Group had, in its recommendations, highlighted the need for a robust legal framework to back the issuance of e₹ as an alternate form of currency and for amending the Reserve Bank of India Act, 1934 (“RBI Act”) to define and cover features pertaining to the e₹. As per the Concept Note, “the introduction of CBDC in India is expected to offer a range of benefits, such as reduced dependency on cash, lesser overall currency management cost, and reduced settlement risk”.

The Concept Note classifies CBDCs into two categories – Wholesale (“CBDC-W”) and Retail (“CBDC-R”). CBDC-W is intended for settlement of interbank transfers and related wholesale transactions and CBDC-R is intended to be an electronic version of cash meant for retail transactions by inter alia, private sector, non-financial consumers and businesses. The first pilot for the Digital Rupee for the retail segment (e₹-R) is expected to launch by December 2022 in select locations in closed user groups comprising customers and merchants.

In addition to providing a background on the technology behind CBDCs, the Concept Note also discusses some of the following key considerations for introduction of CBDCs on banking system and financial stability in India:

  • There is a need to provide a legal framework for providing the legislative mandate to the RBI to issue the CBDCs as well as introduction and amendment of the provisions of the RBI Act based on the form of CBDCs (either account based, or token based).
  • As regards privacy, the RBI acknowledged that it is essential to have privacy policy pertaining to customer data that will be collected by the banks while issuing the CBDCs and to secure the best interests of the citizens.
  • The Concept Note also provides guidelines in respect of cyber-attacks, which also affects the existing payment systems. The guidelines specify that security will be the primary concern along with setting up of a risk management framework for users within the CBDC network, testing of user interface to avoid exploitation of vulnerabilities, use of cryptography for a safe design, etc.
  • The RBI acknowledges that central banks are required to design the CBDCs in a manner that is compliant with the regulations and requirements pertaining to anti-money laundering and combating financial terrorism. As per the Concept Note, the ultimate responsibility for Customer Due Diligence needs to be clearly delineated and the design of CBDC should have the embedded mechanism for identifying and monitoring the transactions.
Our Take:

The RBI has been dealing with the question of introduction and legality of a digital currency for quite some time, particularly in light of the increasing popularity of private cryptocurrencies. Although the RBI has been sceptical towards private cryptocurrencies, repeatedly warning users of its use as well as the associated financial risks, the central bank as well as the Ministry of Finance have taken steps towards defining the legal contours of virtual/digital currency within the country. The amendment of the Income Tax Act, 1961, earlier this year, to introduce a tax on gains and income derived from virtual digital assets was one such step in this direction.

However, CBDCs are centralised and therefore different from the traditional cryptocurrencies that are decentralised and remain largely unregulated. Moreover, CBDCs are intended to act as an alternate form of legal tender whereas cryptocurrencies, at present, lack this ability given that the same have not been officially accepted by the RBI.

Having said the above, the launch of CBDCs in India has raised the expectation of the crypto industry and is being seen as a step towards the possible acceptance and eventual regulation of private cryptocurrencies in the country. The success of the pilot programme introduced by the RBI will be crucial in determining the fate of digital currency as well as cryptocurrency in India.

Links:

Link to the Press Release on Operationalisation of Central Bank- Digital Currency – Wholesale (e₹-W) Pilot: https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=54616

Link to the Concept Note on CBDCs: https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/CONCEPTNOTEACB531172E0B4DFC9A6E506C2C24FFB6.PDF

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