RBI's digital rupee FAQ | From key advantages to risks — all you need to know

India's first digital rupee pilot project will commence on Tuesday, i.e. today, with nine banks, including SBI, HDFC Bank and ICICI Bank, issuing the virtual currency for transactions in government securities. The first pilot in digital rupee in the retail segment is also planned for launch within a month in select locations in closed user groups comprising customers and merchants.

CBDC is a digital form of currency notes issued by a central bank. While most central banks across the globe are exploring the issuance of CBDC, the key motivations for its issuance are specific to each country's unique requirements.

India announced the launch of the Digital Rupee from the fiscal year 2022-23 onwards in the Union Budget tabled in Parliament on February 1, 2022.

According to the RBI website, CBDC is the same as currency issued by a central bank but takes a different form than paper (or polymer). It is a sovereign currency in an electronic form and will appear as a liability (currency in circulation) on a central bank’s balance sheet.

CBDCs should be exchangeable at par with cash.

CBDC can be classified into two broad types: general purpose or retail (CBDC-R) and wholesale (CBDC-W). Retail CBDC would be potentially available for use by all, viz. private sector, non-financial consumers and businesses, while wholesale CBDC is designed for restricted access to select financial institutions.

While wholesale CBDC is intended for the settlement of interbank transfers and related wholesale transactions, retail CBDC is an electronic version of cash primarily meant for retail transactions.

It is believed that retail CBDC can provide access to safe money for payment and settlement as it is a direct liability of the central bank. Wholesale CBDC has the potential to transform the settlement systems for financial transactions and make them more efficient and secure. Going by the potential offered by each of them, there may be merit in introducing both CBDC-W and CBDC-R.

According to the RBI,  payments using CBDCs will be final and thus reduce settlement risk in the financial system. CBDC will eliminate the need for interbank settlement. It can be compared to a UPI system where CBDC is transacted instead of bank balances as if cash is handed over.

Additionally, settlement in central bank money would reduce transaction costs by pre-empting the need for settlement guarantee infrastructure or collateral to mitigate settlement risk.

In a research note, the State Bank of India (SBI) said CBDC could offer benefits to users in terms of liquidity, scalability, acceptance, ease of transactions with anonymity and faster settlement compared with existing forms of money.

Nine banks -- State Bank of India (SBI), Bank of Baroda, Union Bank of India, HDFC Bank, ICICI Bank, Kotak Mahindra Bank, Yes Bank, IDFC First Bank and HSBC -- have been identified for participation in the pilot project.

In a recent concept note on Central Bank Digital Currency, the RBI said CBDC is aimed to complement, rather than replace, current forms of money and is envisaged to provide an additional payment avenue to users, not to replace the existing payment systems.

As per RBI, CBDC could also pose certain risks that may have a bearing on important public policy issues, such as risk to financial stability, monetary policy, financial market structure and the cost and availability of credit. They need to be carefully evaluated against the potential benefits.