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    Explained | How Central Bank Digital Currencies could impact banking

    Explained | How Central Bank Digital Currencies could impact banking

    Explained | How Central Bank Digital Currencies could impact banking
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    By CNBCTV18.com  IST (Published)

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    Thanks to their unique features and growing market share, digital currencies have garnered the attention of major central banks. Several regulatory bodies and policymakers are hard at work, trying to develop and adopt blockchain technology to create and deploy digital sovereign currencies, or CBDCs.

    Imagine a new type of money that has blockchain technology at its core but still has several features of a fiat currency. That’s precisely what a CBDC is. Short for Central Bank Digital Currency, CBDCs are digital forms of fiat money being developed by governments on centralised blockchains. They are expected to offer the features and benefits of a crypto token but will complement the country’s fiat currency, making them less volatile.
    Blockchain technology and decentralised finance (DeFi) have shot to popularity in the last few months. Currently, there are reportedly around 6,000 cryptocurrencies in circulation, and 10 percent of the world’s population has invested in them. Thanks to their unique features and growing market share, digital currencies have garnered the attention of major central banks. Several regulatory bodies and policymakers are hard at work, trying to develop and adopt blockchain technology to create and deploy digital sovereign currencies, or CBDCs.
    The Reserve Bank of India (RBI), for instance, is in the process of rolling out its own digital rupee to ‘curb damaging consequences’ of private cryptocurrencies.

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    However, the mainstay of blockchain technology and decentralised finance is that they remove the need for a central governing body. They put transactional control and data privacy back in the hands of their users. So how will centralised CBDCs impact money flow and the way financial institution's function.
    Although CBDCs are still in the works across most countries, let’s look at how its launch could potentially affect the banking system:
    Domestic Banks
    CBDCs will be created and issued directly by the central bank of a country. So, if you are in India, your account will be held by the RBI. It will typically be backed by gold or reserves just like cash.
    According to RBI Deputy Governor T Rabi Sankar, CBDCs will prove to be beneficial in many ways. CBDC “has the potential to provide significant benefits, such as reduced dependency on cash, higher seigniorage due to lower transaction costs, reduced settlement risk,”
    So, does this mean the role of domestic banks as lenders, deposit holders or a financial intermediary could be usurped? According to Sankar, CBDC is a currency that does not pay interest, its impact on bank deposits may be limited, Sankar said in a webinar in July.
    “Depositors that require CBDCs for transactional purposes are likely to sweep day-end balances to interest-earning deposit accounts,” he said. However, banks are worried that if the RBI does choose to pay interest, it could lead to a drop in deposits leaving them with less money to lend.
    According to The Economic Times, a greater impact will be felt by credit unions and cooperative banks as their business is heavily reliant on cash. A sudden migration to digital currency could create mass confusion and would require some time to adopt.


     
    International Banks
    Cross-currency trading is a significant business component for international banks. And the arrival of CBDCs could completely transform the way foreign exchange (forex) functions. Banks will have to align themselves with new frameworks in an economy that runs on digital and physical currency. New standards may also be created as settlement processes are bound to change.
    A digital infrastructure would also have to be developed to support the same, and multiple new networks would get established in the process. The metamorphosis will require fintech support as innovation will come in handy to streamline operations and improve throughput. However, the transformation will be resource-intensive as the new infrastructure will operate globally. Technological investments will also have to be made for the same.
    Central Banks
    While it is true that the cost of minting and printing new currency will significantly reduce with the arrival of CBDCs, the migration to digital operations will be a humongous task on a national level. However, the resources that are freed up in the process could then be devoted to managing liquidity in the upgraded economy, the ET report pointed out.
    CBDCs will be coded digital currency, improving its traceability and allowing central banks to combat theft or fraud. Current financial systems follow a long paper trail for audits or KYC. The adoption of CBDCs will require central banks across the world to alter the existing norms to incorporate the repercussions of the migration. These are likely to be the biggest challenges that central banks will face.
    For the banking sector as a whole, massive re-education and training efforts will be required to bring the financial workforce up to speed with the new methods and frameworks. The initial cost of this change could be tremendous, and the central governing body will have to chart out a well-thought plan for execution.
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