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1.1 RBI to include CPs and CDs in CBDC pilot programs

💡 What

The Reserve Bank of India (RBI) is planning to start a pilot program for the wholesale segment
of Central Bank Digital Currency (CBDC) in commercial papers (CPs) and certificates of
deposits (CDs), as stated by the RBI’s Governor Shaktikanta Das at the BIS Innovation Summit
2024, Switzerland.

Tell me more
What is a certificate of deposit?

A certificate of deposit (CD) is a promissory note issued by a bank to an investor who chooses to
deposit his funds in the bank for a specific amount of time.

Once the money is deposited, the depositor cannot withdraw the funds without incurring a penalty
for early withdrawal.
The interest paid to the depositor of a CD is higher than for a savings account. Once the CD
matures, the funds are repaid to the depositor with interest.
What is commercial paper?

Commercial paper is a short-term money market instrument that matures within 270 days.

CPs are used to raise funds quickly without collateral, instead of a bank loan with long tenure.

Only creditworthy institutions with high ratings can issue it at low interest rates.

Lower-rated organizations may need to offer higher interest rates to attract investors.

How CBDC will be used in CP and CDs?

CPs and CDs will be tried out in the pilots, along with security and securities tokenization features. This
could involve developing digital platforms or systems where users can exchange CBDC for these
financial instruments.
What does Shaktikanta Das, the Governor of the RBI, say about the CBDC pilot program?

1. The daily retail transaction volume of CBDC through interoperability with the United Payments
Interface (UPI) has reached 1 million/day but retail users still have a strong preference for UPI.

2. The large volume of transactions is required to fully understand the broader economic impact of
CBDC, particularly on monetary policy and the banking sector.

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 3. Permanent deletion of transactions can make the e-rupee or the CBDC anonymous and at par with
paper currency. The basic principle is that CBDC can have the same degree of anonymity as cash,
no more and no less.

a. The benefits of CBDCs will become more apparent with the introduction of offline usage and
programmability features.

b. A key objective of the pilots is to study the change in consumer behavior vis-a-vis bank
deposits. We need many more transactions to understand its wider economic effects,
especially on monetary policy and the banking system,

4. The CBDC is crafted to be non-interest-bearing, aiming to alleviate risks linked with bank
disintermediation.

All about CBDC:

RBI defines CBDC as the legal tender issued by the central bank in a digital form. CBDC denominations
mirror physical currency are the same as a sovereign currency and are exchangeable one-to-one at
par (1:1) with the fiat currency.

Based on the usage, CBDC can be demarcated into 2 broad types:

General purpose (retail) (CBDC-R): CBDC-R is potentially available for use by all private sector,
non-financial consumers and businesses

Wholesale (CBDC-W): wholesale CBDCs are designed for restricted access by financial
institutions.

Single Tier and Two- Tier model:

Single Tier: This is a Direct CBDC system wherein the central bank is responsible for managing all
aspects of the CBDC system including issuance, account-keeping, transaction verification, etc.

This system offers resilience because the RBI possesses comprehensive data on retail account
balances, enabling easy management of claims with readily available verification information.

The major disadvantage of this model is that it reduces private sector involvement and hinders
innovation in the payment system.

Two-Tier Model(Intermediate model):

Due to the inefficiency of the single-tier model, CBDCs are designed as part of a 2-tier system, where
the central bank and other service providers, each play their respective roles. The 2 models are:

1. Indirect Model: In the "indirect CBDC" model, consumers store their CBDC with banks or service
providers. The responsibility to supply CBDC on demand rests with the intermediary, not the RBI.
The RBI monitors only the wholesale CBDC balances held by intermediaries, ensuring they match
the total retail balances held by customers.

2. Hybrid Model - In the Hybrid model, a direct claim on the RBI is paired with a private sector
messaging layer. Entities receive CBDC from the central bank and handle customer-related tasks.
Commercial intermediaries (payment service providers) offer retail services to users, while the
central bank maintains a ledger of retail transactions.

Relatable Chapter: Regulatory Bodies, Fintech

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 Relevance of the fact: This news is related to the governor’s speech where Das is trying to emphasize
the RBI’s new plan on CBDC. You as an aspirant must be aware of these plans. The conceptual
understanding of what CBDC is holds the utmost importance.

1.2 RBI guide NBFCs to stick to gold loan cash payout cap of Rs
20,000

💡 What

Recently, RBI warned non-bank lenders against disbursing cash loans in excess of the
permissible limit of 20,000 rupees ($240).

India prohibits lenders from handing out cash loans in excess of 20,000 rupees to
customers, as per income tax rules.

A significant portion of gold loans are being disbursed in cash.

💡 Why

1. Retail lending in India, especially gold-backed loans, has surged in recent years. This
change aims to prevent large cash payments for gold-backed loans.

2. RBI is closely monitoring lenders who don't follow the rules to safeguard customers and
prevent risks to the financial system.

3. Following recent penalties on IIFL Finance, the RBI is taking swift action against non-
compliant lenders, particularly NBFCs, known for offering large cash loans despite
restrictions.

Tell me more

India prohibits lenders from handing out cash loans in excess of 20,000 rupees to customers, as
per income tax rules.

Non-bank finance companies (NBFC) have been breaking this rule and have been handing over
large cash loans by asking customers to sign an 'indemnity' for accepting liability against income-
tax actions.

"Indemnity" is a legal agreement in which one party agrees to compensate another party for
any losses or damages that may arise from a specific action.

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 ℹ️ Provisions of Section 269SS of Income Tax Act, 1961:

Which stipulates that no individual can receive more than 20,000 rupees as loan amount
in cash.

The provision applies to all types of taxpayers, including individuals, HUFs, firms,
companies, and any other entity, regardless of their nature of business or profession. The
section also covers transactions between related parties.

Exceptions to Section 269SS:

1. Transactions between the government and any other person

2. Transactions between banks and other financial institutions

3. Transactions between the RBI and any other person

4. Transactions between post offices and any other person

Problems:

1. Smaller players are putting pressure on non-bank lenders offering gold loans, leading them to take
bigger risks such as giving out more cash than allowed.

2. The RBI aims to prevent the creation of 'black money' and address any gaps in income tax
regulations that some non-bank finance companies may have been exploiting.

Relatable Chapter: Risk management system, Indian banking system, non-banking system
Relevance of the fact: This news is an important news; the factual information is important here.
Remember the provision and its exception, what is the limit of cash loan? All these information can be
asked by the examiner.

1.3 Climate change impact on monetary policy transmission: RBI

💡 What

As per the recent report of the RBI, it has been observed that frequent weather shocks pose
challenges for monetary policy.

For these reasons, central banks are increasingly incorporating climate risks explicitly
into their modeling frameworks

Tell me more

Climate risk:

As per RBI's Monetary Policy Report April 2024, Global average temperatures are on the rise, with an
accompanying increase in extreme weather events (EWE), and the economic and social impact of

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 global warming is becoming increasingly evident.

How can Climate change affect monetary policy?

Climate change directly impacts inflation through adverse weather events affecting agricultural
production and global supply chains.

Climate change could impact the natural rate of interest, and the after-effects of climate change
might weaken the transmission of monetary policy actions to financing conditions faced by
households and firms.

The natural or neutral rate of interest is the short-term interest rate that would, support the
economy at full employment GDP while keeping inflation constant. It's the interest rate that
neither stimulates nor restricts economic growth.

In the absence of any climate mitigation policies, the long-term output will be lower by around 9%
by 2050 vis--vis a no climate change scenario with full pass-through of the physical risks of
climate change to the economy.

Lower productivity may lead to a fall in the natural rate of interest. Frequent shocks to inflation will,
however, necessitate tighter monetary policy even with a lower natural rate of interest

Relatable Chapter: Regulatory Body, Risk Management System

Relevance of the fact: This news emphasizes how climate change can make monetary policy
ineffective. The RBI has started recognizing the effect of climate change on MPC. This information is
important and can be used in the descriptive answers.

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