What Is The Wholesale E-Rupee And Why Do We Need It? BQ Explains

On an average day in October, government bonds worth over Rs 35,000 crore were traded on Indian markets. However, these transactions were settled on 'T+1' basis, meaning the transaction is only completed a full day after the trade is logged.

That could be in for an overhaul, with settlement done instantly, if the digital money that the RBI has been quietly tinkering with succeeds.

Even though most people don't deal with inter-bank transactions in government securities very often, the wholesale central bank digital currency is likely to have a systemic effect.

Instant settlement will absorb risk from the financial system and could boost market liquidity as well. But getting there will also involve a change in market participant behaviour that may very well have a teething clock, and some of the pains that come with it.

The ongoing pilot of India's wholesale central bank digital currency has been progressing smoothly, according to bank executives and people familiar with the pilot.

Government securities worth at least Rs 200 crore were traded each day during the pilot's first week, a blockchain industry executive speaking on the condition of anonymity told BQ Prime.

While reducing settlement times is the immediate aim for the wholesale CBDC, the pilot is only the first step towards checking how well the digital money pipes work, according to a private banker familiar with the pilot.

"Wholesale CBDC has the potential to transform the settlement systems for financial transactions and make them more efficient and secure," the RBI noted in its concept note released in October.

Making settlement instantaneous removes the need for settlement guarantee infrastructure, according to a person familiar with the pilot. This will not only reduce counter-party risk, but will also make the Clearing Corporation of India's job easier.

The CCIL clears and settles transactions in government securities and other assets.

The Transaction Flow 

Settlement times have been compressing throughout history, easing from "T+5" in the 1960s to "T+2" or "T+1" currently, depending on the market.

The desire to reduce settlement times was also partly prompted by the Black Monday market crash of 1987, which demonstrated how extreme volatility can choke markets and leave transactional assets in the fray as brokers or counterparties go under.

Under the pilot, the CCIL's role is switched to more of a technology facilitator than a clearing house for trades. Here's how the transaction flow looks according to the banker familiar with the pilot:

• A bank sends a request to the RBI via the National Payments Corporation of India to convert a specified amount of money from their main deposit with the central bank.

• The banks then use a dedicated portal built by CCIL for the transactions which relies on a request for quote mechanism as opposed to the public broadcasting of a bid done currently.

• Once a bid is accepted, the details are forwarded to RBI which uses an automated system to the balances of cash and securities with the relavent parties.

• If the required checks are successful, the transaction is then executed and settled instantly.

While the CBDC's transaction flow is markedly different from the existing system—especially when it comes to the bidding process—it's likely that the two systems will converge once a wide rollout happens, the banker said.

The Upsides

As trade volumes rise in government securities, it is important to reduce the load on CCIL, Ajay Manglunia, managing director at JM Financial, told BQ Prime. CCIL has been the only agency providing clearing and settlement for government securities for ages, thus creating an alternate flow will also reduce systemic risk, he said.

In addition to the immediate goal of reducing settlement times, the RBI also sees the current pilot as a base for experimenting with cross-border transactions and the programmability of bonds in the future.

Theoretically, a bond issued in tokenised form could be programmed to follow a certain payout schedule and only payout if certain pre-defined conditions are met.

This is likely to be a long-term goal, but it will also add layers of customisation to bonds that would otherwise require multi-party coordination.

The Downsides

Going by how the pilot currently operates, there are two major downsides that bankers and industry executives pointed out.

The first one relates to how the transactions are processed. Due to the instant settlement time, banks can no longer rely on the "net" total of their transactions to manage their liquidity.

For example, a purchase worth Rs 50 crore followed by a sale of Rs 50 crore followed by another Rs 50 crore purchase would only require Rs 50 crore worth of "net" settlement liquidity at the end of the day.

But since the CBDC transactions are settled instantly, the advantage of netting transactions evaporates, according to the banker mentioned earlier. This makes liquidity management much more linear and can also curtail some creative ways to use liquidity during the day, the person said.

"In the last 30 years, it's always been 'T+1'," Manglunia said. Banks are familiar with how it operates, so there's a level of comfort—supplemented by the comfort of netting transactions.

While there might be some demand for instant settlements, "I would say only 10% to 15% of people would currently be keen for T+0, but I could be wrong," he added.

The second downside flagged by the people BQ Prime spoke with related to the technology being used for the trial.

Instead of using a dedicated fresh system, the RBI is currently using a mixture of existing tech platforms, including a blockchain platform called 'Vajra' built by the NPCI with certain customisations, according to an industry executive familiar with the pilot.

The mixture of technologies presents scaling challenges and can also add lag to the overall flow, the person said.