Author: Anubhuti Misra, Himachal Pradesh National Law University Shimla

The emergence of central bank digital currencies (CBDC) is a revolutionary shift in the history of international monetary systems. This study explores the ways in which CBDCs can transform monetary policy through better policy transmission, better monetary control and better payment infrastructure. It analyses the design models of CBDCs and how they affect financial stability and the consequences on banking intermediation. Based on the pilot projects implemented in other countries, as well as the existing academic studies, the work concludes that, although CBDCs may enhance the effectiveness and effectiveness of monetary policy, their effectiveness relies on effective legal protections, moderate regulation, and prudent integration within the current financial system.

Keywords 

CBDC, Monetary Policy, Monetary Transmission, Banking Intermediation, Financial Stability, Digital Payments, Central Banking, Financial Inclusion, Currency Regulation.

Central banks across the globe have been motivated by the electronic revolution in the financial sector to consider sovereign digital currency that has the potential of meeting the changing demands of the current economies. CBDCs are a type of digital central bank money that is intended to increase payment efficiency, increase monetary control, and ensure that the central bank remains relevant in a more digital financial world. CBDCs present a possible way to enhance the effectiveness of policies as the traditional monetary tools are under threat by the private digital currencies and decentralized payment systems. Nevertheless, how well they redefine the future of monetary governance will depend on the way they are designed, implemented, and aligned with the regulations.

The current literature identifies CBDCs as an instrument of enhancing payment efficiency, promoting financial inclusion, and enhancing monetary transmission. According to scholars, the CBDCs enable central banks to directly manipulate the liquidity and interest-rate channels which can help to eliminate the frictions in the policy conduction. According to policy papers by BIS, IMF and ECB, the results are influenced by the design decisions that include interest-bearing models and access structures. Simultaneously, issues related to disintermediate commercial banks, cybersecurity, and the necessity to have strong regulatory control are still of concern. The case studies concerning China, the Bahamas, and Nigeria present the possibilities and setbacks that can be used in practice.

1. To study the effect of CBDCs on monetary policy formulation and transmission.

2. To determine the impact of CBDC design features on monetary control and financial stability.

3. The purpose of the research is to evaluate how CBDCs will affect banking intermediation and liquidity management.

4. To examine both international CBDC pilot studies to determine practical difficulties and policy lessons.

The methodology used in this study is qualitative, doctrinal and comparative. It is based on scholarly sources, reports of the central bank, BIS/IMF reports and policy papers. Comparative study of international CBDC pilots offers empirical information, whereas conceptual analysis investigates the interaction of the CBDCs with the traditional financial instruments, e.g., interest rates, liquidity, and credit generation.

CBDCs are legalized because of the laws of a central bank, legislation of currency and laws of payment systems.

Central Bank Authority: Issuance of CBDC must be explicitly granted in central bank laws or currency laws.

Legal Tender Status: CBDC should be legally defined as sovereign and a central bank liability.

Monitoring of Monetary Policy: Rules should be in place to make sure that the issuance of CBDC is in line with monetary and price stability.

Privacy and data protection: CBDC systems should be in accordance with the requirements of the national data protection laws, and cybersecurity standards.

AML/CFT Compliance: It is necessary to have strong KYC and transaction-monitoring standards relying on AML/CFT legislation.

Consumer Protection: The laws regarding the payment systems must guarantee the safe, transparent, and responsible use of CBDC.

International Standards: CBDC should be developed in accordance with the BIS, IMF and FATF standards on international interoperability.

CBDCs can become a new way of defying monetary policy, involving central banks with a more direct way of influencing economic activity. A retail CBDC would improve the mechanism of transmission of interest rate, decrease reliance on intermediaries and enable quicker application of policy modifications. These advantages are, however, very design driven.

As an example, a CBDC with interest could be useful in a central bank directly affecting saving and spending behavior but may also lead to deposits being taken out of commercial banks, which impacts on their lending ability and therefore credit creation. A token-based model can have better privacy, but at the expense of the complexity of AML/CFT compliance, an account-based model can have a high level of regulatory oversight and identity control.

Experience of international pilots, including e-CNY in China or the Sand Dollar in the Bahamas, demonstrates that CBDCs can enhance the efficiency of payment and inclusion but would require robust legal, technical, and institutional frameworks to prevent systemic risk. Thus, although CBDCs provide a game-changer in policy-making, their effectiveness will be determined by a balanced approach to innovation, regulation, and coordination of financial systems.

CBDCs can intensify the transmission of the monetary system by minimizing the structural weaknesses within the financial system.

The key to reducing the risks in the system and facilitating monetary stability is the designing of effective CBDC.

Banking intermediation can become an issue due to deposits being transferred to CBDSs.

International pilot projects accentuate not only the increase in efficiency but also the necessity to have strong legal and technical structures.

CBDCs are more likely to complement, not to substitute, traditional monetary instruments, making policies more accurate.

The introduction of the CBDC requires regulatory and legal clarity that would provide safe and efficient implementation of the process.

CBDCs are one of the milestones in the modernization of world monetary systems. They can increase the effectiveness of monetary policy, boost financial inclusion, and increase the power of central banks in an ever-digitizing world by providing a safe and efficient system of digital payment. Their capacity to redefine monetary policy, however, relies upon careful design, excellent legal bases, and integration with the current financial frameworks. CBDCs have huge potential, as the experiments around the globe demonstrate, but should be carefully managed to remain innovative and stable at the same time. CBDCs would be able to reform the future of financial governance with the correct regulation and implementation, and the integrity of financial systems would remain intact.

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