Two-Tier CBDC Model

The Two-Tier Central Bank Digital Currency (CBDC) model refers to a structural framework for issuing and distributing digital currency in which responsibilities are divided between the central bank and intermediary institutions, primarily banks. This model mirrors the existing two-tier monetary system, where the central bank issues base money and commercial banks distribute it to the public. In banking and finance, the two-tier CBDC model is widely regarded as the most practical and stable approach to introducing digital sovereign money. In the Indian economy, this model has particular relevance due to the size, diversity, and complexity of the financial system.
By preserving the role of banks and financial intermediaries, the two-tier CBDC model seeks to combine innovation with financial stability, inclusion, and effective monetary control.

Concept and Meaning of the Two-Tier CBDC Model

Under the two-tier CBDC model, the central bank issues CBDC to regulated intermediaries, such as commercial banks, which in turn distribute it to end users including individuals and businesses. The central bank remains the sole issuer of the digital currency, while intermediaries handle customer-facing activities.
The two tiers typically consist of:

• Tier One: The central bank, responsible for issuance, overall control, and settlement.
• Tier Two: Banks and authorised financial institutions, responsible for distribution, customer onboarding, and transaction services.

This structure closely aligns with existing monetary and banking arrangements, reducing disruption while enabling digital innovation.

Rationale for Adopting a Two-Tier Model

The two-tier CBDC model is preferred by many central banks because it balances efficiency with systemic safety. Direct issuance of CBDC by the central bank to the public could bypass banks, potentially weakening financial intermediation.
Key reasons for adopting a two-tier model include:

• Preservation of the banking system’s role in credit creation.
• Avoidance of large-scale disintermediation of banks.
• Utilisation of existing banking infrastructure and expertise.
• Better scalability and operational efficiency.

For economies with well-established banking networks, this model offers a smoother transition to digital currency.

Role of the Central Bank in the Two-Tier Model

In the two-tier CBDC framework, the central bank retains full control over issuance, redemption, and monetary integrity of the digital currency. It defines the legal tender status, technological standards, and policy objectives of the CBDC.
Key responsibilities of the central bank include:

• Issuing CBDC to authorised intermediaries.
• Maintaining the core ledger or settlement layer.
• Ensuring cybersecurity and system resilience.
• Aligning CBDC issuance with monetary policy objectives.

In India, these functions are performed by the Reserve Bank of India, which has emphasised a calibrated and cautious approach to CBDC implementation.

Role of Banks and Financial Intermediaries

Banks and other regulated intermediaries form the second tier of the CBDC model. They act as the interface between the central bank and the public, similar to their role in physical cash and deposit money.
Their responsibilities include:

• Distribution of CBDC to customers.
• Conducting Know Your Customer (KYC) and compliance checks.
• Providing digital wallets and payment services.
• Customer support and grievance redressal.

This arrangement leverages banks’ existing customer relationships and compliance frameworks, making CBDC adoption more practical and inclusive.

Two-Tier CBDC Model and Banking Stability

A major advantage of the two-tier CBDC model is its positive impact on banking stability. By routing CBDC through banks, the model avoids sudden shifts of deposits from bank accounts to central bank money.
This helps in:

• Maintaining banks’ deposit base.
• Ensuring continued availability of credit to the economy.
• Reducing the risk of digital bank runs.
• Supporting orderly financial intermediation.

For a bank-dominated financial system like India’s, these considerations are critical.

Implications for Financial Markets and Payments

The two-tier CBDC model enhances the efficiency and resilience of payment systems without undermining existing market structures. CBDC can coexist with cash, bank deposits, and digital payment instruments.
Key implications include:

• Faster and more secure retail and wholesale payments.
• Reduced settlement risk.
• Improved interoperability across payment platforms.
• Enhanced transparency and traceability.

These benefits strengthen the overall financial infrastructure.

Relevance to the Indian Financial System

In the Indian context, the two-tier CBDC model aligns well with the country’s institutional and economic realities. India has a vast banking network, diverse customer base, and varying levels of digital literacy.
The model supports:

• Gradual and controlled introduction of CBDC.
• Financial inclusion through banks and regulated intermediaries.
• Integration with existing digital payment systems.
• Effective regulatory oversight.

By building on established structures, the model minimises disruption while maximising benefits.

Impact on the Indian Economy

At the macroeconomic level, the two-tier CBDC model supports economic efficiency and stability in India. It allows the benefits of digital currency—such as lower transaction costs and improved transparency—without destabilising the financial system.
Economic implications include:

• Enhanced efficiency in retail and wholesale payments.
• Better transmission of monetary policy.
• Support for formalisation of the economy.
• Strengthening of trust in sovereign digital money.

These outcomes are particularly valuable for a large, developing economy undergoing rapid digital transformation.

Advantages of the Two-Tier CBDC Model

The two-tier model offers several advantages:

• Preserves the existing banking and financial structure.
• Reduces operational burden on the central bank.
• Enhances scalability and adoption.
• Supports financial stability and inclusion.