Transformation of Central Banks: Digital Central Banks for the Digital Era

The objectives of central banks worldwide are largely similar in nature. National laws define these objectives, focusing primarily on monetary stability, financial stability, and economic growth. The wave of central bank establishments began in the early 18th century.

The first battle for central banks worldwide was transitioning from a non-monetized to a monetized economy. The second battle involved establishing a secure payment system, maintaining monopoly over national currency issuance, and fostering financial inclusion through innovative means. Now, central banks are engaged in the third battle—embracing digitization to transform the entire economic system into a digital one. Many central banks have already achieved significant success in this endeavor, though challenges remain, particularly in mitigating financial risks while adopting emerging technologies.

Nepal’s Journey Towards a Digital Economy

In Nepal’s case, the Nepal Rastra Bank Act of 2012 mandated the central bank to regulate currency issuance, ensure stability in the exchange rate of Nepali currency, and develop the banking system. In its first decade, Nepal Rastra Bank (NRB) focused on expanding the circulation of Nepali banknotes and stabilizing the exchange rate with the Indian currency.

During the second decade, the central bank emphasized the implementation of monetary policy tools and ensuring the presence of at least one commercial bank branch in every district, which was achieved by 2034 B.S. The third decade saw NRB diversifying credit distribution, particularly in agriculture and productive sectors, through priority lending programs and promoting foreign investment in joint-venture banks. In recent years, the central bank has played a crucial role in Nepal’s digital transformation under the government’s Digital Nepal Framework, facing both opportunities and challenges in this process.

Evolving Banking Practices and the Changing Role of Central Banks

Initially, commercial banks provided only limited financial products. There was no interbank check clearance, and credit diversification was minimal. Traditionally, banks were seen merely as intermediaries accepting deposits and providing loans. However, the evolution of banking has expanded the definition, with non-banking institutions playing a significant role. Bill Gates’ 1994 statement, “Banking is necessary, but banks are not,” took years to be fully understood.

The rise of fintech companies, payment system operators, and card networks (Visa, MasterCard, American Express, UnionPay) has transformed banking. Modern regulations now extend beyond traditional banks to include these digital players. Compared to global markets, Nepal’s financial system was slow in digital adoption, with the first credit card introduced in 1990 and internet banking launching only in 2002. However, in recent years, digital adoption has accelerated significantly, strengthening Nepal’s digital financial ecosystem.

Strengthening Nepal’s Digital Financial Infrastructure

NRB has prioritized the development of digital payment infrastructure. The digital adoption seen today is largely based on Nepal Payment System Development Strategy (NPSDS), formulated in 2014. Following this, in 2016, the Payment Systems Department was established within NRB. In 2019, the Real-Time Gross Settlement (RTGS) system was introduced to facilitate large-value transactions in real-time, reducing reliance on expensive SWIFT systems.

A major challenge remains the reliance on foreign card schemes, leading to significant outflows of foreign currency in service fees. To address this, NRB has initiated the development of a domestic card scheme, “Nepal Card,” and a national payment switch, which will retain substantial financial data and capital within Nepal while fostering fintech growth.

Pressure for Central Banks to Go Digital

Rapid technological advancements present both opportunities and challenges for regulatory bodies. Governments and regulators are generally conservative in adopting new practices. However, private sector-driven innovation is crucial for digital transformation. A 2020 Accenture study highlighted how technology-driven changes in the financial sector will have profound impacts on central banks and regulatory frameworks.

AI, machine learning, big data analytics, distributed ledger technology, and IoT are reshaping economies, with banking being one of the most affected sectors. Traditional regulatory approaches may no longer suffice. If central bank digital currencies (CBDCs) become necessary, NRB will need to consider their implications on money supply, financial inclusion, and system security. Regulatory and supervisory technology (RegTech and SupTech) will be indispensable for overseeing the evolving financial landscape.

The Road Ahead for Nepal Rastra Bank

As Nepal moves towards a digital economy, the central bank must proactively embrace regulatory reforms, digital payment innovations, and financial inclusion strategies to ensure a stable and secure financial ecosystem in the digital age.