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12/20/2012

Cash is here to stay, the question is how you manage it

Despite many experts' forecasts proclaiming the rise of a cashless society, recent studies show that cash remains the most popular payment instrument in Europe. According to figures from the EPC and ECB , it appears that cash still accounts for 60 to 80% of the annual payment transactions in the European Union. With the technology available and ongoing innovations, how to explain this affection for physical currency? How banks can efficiently manage the cash cycle? What to expect in the future?

Cash is king!
Even if the proportion of cash usage has been declining within the payment instruments mix, many consumers, especially the older ones, still feel more confident with cash, because it is accessible for all, tangible, instantaneous and apparently free.

It is of course not easy to know exactly the volume of cash payments amongst other means, as cash is mostly used for small amount transactions, which are not recorded. Nevertheless, several studies have been trying to estimate the proportion of cash usage and all come up with similar conclusions: cash is by far the most preferred means of payment in volume of transactions. However, some differences exist between EU countries and are interesting to be noted.

  • Southern and eastern countries (such as Italy, Spain, Greece, Romania, Hungary, Poland) are still high cash users. This can be explained by historical and cultural habits, attitudes towards payment innovation.
  • Benelux and northern countries have become more card users, influenced by new technologies, efficiency of electronic payments or even by law. In Belgium for example, payments in cash have been limited in value to fight against fraud and money laundering. As of 2014, maximum threshold for cash payment will be 3,000 . EUR.

Figure 1 - Cash usage statistics per country in EU

The average trend is quite clear; cash will continue to have a large place in society as means of payment. This expectation is easily explained by its advantages:

  1. Cash is untraceable and therefore guarantees the protection of privacy.
  2. Cash transactions do not need any electronic infrastructure (POS terminal).
  3. Cash is accessible for all (people not part of the banking system, teenagers...).
  4. Cash can be perceived as a more trusted payment instrument compared to new cashless payment services

Moreover, during these times of financial crisis and economic trouble in Europe, consumers tend to use cash as a way to control their budget.

Cash appears convenient but is costly

In parallel to its high level of convenience for settling a transaction on the spot, most people still believe cash is free of charge; indeed, there is no fee or any subscription while it is often the case for other means of payment. However, if cash is apparently free, it is in reality a very expensive payment instrument, especially compared with other ones. Estimated by a recent study conducted by ECB on a sample of 13 main European countries, the total social costs for all payment instruments are calculated in average close to 1% of GDP. Cash is the largest component of these social costs, representing half of the total.

Figure 2 - Social costs statistics per payment instrument

Figure 3 - Social costs per stakeholder and payment instrument

This high social cost of cash is explained by its higher production costs, costs of storing, distribution and security measures, as well as other costs for society, such as fraud and tax evasion. In 2008, the total cost linked to cash payments (i.e. distributing, managing, handling, processing, recycling and accepting cash) was 84 billion euros; equivalent to 130 euros per person. As Figure 3 shows, the main costs of managing the cash cycle are borne by banks and retail businesses. Retailers incur the most costs on accepting and using cash (handling and transport costs, security costs...), and banks incur slightly higher costs for cash than for card payments. While the level of costs for banks can differ substantially across countries, the social costs incurred by central banks and CIT companies remain marginal.

Even if cash shows the lowest social costs per transaction (0,42€ compared to 0,7€ for debit cards or 3,55€ for cheques), it is definitely not the most cost-efficient payment instrument (low unit costs are due to the high volume of cash payments). In addition, cash is not the safest means of payment, being subject to counterfeiting and robbery. Many consumers, however, are unaware of its full end-to-end cost, rarely charged directly. Costs of transportation for example - amongst others within the wider cash cycle - are significant and are financed via the pricing of services and products provided by retailers, credit and payment institutions.

Figure 4 - Share of costs along cash value chain

If we take a look at the banking industry in particular, the cost of cash represents a significant issue, since banks are at both ends of the cash cycle and therefore incur sizeable costs. For various reasons (cultural, regulatory, commercial), however, banks are unable to pass on the cost of cash to end users, and its use is being cross-subsidized by other bank revenues. In order to decrease the cost of cash and optimize operating activities, banks must have a deep understanding of the dynamics that drive the cost of cash, as well as the factors influencing their customers' payment preferences, in order to identify a winning strategy and encourage a shift from cash to electronic payments.

Challenging and improving Cash Handling model
Cash is here to stay, at least in the near future, and its cost will remain significant for market players. It is thus decisive for banks to know market stakes and best practices, monitor innovations and new regulations, as well as challenge their internal processes. Optimizing its cash supply chain will not just generate bottom-line benefits in terms of costs and resources, but it can also turn cash into a positive competitive differentiator. By focusing less on managing logistics and more on customer satisfaction, a bank will deliver a better and more responsive service to its customers.

A first aspect of cash handling optimization is to focus on operational costs and the associated tasks or processes. Cash-related activities are basic for retail banks and have been in place for a long time; and most of the time not reviewed or challenged as market evolves. Tasks such as ordering, delivering or counting cash, ATM servicing, communication with stakeholders (such as central banks, CIT companies, retailers...), accounting are as many examples of processes that must be regularly reviewed to be optimized or automated. Some activities require substantial infrastructures as well as resources, and are time consuming for back-offices and for branches which should focus on customer service and satisfaction. Examining outsourcing opportunities along the value chain is a key element in reducing cost of cash handling and focusing more on services delivering high added-value.

Improving cash circulation within the retail network (branches, retailers, ATM) is another essential criterion to decrease or optimize cost of cash. It means in particular optimizing the cash positions at ATM, in branches and with CIT companies, in order to maximize the availability of cash across cash points and minimize total cost of cash supply. The larger the ATM and branch network, the more important becomes proper cash ordering method. Between ATM and counters or even between branches, recycling fit notes received from customers can also make cash handling model more efficient, with no impact on workload for branches.

As an example besides costs, quality of service for ATM users can also be considered as a critical indicator of ATM cash management, but many cash managers do not measure ATM performance in the most accurate and meaningful manner. Understanding customer's behavior, defining and monitoring a set of relevant ATM performance metrics are the keys to ensure customer satisfaction - by improving cash and technical availability of ATM - and to help cash managers with automatic and standardized reports.

Maybe more than in any other retail activity, mitigate operational risk is a last key aspect. Cash handling involves many stakeholders and subsequently many file exchanges between them. Any loss of information between parties can have serious impacts on customer service and/or costs. Monitoring communication allows anticipating issues and helps, via problem-solving indications, to reduce risk and increase operational performance. In this context, creating a dashboard relaying information regarding the ordering, distribution, recycling and reconciliation of cash between the bank and its stakeholders can also help monitoring operational performance and thus mitigate risk. In this area of risk mitigation, some innovative approaches may be considered as well, such as RFID (Radio Frequency Identification) to track and trace cash transported between customers, branches, CIT companies, central bank.... Such an automated technology can increase the global treatment efficiency (no more manual scanning, less risk of errors or loss, automated dispatching system...) and allow a real time monitoring of orders and stock management.

Cashless society is on its way
As explained above, cash usage is much more expensive than other means of payment, especially for banks and retailers. Hence, while reducing the costs of wholesale cash distribution, various players within the payments market are willing to promote the increase use of electronic payment instruments. The benefits of cash substitution and cash-handling efficiencies could be substantial and help to explain why authorities are likely to pursue the war on cash. Moreover, it represents a huge potential market for PSPs to provide non-cash payment solutions. To accelerate cash substitution, banks could for example give transparent and direct pricing signals to consumers on the real costs of the payment methods they use at retailers' points of sale.

Most agree a cashless society is not only inevitable, for most of us, it's already here. The actual question isn't if cash will eventually die out but when.... It is thus essential for banks to be prepared and be part of this cashless society train that has already left the station. Mobile banking, electronic money and digital wallets, contactless cards are so many examples of upcoming innovative solutions aimed to replace cash usage. Growth of cashless payments will vary between countries, depending on several factors such as the impact of the financial crisis on the economy, the domestic banking and payments infrastructures, banks' and acquirers' commercial practices, consumer preferences and habits, adoption of product and technological initiatives...

In any case, our good old euro notes won't leave our wallet for quite a while as recent European figures forecast that cash would still represent 56% of retail payment transactions in 2014, even in the case of an "accelerated" scenario with greater levels of cash substitution. It is awaited that such a scenario will take place first in northern countries such as Finland, Norway and Sweden.

Sia Partners


Retail Banking Research: The Future of Cash and Payments, 2010
The social and private costs of retail payment instruments: a European perspective - ECB Sept. 2012
Retail Banking Research: The Future of Cash and Payments, 2010 - ECB Sept. 2012
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