On the Shelf Life of a Banknote or How to Promote the European Digital...

On the Shelf Life of a Banknote or How to Promote the European Digital Market: Electronic Legal Tender Is Now a Matter of Fairness

Fresh thinking is required to bring greater coherence to the policy target of payment innovation

25 April 13

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Legal electronic tender is on the march, powered by popular acceptance rather than legislative mandate or administrative fiat

Two years have gone by since in this same newsletter I first exhorted policy makers to dare to be bold, and consider electronic legal tender as an option. That article elicited a lot of interesting comments from the market, although I have to admit that some cash handling intermediaries seem to have removed me from their Christmas mailing list - but they may have gone electronic themselves in the meantime!

So where are we, two years on, with the penetration of electronic payments in Europe? Signs are encouraging, we have more data from reputable sources, and that data shows a continuous movement towards dematerialisation. According to a European Central Bank (ECB) Working Paper 'The social and private costs of retail payments instruments: a European perspective' (September 2012) (see 'related links' below), cash payments already account for as little as 36 percent of the volume of all payment transactions in Finland. Looking at large payment countries cash payments account for just 44 percent of the payment transaction volume in France, and 45 percent in Great Britain (in value terms cash payments account for respectively 0,70 percent 1,17 percent and 0,39 percent of all payments in these three countries). What must be highlighted is that these remarkable figures are the result of buyers and sellers expressing their preferences in response to a vast choice of payment options available to them for both proximity and remote payments. The 'payment citizen' is voting, and in these countries his/her vote is clearly cast in favour of non-cash, account-based payment instruments. Actually there are already eight European Union ( ) countries whose payment citizens give a clear majority (55 percent or more) to non-cash payments. So one could say that the legal electronic tender is on the march, powered by popular acceptance rather than legislative mandate or administrative fiat, which in itself is a very positive message. Of course these countries are the 'best-in-class' performers, the 27 snapshot is that cash payments account for just short of 60 percent of the payment transaction volume, and 2,16 percent of the value of all payments. And admittedly the above data has been compiled (on the basis of 2009 data) whilst most of the effects of the current economic crisis are yet to unfold. So more research will be welcome - for example in the form of systematic, wide-scale cash diary exercises, in relation to e.g. income and education levels - to better understand what is keeping the payment citizens in those countries, that continue to see comparatively high use of cash, from in turn casting many more votes in favour of non-cash, account based payments.

"Everything that can be digital, will be digital": the impact on payment practices. Better understanding not only payment practices but also expectations will soon be critical, as a whole tranche of the population, who has never known anything other than internet and the mobile phone will come of 'paying age'. Young people born after the famed Y2K are shaping their own digital world on social networks (in the US 13 to 17 year olds send on average 3,364 SMS per month...). They  are certainly in no need of a learning curve when it comes to things digital, and they are quick (no more than two clicks and very few seconds of patience....) to express their preferences for what they deem to be no-nonsense value propositions. Chances are they will not consider anything other than digital for remote payments, and provided some progress (already well on the way) is delivered in terms of convenience, then their proximity and person-to-person payments will go the same way. Of course, looking at the 's age pyramid (see figure 1 below), this upcoming generation of payment citizens will not solely tilt the scales of European payments. But this imbalance holds a message and a warning - more about this later.

Figure 1: age pyramid (source: CIA World)

Even without, at this stage, the contribution of this post-Y2K generation the e-commerce world is booming. Online sales have been surpassing one record benchmark after another all over the world, and it is hard to see what dent the financial and economic crises could have made in this relentless progression. As the Swedish economist Kjell Nordström repeats, assuredly "everything that can be digital, will be digital". With over 15 billion devices worldwide connected to the internet by 2015, would it be realistic to expect that the bulk of future internet orders will be paid for in cash? Hardly so. As more and more people order goods and services electronically - also for their everyday lives - the share of routine transactions for which cash was or is still being used today will continue to erode.

The launch of the second series of euro banknotes

In parallel to these and other market developments the straightjacket of regulatory and legislative requirements for cash recirculation (actually: the re-circulation of euro banknotes) tightened significantly. Between 2001 and 2012 no less than six texts were issued: Article 6 of Council Regulation 1338/2001, ECB terms of reference regarding cash recycling machines, banknotes recycling framework, amendment to EC Regulation 1338/2001, ECB decision on authenticity and fitness checks and recirculation of euro banknotes, and amendment to this decision. In essence these texts establish and clarify the conditions under which euro banknotes may be re-circulated. They focus on authenticity and fitness - indeed apparently essential conditions for the public to trust a physical currency: does it look right, does it feel right, is it valued i.e. not completely torn and tattered? The ECB says that these texts, in particular the latter one, are in preparation for the issuance of the second series of euro banknotes, commonly referenced as 'ES2'. This second series has been in the making for a number of years, and new banknotes will be issued from 2013 onwards - surprisingly starting with the five euro banknote, followed in yearly instalments (or so has been announced so far) by the other denominations. The choice of the five euro note to kick off the replacement wave stopped short in his/her tracks more than one observer of the cash scene. Five euro notes in our wallets usually look quite ugly (all the more so when you travel south, where apparently they change hands more often and over a longer period of time). Hence they somehow miss the Eurosystem's1 fitness expectations. At the same time these notes - as would be expected - account for a minute proportion of counterfeits. If fighting counterfeiting was the true motive for introducing a new series of euro banknotes, why not begin with the introduction of new 20, 50 and 100 euro notes, which account for 96 percent of all counterfeits? Making the introduction of the five euro note the first step in the ES2 roll out suggests that the Eurosystem is primarily concerned with cost containment, i.e. bringing down the costs of a series of banknotes.

Actually it is not only the choice of the value sequence (starting with the lowest denomination) to introduce the new series of banknotes that is raising eyebrows. To the casual observer the new series looks only marginally different from the series introduced in 2001, which was actually developed in the second half of the 1990's.

The incongruity of responding with traditional banknotes (and coins) to the prompt of a smart interface

We have been assured - and we believe - that the new series contains security features which were previously not available. But in essence a punter would still be handing over to a seller a few square centimetres of paper. This tends to compare awkwardly with the evolution of the cash register. The latter was patented back in 1879 when a gentleman by the name of James Ritty designed a machine on the basis of a mechanism inspired by the apparatus counting the propeller spins of an ocean liner. Not only is the ocean liner gone now, but many will have noticed that the chime of the cash register is being substituted by the collection of songs accessible from a smartphone: point of sale devices are rapidly migrating to the new age. The incongruity of responding with traditional banknotes (and coins) to the prompt of a smart interface will become increasingly obvious to more and more people, be it consumers or merchants. In particular the latter now realise that on average 75 percent of their costs for accepting payment instruments are attributable to their back office costs. In other words merchants would gain tremendously by addressing such inefficiencies generated by tasks which would all become redundant with electronic payments e.g. checking incoming cash, depositing cash, and reconciliation.

To avoid an unacceptable societal paradigm, preparations for the third series of euro banknotes should begin now: the next generation must move away from the physical form factor

As a supporter of the idea of Europe one should certainly welcome that the currency that embodies this idea is continuously being reinforced, especially for those parts that are in the eyes of the general public. But it should be acknowledged that these eyes are changing. And it should not be overlooked that there is not one payment citizen across Europe, but several: those from countries in which electronic payments are already a majority, the post Y2K generation who barely know anything but electronic, and the e-commerce addicts, to name a few. As in most instances the cost of cash may not be charged directly to the users of cash, the 'non-cash payment citizens' de facto bear the costs of the cash they do not use, or use very little. With cash use declining, the cash handling infrastructure will however not shrink at the same speed (conversely to the Easter Island paradox2 it is - almost - the last note in circulation that will dictate when the re-circulation infrastructure has to remain available). In order to avoid an unacceptable societal paradigm, preparations for the third series of euro banknotes should begin now. With a clear mandate: this next generation must move away from the physical form factor.

A legal tender model

This author reiterates his invitation to policy-makers to dare to be bold: the advanced European payments landscape allows designing a legal tender model spanning both cash and electronic payments which would notably fully transpose the principle of 'indifference' between payment instruments so often referred to by policymakers, and in which banknotes would not necessarily take a physical form. In such a model, either discounting or surcharging for the use of any payment instrument would also be allowed, in order to enable genuine competition in the marketplace. Merchants would no longer be compelled to accept high denomination banknotes, and the quality of legal tender would be awarded to any payment instrument. The earlier question stands: what are we waiting for?

Norbert Bielefeld is Deputy Director - Payment Systems with the European Savings Banks Group (ESBG) and World Savings Banks Institute (WSBI). He is chairman of the board of Trionis, a processing company. He serves as a member of various bodies including the Cash Working Group. The ESBG is a member of the . The views expressed in this article are those of the author and may not necessarily represent the views of all ESBG members.


Related links:

EPC Public Consultation: Improving the Efficiency of the Handling of Cash - Cash Cycle Models

European Central Bank: The Social and Private Costs of Retail Payment Instruments. A European Perspective


Related articles in this issue:

What's Your View? EPC Launches Public Consultation: Improving the Efficiency of Cash Handling in SEPA. Stakeholders are invited to feedback on possible future cash cycle models by 14 July 2013

Sign up! The European Commission's Proposal for a Regulation on Electronic Identification and Trust Services for Electronic Transactions in the Internal Market. European Commission follows up on key actions defined with the 'Digital Agenda for Europe' to boost cross-border e-commerce


Related articles in previous issues:

Dare to be Bold: Electronic Legal Tender is an Option A SEPA legal tender model spanning both cash and electronic payments ( Newsletter, Issue 10, April 2011)

Overcoming the Homer Simpson in us. How to create a less-cash society ( Newsletter, Issue 2, April 2009)

EPC Newsletter Articles Published in the Section: 'Focus: On Integration and Innovation'

EPC Newsletter Articles Published in the Section 'SEPA for Cash'

1 The Eurosystem is comprised of the ECB and the national central banks of countries which have adopted the euro.

2 Easter Island (Rapa Nui) is a Polynesian island at the south-easternmost point of the Polynesian Triangle. It is famous for its 887 monumental statues, called moai, created by the early Rapa Nui people. It is a UNESCO World Heritage Site. (Wikipedia). "The island was dominated by a powerful chiefdom that promulgated a cult of statue making, exercising a ruthless hold on the island's people and rapaciously destroying the environment, cutting down a lush palm forest that once blanketed the island in order to construct contraptions for moving more and more statues, which grew larger and larger. As the population swelled in order to sustain the statue cult, growing well beyond the island's agricultural capacity, a vicious cycle of warfare broke out between opposing groups, and the culture ultimately suffered a dramatic collapse." (Hunt, T. and Lipo, C. (2011), The Statues that Walked: Unraveling the Mystery of Easter Island, 1st ed., FREE PRESS).

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