Modern banknotes and modern cash cycles have benefitted from significant levels of innovation in recent decades and this has increased the efficiency of cash.
Firstly, banknotes and coins incorporate state-of-the-art technology not only to stay ahead of counterfeiters but also to improve their durability. One example is the recent evolution in banknote substrates. Banknotes used to be printed on paper produced with natural fibres, essentially cotton. In the early 80s, various attempts to use substrates based on plastic met with only limited success, but in the late 80s, the Reserve Bank of Australia issued the first banknote on a polymer substrate. The original intention was to reduce counterfeiting but the new substrate also increased the lifecycle of the banknote. In 1996, all Australian notes were switched to polymer.
Following this radical change, manufacturers of paper substrates also turned their attention to making notes last longer. In the 1990s significant developments were achieved in the varnishing and coating of notes: the protective coating helped to reduce soiling while maintaining the traditional feel of paper notes. Another innovation was the embedding of synthetic fibres into paper substrates in order to add strength and increase longevity. More recently, several manufacturers have launched “hybrid” substrates, combining layers of paper and polymer.
Secondly, central banks have adapted their cash distribution policies with a view to increasing the velocity of banknote circulation and the efficiency of the cash cycle. The optimal model depends on a number of national factors such as the maturity of the payment systems, the number of bank branches and ATMs, and the capabilities of central bank and commercial bank processing. In mature markets, as well as in some emerging countries, there has been a trend for central banks to delegate the processing of banknotes to commercial banks and other operators. This fosters a stronger cooperation between the key stakeholders in the cash supply chain. But it also requires central banks to increase their monitoring and supervisory role to ensure the quality and authenticity of cash in circulation, as illustrated by the ECB decision on the authenticity and fitness checking and recirculation of euro banknotes84. The regulation defines the standards for fitness sorting of notes, the procedures to be followed, and the reporting requirements for banks and commercial cash handlers.
Central banks have been elaborating innovative policies to increase the overall efficiency of the cash cycle. Examples include:
- The establishment of recirculation policies that define the standards and procedures for fitness sorting by commercial parties;
- A balance sheet relief mechanism to encourage the commercial sector to recirculate;
- Optimising cash inventories throughout the cash cycle.
Some central banks have introduced policies to promote the recirculation of banknotes outside central banks and compensate the cost of funding additional cash inventories with balance sheet relief. Some mechanisms, such as the Finnish DEPO scheme, are based on interest compensation; the Bank of Finland compensates private partners for a portion of their interest loss. Other countries, such as Australia, South Africa or the Netherlands, apply a Notes-Held-to-Order arrangement, where the central bank will credit the holder’s account without the cash being returned to the central bank85
. It is worth noting that these models have a positive environmental impact as they reduce the need for transporting banknotes.
Banknote distribution has been the third area of innovation. The first ATM was deployed in London in 196786 and, according to Retail Banking Research, the installed base will treble from 1 million machines in 2000 to 3 million in 201587. The total number of cash withdrawals is set to reach 103.2 billion in 2015 and the ATM has become the main distribution channel for cash in modern economies. Clearly, ATMs have played a major role in increasing the availability and efficiency of cash. Numerous studies have emphasised that ATM withdrawals are significantly cheaper than withdrawals at bank branches. In the US, the difference in cost is about 18%, indicating that technological improvements are an important factor in keeping the number of cash transactions relatively high88.
Numerous other innovations contribute to the efficiency of cash. In Kenya, M-Pesa (Pesa is Swahili for money) was launched in 2007 by Kenyan telecommunications provider Safaricom as a money transfer service, enabling users to send and receive money through their mobile phones. Today M-Pesa is the most developed mobile money system in the world and often recognised as one of the key innovations in payments of the last decade. While numerous features have been added to M-Pesa since its inception, it remains essentially a cash transfer system using a network of over 60,000 agents that constitutes a form of branchless banking. According to the World Bank89, in 2012, 21 million Kenyans made 527 million such transactions.