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Three reasons why banks should embrace cash

Categories : Uncategorized
July 28, 2017
Tags : Commercial bank, Demand, Negative interest rates/interest rates, Virtual currencies
Cash sets a floor to negetive interest rates. Without cash, central banks could provide digital currencies to the public and compete with retail banks. Consumers actually want it.
Guillaume Lepecq

Cash sets a floor to negative interest rates

Ever since the Global Financial Crisis, central banks have introduced quantitative easing to stimulate economic growth.  Some central banks – including those of Denmark, Japan, Sweden, Switzerland and the ECB have set negative interest rates. This means that the central banks are charging those banks that choose to hold their excess cash rather than extending loans. Because  retail banks cannot transfer negative rates onto deposits, principally out of fear of losing customers, they have been experiencing a fall in net-interest income. According to analysis from Frankfurt-based Bankhaus Metzler, should rates remain at current levels, the lending revenue of Germany’s five publicly traded banks will fall by a total of €2.1 billion in 2018, equivalent to a drop of 9 percent from 2015 levels.

For economists, there is a limit as to how low interest rates can go: the zero lower bound. If rates go too low below zero, savers would effectively be facing negative returns and would be encouraged to hoard cash. Some economists, including Bank of England chief economist Andrew Haldane or Harvard Professor Kenneth Rogoff have floated the idea that abolishing cash would widen monetary policy options for central banks and enable them to  further reduce interest rates.

Without cash, central banks could provide digital currencies to the public and compete with retail banks

Central banks already provide digital money to financial institutions in the form of deposits. But so far, for the consumer, electronic payments have been offered by the financial industry, not the monetary authority.

But several factors could change this. Firstly, if cash were abolished, consumers could prefer to hold claims on the central bank to avoid the risk of default by a commercial bank. Secondly, technology and in particular Distributed Ledger Technology could contribute to make digital money easier and more cost-efficient to implement.

Many central banks – including the Bank of Canada, the Bank of England, the ECB, the People’s Bank of China and the Sveriges Riksbank – are conducting research on the topic. BBVA research “consider it likely that a Central Bank Digital Currency will be adopted at least by some central banks over the next few years.” This will likely incur potentially large disruption to the existing payment infrastructure.

Consumers actually want it

The global increase in cash demand is one indicator of consumers’ preference for cash: in the euro area, cash in circulation grew by 6.58% in 2015 in value; in the US, notes in circulation grew by 6.2% in value in 2015; in the UK, ATM cash withdrawals experienced a 3% year-on-year increase in July 2017.

Measuring the share of transactions settled in cash is another indicator. Speaking at the occasion of the launch of the new € 50 banknote in April 2017, Mario Draghi, President of the European Central Bank stated “Though electronic payments are becoming more popular, cash is still our most important means of payment. A soon-to-be-published survey on cash use, carried out on behalf of the ECB, shows that over three-quarters of all payments at points-of-sale in the euro area are made in cash. In terms of transaction values, that’s slightly more than half. So even in this digital age, cash remains essential in our economy.” He added that  banknotes are also an important symbol of European integration. “Holding a euro banknote and knowing that it can be used in 19 countries is a reminder of the deep integration Europe has attained. Indeed, when asked about the most important elements of European identity, the single currency is the one most frequently quoted by euro area citizens after democracy and freedom. And in spite of the difficulties in recent years, support for the single currency now stands at 70%, equalling the highs recorded in the pre-crisis period.”

At a time when confidence in banks remains low, providing acess to a product consumers want and need could contribute to restore banks’ image with the public.