Published: September 01, 2008
While the US is reported as fast becoming a cashless society, countries such as Great Britain, amongst others hit by today’s economic downturn, is seeing a significant increase in the use of cash. For example, a recent survey by the British Retail Consortium showed that Britons made 60% of transactions in 2007 using cash, and the Bank of England produced 500m new notes in 2007 alone. The research also showed that some members of society are turning their backs on plastic in a bid to reduce the risk of falling into debt or being hit by fraud. Consumers try to keep control of their finances using different methods, but one thing is certain: cash still has its place in today’s increasingly global society, and if anything, its use is set to rise further in many regions.
The average paper banknote costs around £0.03 to produce in the UK and $0.04 to produce in the US.
The world of physical currency trading is not an easy one to understand. There are billions of notes making their way around each country at any one time and every note has been through a rigorous system designed to make sure it is tagged and recorded at every possible opportunity. With banknotes produced, recycled, restocked, distributed overseas, washed and torn, and eventually withdrawn, the story of a banknote’s journey through its lifetime is one which warrants attention both inside and outside of the treasury management profession.
The initial production of banknotes is fully controlled by central or reserve banks (for example, the Bank of England, the European Central Bank or the US Federal Reserve), which retain responsibility for the monetary policy of individual countries or groups of member states around the world. While some central banks produce their own banknotes, others outsource the production of banknotes to specialists such as DeLaRue and G&D, and/or to government-owned subsidiaries such as the Bureau of Engraving and Printing in the US.
Banknotes are produced using printing presses which are not commercially available, in order to limit the risk of fraud. The materials used in production vary from country to country, with individual choices impacting on factors such as the cost of production, life expectancy and the risk of counterfeit. The average paper banknote costs around £0.03 to produce in the UK and $0.04 to produce in the US, with an average lifespan of around two years depending on its denomination. Plastic banknotes cost twice as much to produce but they last four times longer.
The majority of the world’s banknotes are made of toughened starch paper, which is sometimes mixed with linen, abaca, or other textile fibres. The paper used is therefore different from ordinary paper; it is much more resilient, resists wear and tear, and does not contain the usual agents that make ordinary paper glow slightly under ultraviolet light. Unlike most printing and writing paper, banknote paper is also impregnated with polyvinyl alcohol or gelatin to give it extra strength and a mould-made watermark and security thread are incorporated during the paper forming process in order to reduce the risk of counterfeit and fraud.
Polymer or plastic notes, first issued as a currency in 1988 in Australia, are much more durable than paper banknotes. They make counterfeiting much more difficult, but are a lot more expensive to produce. Particularly in warm and humid climates, polymer substrates are less prone to degradation and stay in circulation for much longer; countries that have converted fully to polymer banknotes include Australia, New Zealand and Vietnam. Brazil and Israel, amongst others, also print some notes on polymer, and Hong Kong is currently undertaking a two-year trial.
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Once produced, the banknotes are issued into circulation by the central banks. The central banks make a profit by selling notes at face value to a select number of commercial banks that in turn distribute currency to a worldwide network of different bank branches and global payment companies such as American Express and Western Union. Eventually the central banks have to buy the banknotes back when deemed unfit for circulation, but they make an overall profit by holding on to the value of the money for the life of the banknote, investing the ‘float’ in the same way that issuers of travellers cheques do. Commercial banks that have access to federal reserve accounts include the larger international players such as HSBC, Barclays and Commerzbank, which then make a business through buying and selling currency to smaller players at competitive rates.
Those commercial banks with excess currency can deposit it in a reserve account with their central bank and then access it when required. This procedure varies by country. For example in the UK, the commercial banks can sell the value of excess notes back to the Bank of England, but will hold the physical notes in their vault (i.e., they keep the stock ‘off balance sheet’). In New Zealand, on the other hand, the banks hold the cash on balance sheet, but the central bank pays them interest as a form of compensation. The reason for this is that it is very expensive for the central bank to handle the cash physically, so rather than constantly counting it in and then out again they prefer to let the commercial banks keep the cash in storage.
Central banks in some markets appear to be stepping out of the cash supply process and now just fulfil the tasks of issuing new cash and destroying old cash. They are leaving it up to the commercial banks to deal with the cash supply chain. While the central banks do not want to handle the cash because it costs them a lot to do so, the commercial banks do not want to sit on large stock piles of cash, due to the ‘funding cost’. They would rather put it into the bank and earn interest on it. Thus the central banks and commercial banks come to arrangements that work best for both of them, and this varies according to region. It seems that most are moving towards a system where the central bank avoids the physical cash handling, but which ensures that the commercial bank is not out of pocket in lost interest.
Those commercial banks with excess currency can deposit it in a reserve account with their central bank and then access it when required.
When it comes to the trading of currency between various banks, lower rates are applicable to the banks that can afford to buy currency wholesale and, like stocks and shares, currencies may sometimes be traded at less than market value if bought or sold under the right conditions. Those who buy on a lower level will have to pay more on a per note basis. Cash trading rates also depend heavily on currency type, with euros being a lot easier to sell than Japanese yen, for example, as they are more in demand from end-users. When individual banks or travel companies then sell currency on to companies or consumers, they charge a mark-up just as their supplier did to them. They will then recycle the notes by buying them back at a lower price and passing them on to another customer in order to avoid losing money by selling the notes back to the wholesaler at a reduced rate.
At various points during this course of circulation, banknotes are subject to rigorous processes by high-speed cash handling machines which count, inspect, sort and authenticate every note. Individual notes are withdrawn from circulation and destroyed when they are too dirty or damaged for further use, or if they are identified as counterfeit. Lower frequency denominations undergo more transactions and need to be replaced more frequently than higher denominations, and different banks in different markets re-print notes at different rates, with less economically developed countries keeping notes in circulation for much longer than their western counterparts. Interestingly a five euro note in Ireland lasts an average of one year in circulation, whereas a five euro note in Germany lasts five years.
Coins, coincidentally, are much more expensive to produce in the short term, but they last much longer. The cost of reprinting notes is high over the longer term, with studies showing that the US would save $500 million a year by replacing the $1 note with a coin. Currently, however, due to high metal prices, some coins cost more to produce than their face value, and what’s more, coins need to be paid for at face value from the mint, so the profit margin on notes is higher. Once a note is deemed unfit for circulation, the central bank will buy it back from any bank at face value. Paper notes are destroyed by shredding or burning. Polymer notes in Australia, on the other hand, are melted down and mixed together to form plastic garbage bins!
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Whether in the form of notes or cash, there is a plethora of security systems in place to ensure the safe arrival of currency between central banks and the eventual point-of-sale destinations. The vaults of the banks which hold large amounts of notes use varying mechanisms for physical security, including locked double-door systems incorporating weighing machines, fingerprint and retina scanner identification systems, human searches and intelligent camera systems, amongst others. Again, the security put in place varies from country to country, with the South African Reserve Bank in Johannesburg boasting one of the most advanced security systems in the world. South African banks have traditionally suffered an elevated risk of robbery, so every effort is made to make their vaults as inconspicuous as possible.
Measures to increase security are increasingly being implemented.
Research by the British Bankers’ Association, however, shows that bank robbery no longer pays. According to their latest study, 2007 saw the lowest-ever number of heists since records began. Researchers say increased security, the prevalence of CCTV and improved bank layouts could all have helped to push criminals away from banks, and inevitably towards softer targets. Unfortunately this can mean that bank employees and their families may sometimes be put at risk, so banks try to cap this risk by limiting employees’ access to cash as much as possible. Maculation systems whereby a dye ‘bomb’ is included in packs of banknotes are also appearing in order to render the haul useless in case of a raid.
Once out of the vaults, cash handling is usually outsourced to specialist companies who arrange its delivery via airfreight, armoured trucks or toughened cash-in-transit vans. This is done for efficiency and cost reasons, but also in view of the security risks which are extremely high. There are currently four cash-in-transit attacks every working day in the UK, with Irish cash-in-transit carriers being at the highest risk of armed attack in any European country. In the UK alone, £1.4bn is moved daily in 4,500 vehicles, and during 2006 over £20m was lost due to criminal activity (up from £15m in 2005).
Measures to increase security, however, are increasingly being implemented. G4S, one of the world’s leading cash services providers, has started using Smart Water (a special dye that marks offenders with a unique, DNA-style code) in its cash boxes. Once the ultraviolet dye, which is invisible to the naked eye, marks an offender it will remain detectable on their skin, clothes and hair for weeks after the attack. Police can then match the Smart Water’s code with the scene of the crime to confirm the suspect’s involvement.
With foreign borders opening up across a number of continents, and especially in Europe with the introduction of the EU Payment Services Directive coming into force in November 2009, the level of fraud and the counterfeiting of notes are both expected to rise. The automation of procedures surrounding management of currency therefore, will become an increasingly critical resource for those within the cash industry, and especially so for those who are in the business of foreign exchange.
Using the right technology, organisations can improve their profitability by better managing their inventory, tracking their business and profitability, minimising fraud and reducing manual labour involved in processing transactions. Hand in hand with technology solutions to move money are anti-money laundering systems, which provide checks and regulatory controls on money transfer transactions. Ultimately, the growth of regulatory controls over the money changing business will make it increasingly difficult to operate an efficient business without automation to manage anti-money laundering and counter-terrorism financing compliance currently being introduced in most jurisdictions.
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