Cash and Card Usage by the Public and Merchants

Transcription

1 Cash and Card Usage by the Public and s by John Winchcombe December 2016 Cash Essentials

2 Cash and Card Usage by the Public and s Executive summary This paper reports on the cost of cash based on the investigative work of the European Commission s Directorate General for Competition (ECDGC), work that led to EU regulation 2015/751, the cap on European interchange fees, implemented in June The European Competition Authority has been investigating card payments for many years leading up to this EU regulation. The EU report compared the cost of card payments to the cost of cash using a methodology called the Indifference Test, the cost at which a merchant would be indifferent in financial terms whether a customer chose to pay with a card or with cash. John Winchcombe Head of Sales Operations Innovia Security The EU competition authority investigated this area because the card market is highly concentrated. The existence of cash, and its widespread use, provided a point of comparison so that the card market could be assessed and understood. Cash, therefore, provides competition and efficiency in the transaction market. The key findings relevant to cash were: Cash almost always costs merchants less than cards. The charges imposed at different points in the card payment system varied significantly by country and are in line with the market power of the different parties. Yet these charges were not visible. The cost to merchants when paid for goods and services by credit and debit cards was significantly more expensive than when paid with cash. EU regulation 2015/751 has regulated this market and cut the charges very significantly. Cash costs are significantly lower for high volumes, low value transactions than card costs. The research demonstrated a significant cost advantage for cash particularly when considering high-volume transactions. The cost structure of the different parties involved in the payment systems is complex. At the end of this report is an Annex that lays out four key payment systems and the interactions of those involved. 2

3 Source data The European Commission s Directorate General for Competition issued a report in March 2015 called the Survey on s costs of processing cash and card payments. The observations made here are taken directly from that report. The Directorate responsible for Competition is not involved in the cash cycle and, therefore, unlike other reports or white papers, it has approached this subject from a completely independent position. In addition, since it used the ECDGC s report as part of the evidence gathering behind its 2016 changes to European Interchange fees, it used a robust evidence-based methodology to draw its conclusions. Where its approach had limitations, the report notes these, but it represents an independent and extensive investigation into the cost of cards and cash. Value of card transactions compared with cash The value of card transactions is significantly higher than for cash average transaction value for cash was 15 and for debit cards 42 and credit cards 52. It is unclear why this is and the report questions whether this is because cash is an imperfect substitute for cards or visa versa and if the difference may be due to the level of Multilateral Interchange Fee (MIF) which was in place at the time of the research. If merchants either refuse to accept cards for low-value transactions or make a surcharge to use cards for low-value transactions, then this may indeed be right. Since consumers are not aware of MIFs, it is improbable that they are influenced by them. Cost of cash compared with cards: with and without the Service Charge Figure 10 (Composition of marginal cost of cash and cards for surveyed merchants), in the report shows that when the Service Charge (Multilateral Interchange Fees, Scheme fees and processing charges) were included, the marginal cost of cost of cash expressed as a percentage of the transaction, was less than that of cards. When the Multilateral Interchange Fees (MIF) was not included in the assessment of transaction costs, cash costs slightly more than cards. Cash 0.55% Debit cards 0.92% Credit cards 1.45% According to the report: Firstly, the marginal cost of cash appears to be higher than the marginal cost of (debit or credit) card if the MSC (and hence the interchange) component is excluded. However if the MSC cost component is included, the current marginal costs of (debit or credit) cards exceed the marginal cost of cash per transaction. Therefore, whenever a consumer decides to use a card instead of cash to make a payment, on average the merchants surveyed suffer a negative externality due to an excessive MIF level. That means that the merchants in the sample would be better-off, on average, if the transactions currently executed with a card were carried out with cash. That implies that the MSCs and therefore the MIFs are currently on average above the indifference threshold for the surveyed merchants. It is interesting that the EU spent nearly 3 years gathering data and investigating the cost of card transactions before imposing a ceiling on MIFs due to the complexity and opaqueness of the different card payment schemes. The MIF cap imposed from June 2015 has been fixed at 0.2% for debit cards and 0.3% for credit cards. Before this cap, MIF rates varied widely across the Euro zone. According to the EC, in 2013 Visa credit MIF rates ranged from 1.8 percent in Germany to less than 0.5 percent in France, while Visa debit rates topped out above 1.7 percent in Germany, but dropped to 0.2 percent or less in nine countries. Without this long and complex investigation, European MIFs would have remained higher and cash would have continued to cost merchant s less. Very few countries have competitive card markets such as what has now been imposed by the European Commission s Directorate General for Competition and so for most countries, cash will remain the cheapest payment tool for merchants. Cost of cash compared with cards: as a proportion of total turnover and per transaction Figure 8 (distribution across cost categories of the total costs of cash and card transactions of surveyed merchants) provides details of the relative cost of cards and cash as a proportion of total turnover and per transaction. Due to the higher value of card transactions, this showed that cash represented a cost of 1.26% compared to 1.17% for a credit card and 0.67% for a debit card (paragraph 173). When measured per transaction, the costs told a very different story: 3

4 Cash 0.19 Debit cards 0.28 Credit cards 0.59 This may explain why cash remains such a popular payment system for merchants dealing with high volume, low value transactions. The study relied on voluntary participation of those surveyed. Unsurprisingly large companies response rate was higher than that of smaller companies. The data for larger companies is therefore more robust. The larger the merchant, the more efficient (and lower cost) they were at handling cash. A 200 million turnover company had cash costs of 0.59% compared with a million company which had cash costs of 0.88%. The benefits of economies of scale were marginal for cards. Card payments as a tax Every card payment then imposes an invisible tax on others (the merchant and its customers) compared with non-card payments, which would most often be cash (paragraph 43). Note that this tax is an income stream for banks or scheme operators rather than the government. Speed of transactions Larger merchants are more efficient at dealing with cash than cards (paragraph 168, First, the regression seems to show that larger merchants are more efficient in dealing with cash payments as opposed to card payments ). For merchants with a turnover of more than 200 million per annum in the retail sector other than cars in the UK (one of the segments of the economy studied in the report), the time for a transaction was: Cash Debit cards Credit cards seconds seconds seconds Societal Benefits In 2012 the ECB occasional paper 137 by Schmiedel, Kostova and Ruttuenberg concluded that total societal costs for credit cards were greater than for cash. The total societal costs for debit cards were less. In all payment systems except for cash, there is no direct financial benefit to society from the systems other than the taxes paid on profits earned by the participants but the costs and risks of the systems are carried by those involved. The government s role is limited to a regulatory role to ensure that the systems are robust and do not distort the market. The Seignorage paid on cash goes to the government, either the Central Bank or Treasury, and is effectively a tax. In return, the government bears direct costs and risks associated with the creation, issuance and destruction of cash. Conclusion Although the 2015 paper set out to apply the Indifference Test to assess whether MIFs were at an anti-competitive level in the EU, it also highlights some key strengths of cash that may explain its enduring popularity as a payment instrument for both the public and merchants: Without cash, there would be little or no competition The public likes cash sufficiently to use it even when it costs more to use The cost of cards is generally higher than cash For high volume, low value transactions cash is cheaper than cards For efficient, large scale retailers the speed of transactions can be faster with cash than cards and they are able to drive down the cost of cash close to that of cards The tax that is associated with card transactions benefits the card scheme owners, not society The public s preference for cash The fact that countries with small or zero interchange fees are still far from perfect substitution between cash and cards supports this view (paragraph 92), this view being that the public prefer cash even when it costs more to use than cards. 4

5 About the Author John Winchcombe has worked in the banknote industry for 28 years in sales and marketing roles. As Marketing Manager and then Marketing Director at De La Rue Currency he and his team were responsible for understanding worldwide banknote demand and supply and did so by working closely with Central Banks using their data and information from the market. John played a central role in developing De La Rue Currency s current strategy. He was also responsible for product development surveying Central Bank and State Printing Work staff to understand their needs as well as tracking what security features and functionalities were actually being used on banknotes. De La Rue s current security feature portfolio was developed by John and his team. Since leaving De La Rue, he has worked on a number of client-led assignments including bringing a big data analytic software package to market so that Central Banks have ready access to hard evidence about banknote performance and demand and supply when making decisions. Since completing this study, John has joined Innovia Security as their Head of Sales Operations. 5

6 Annex: Overview of Payment Systems The European Commission s Directorate General for Competition issued a report in March 2015 called the Survey on s costs of processing cash and card payments. The Directorate responsible for Competition is not involved in the cash cycle and, therefore, unlike other reports or white papers, it has approached this subject from a completely independent position. In addition, since it used this research as part of the evidence gathering behind its 2016 changes to European Interchange fees, it used a robust research evidence based methodology to draw its conclusions. The 2015 paper involves a complex review of the Service Charges in Europe at the time paying particular attention to a Indifference Test to assess whether the Interchange Fees were set at anticompetitive levels or not. This paper lays out simply and briefly the high level cash and card landscape so that the 2015 paper can be more easily read and assessed. Whether it is cash, a card payment or an electronic payment, mobile or otherwise, a whole system is needed to enable the transaction. Everything has a cost and their allocation and size depends on the payment system being used. Each country has different dynamics and the findings of the EU paper are specific to the EU but by understanding the overview provided by the EU, it is possible to investigate more quickly and easily your own specific situation and to see anomalies and problem areas in your own country. Types of Payment Systems This paper concentrates on 4 main types of payment system: Cash Card based systems (3 party, for example Amex) Card based systems (4 party, for example Visa) Mobile payment systems (variant of the 4 party, for example Apple Pay or Google Wallet) Cheque payment systems and electronic fund transfers, such as Direct Debits, Credit transfers and Standing Orders, are not included. Cash Participants Bank Consumer A bank is an optional part of this cycle. Fundamentally this is a simple 2 party system but with costs associated with the wholesale handling of cash. 6

7 1. Front office Time to serve customers 2. Labour Transport cash to and from the till Cash counting Preparation of cash for the tills Cash reconciliation Identification of counterfeit notes (training) 3. Equipment Cash register Cash counters Safes Counterfeit note detectors 4. Third party services Transport of cash to and from the bank and depositing costs Insurance costs against losses Obtaining and transporting change 5. Losses and revenues associated with the use of cash Costs of fraud and theft Opportunity cost of money held in tills and not in the bank 3-Party System (Amex, Diners) Participants Card Scheme Cardholder One company runs the scheme. They issue cards, they recruit ( acquire ) the merchants into the scheme to accept the cards and they set the fees paid within the systems. 7

8 Costs 1. Front office Time to serve customers 2. Labour Card reconciliation Checking card terminals for security Dealing with card fraud reimbursement applications 3. Equipment Electronic Funds Transfer equipment (hardware) Dedicated card processing software (cost of ownership and maintenance) 4. Third party services Interchange fees Costs of security Credit losses Technological developments New payment innovations Bill and administration of the individual card accounts Scheme fees and processing margin (costs and profit of the scheme owner, e.g. Amex/Diner) 4-Party System Participants Card Scheme (Visa or Master Card) Scheme fees Card Issuer Interchange fees Acquirer Cardholder fees Service Charge Cardholder Transaction The card scheme is usually owned jointly by the card issuer and the acquirer and they set the scheme fees. Costs 1. Front office Time to serve customers 8

9 Consumables: ink, paper, electricity 2. Labour Card reconciliation Checking card terminals for security Dealing with card fraud reimbursement applications 3. Equipment Electronic Funds Transfer equipment (hardware) Dedicated card processing software (cost of ownership and maintenance) 4. Third party services Service Charges Costs of security Credit losses Technological developments New payment innovations Bill and administration of the individual card accounts Scheme fees (costs of the scheme owner, e.g. Visa/MasterCard) Processing margin (including the profit margin of the acquirer) Fraud detection software Mobile Payment System Although there is currently relatively little usage of mobile payment systems, they generate a great deal of media coverage. As a result, they are included in this paper. There are 4 main types of mobile payment systems. Mobile phone app versions of online payment platforms, for example PayPal. Direct carrier billing where charges are added to phone bills. Closed loop payment systems where funds are pre-loaded to an app and are redeemed at a single location, for example Starbucks coffee shops. Payment executed by contactless communications at the point of sale, for example Apple or Google Wallet. The diagram and details below are only concerned with the last of these, contactless communications at the point of sale. In this payment system the credit/debit card details are either encrypted and stored on the Secure Element of the chip in the phone (Apple) or stored in the Cloud (Google Wallet) and the stored data acts as Host Card Emulation (HCE) the card is not present but the data emulates the card. Near Field Communication (NFC) is the underlying technology used for the contactless transaction. For the payment transaction from device to payment terminal it is made secure by itouch if on an Apple phone (finger print recognition on the phone) The card details are not held by Apple or Google The card details are sent to the merchant s payment terminal scrambled as tokens with a unique dynamic security code. This payment model introduces a new intermediary into the payment process, a Trusted Service Manager (TSM). In the case of Apple, Apple fulfils this function and receives a fee for this. The TSM manages the 9

10 exchange of the secure elements between the merchants, banks and the telecommunication network operators (Telco s). For Google or other similar Android device based payment systems, the Secure Element is provided by the Telco as part of the Secure Element of their SIM card. Participants Card Scheme (Apple/Google wallet) Scheme fees Mobile payment tokenisation fees Scheme fees TSM Apple Card Issuer Interchange fees Acquirer Transaction fee Cardholder fees Service Charge Cardholder Transaction Costs The basic costs are the same as for the 4 party payment system but it has added significant complexity and generated new fees for the TSM and to cover the Telco s costs. Apple acts as the TSM and so earns fees both for its role as a TSM and from the mobile payment tokenisation fees. 10

11 Useful Links 2015 Survey on s cost of processing cash and cards: Regulation (EU) 2015/751 of the European Parliament and of the council 29 Apr 15 on interchange fees for card-based payment transactions: J.L_ ENG ECB glossary of terms related to payment clearing and settlement systems: pdf/other/glossaryrelatedtopaymentclearingandsettlementsystemsen.pdf 11