Lars Nyberg: Will cash replace cards?
Speech by Mr Lars Nyberg, Deputy Governor of the Sveriges Riksbank, at the Cards and
Cash Payments Forum, Stockholm, 3 May 2011.
* * *
I would like to thank Björn Segendorff for his contributions to this speech.
Since the latter half of the 19th century, the theory of evolution has gained general
acceptance. It is considered to be self-evident that better-adapted species will outcompete
those that are less-well adapted. Environmental changes may even lead to some species
becoming extinct. There are no longer any sabre-toothed tigers or mammoths because the
Ice Age is over. A new species may also be superior to another species in a crucial way. This
is why we no longer see Neanderthals walking the streets. Nevertheless, some other
amazingly old species are still with us. Crocodiles have been around for 85 million years and
the coelacanth, if I am correctly informed, can be traced back 400 million years!
An evolutionary process, although of a slightly different kind, is now also taking place on the
payment market. Rapid technological development is changing the world around us. New
payment methods are arising. Bank cards and credit cards have become a natural part of our
everyday lives, as has Internet banking. In Sweden, cheques have been outcompeted and
are hardly used at all. The number of paper-based giro payments is falling rapidly and it also
appears that the use of cash is declining. The value of the banknotes and coins in circulation
has fallen from 9.6% of GDP in 1950 to 2.9% in 2010. So, the question is: Should cash be
compared with the extinct Neanderthals or the surviving Crocodiles?
But why is this of interest to the Riksbank? Well, a first obvious answer is because it is the
Riksbank that issues banknotes and coins. Another, and more complicated, answer is
because one of the tasks of the Riksbank is to promote a safe and efficient payment system.
This may sound a little high-flown, but it means, among other things, that we should promote
the development of safe and efficient
payments. This is why we have a natural interest in
cards and cash. Hence, we are interested in the evolution of the market for payments, and
that is why I am standing before you today.
What I intend to talk about today is why I believe that cash will continue to play an important
role in our payment system for the foreseeable future (even though not 85 million years) and
why cards and other technological developments will not be able to fully take the place of
cash. Ironically, part of the explanation for this lies in the strong position that debit and credit
cards hold on the Swedish market. As usual I would like to make clear that my speech is an
expression of my own views and that it may not necessarily be shared by my colleagues in
the Board of the Riksbank.
Cards and cash in Sweden
Cards compete with cash when we pay directly at the point of sale, for example in
supermarkets, petrol stations, restaurants or at cinemas. It is the customers who choose how
they want to pay, and as we no longer use cheques in Sweden the choice is between cards
and cash. A high level of card usage thus tends to go hand in hand with a low level of cash
usage, and vice versa.
In Sweden, the use of cards has increased rapidly in recent years. In 2009, the average
Swede made 182 card payments but less than 30 cash withdrawals. This means that the
value of the payments made by card has increased fivefold, and that the number of card
payments has increased more than sevenfold, over the last 10 years. Unfortunately, there
are no corresponding statistics for cash payments, but if we assume that the cash withdrawn
from ATMs is used to make purchases then the value of all the card payments is three times
higher than the value of all the over-the-counter cash payments. Another way of measuring
cash usage is to compare the value of the banknotes and coins in circulation, which is
usually referred to as MO, with GDP. If we do this we can see that between 2001 and 2010,
MO fell from 3.8 per cent to 2.9 per cent of GDP. Approximately two-thirds of the payments in
the retail sector are made using cards, with some reservation for the fact that it is difficult to
measure the number of cash payments in the economy exactly.
The situation in Denmark and Finland is roughly the same as in Sweden. In Sweden's case
this means that we have really caught up since the beginning of the millennium when we
used cards only half as much as our Nordic neighbours. In a broader international
perspective, we use cards to a relatively high extent in Sweden. This particular combination
of low cash usage and high card usage is unique to a limited number of countries, including
the Nordic countries and Canada.1 Some countries, for example the United States, have high
levels of both card usage and cash usage, but we must also bear in mind that a proportion of
the United States' banknotes and coins is in circulation outside the country. This applies to
the euro area too, but the level of card usage is much lower there.
Why is cash used?
Why do people choose to pay in cash? There are several reasons. First, paying in cash is
quick and easy for small sums. Handing over the exact sum in cash to buy an evening
newspaper, for example, may be quicker than using a card. In a survey commissioned by the
Riksbank in the autumn, 59 per cent of the respondents said that they preferred to pay in
cash for sums below SEK 100. For sums between SEK 100 and SEK 500, 22 per cent said
that they prefer cash. Second, it appears that cash imparts a sense of security and our
survey showed that 65 per cent felt very secure about using cash as compared to 35 per
cent for cards. The term security may mean many different things, but the feeling of having
the entire transaction under control is central. A card transaction may feel less concrete and
be harder to understand. It may also be difficult to estimate the risk of fraud, for example as a
result of skimming. We know that older people are much more prone to use cash and less
prone to use cards than younger people. The difference is also substantial. Third,
appropriate substitutes for cash are not always available. Although cards are accepted
almost everywhere, there are few alternatives when it comes to payments between private
individuals, for example on second-hand markets on the Internet. Using your Internet bank in
the evening to make a transfer between two bank accounts in order to pay for a sofa is not
always a smooth and easy alternative to cash. It was in such cases that cheques performed
an important function. Fourth, cash is one way of storing a value and it is often wise to
maintain a certain liquidity reserve in the form of cash.
However, despite everything I have said about the use of cash in Sweden and internationally,
there is a lot that we do not know or cannot explain. The Riksbank conducted a study in 2007
with the aim of investigating how large a proportion of the cash in circulation could be
explained on the basis of what we know about cash usage.2 The study was based on
available statistics on retail sales, secondary markets, liquidity buffers, lost or destroyed
banknotes and coins and a number of other factors. Despite this we were unable to explain
more than around 40 per cent of the value of the banknotes and coins in circulation. Although
the study did not reach beyond 2004, I dare to claim that we still cannot explain what a large
proportion of the cash is used for. Part of the explanation may be that the public has more
cash at home, as a buffer, than we believe. Unfortunately, it is difficult to get good statistics
on things like this as people may feel it is risky and sensitive to say how much cash they
have at home. Another explanation is that cash is used in the shadow economy, for example
for various household services such as repairs and cleaning.
There are thus a number of good reasons that explain why we use cash and why we will
continue to do so for some time to come. For this reason alone there is a lower limit below
which cash usage cannot fall. Where exactly this limit lies and how quickly we may reach it
will largely depend on what other payment services are developed. For payments from
private individuals to companies there are a number of competing services such as card
payments, mobile payments, Internet transfers and so on. However, for payments between
private individuals there are far fewer alternatives. Despite the rapid rate of technological
development, no satisfactory replacement for cheques has emerged in this context.
What is required to make new payment services successful?
There are a number of fundamental characteristics of the payment system that affect the
chances of successfully launching new substitutes for cash and other existing payment
services. Some of these characteristics raise barriers to innovation and may thus help to
protect the already established payment services. If we assume that, in one way or another,
new payment services will be based on payment by electronic means between accounts in
one or several custodial institutions, then there at least three problems that a payment
service must overcome in order to succeed.
First, launching a new payment system is in itself costly. On the other hand, it is in general
not much more expensive to produce a large number of payments than a small number of
payments due to the benefits provided by economies of scale. However, it takes some time
before a new system can reap these benefits. The costs for building, manning and
maintaining such a technical system are rather high and it is only when the system is in place
that costs begin to fall. Then the cost of processing an additional payment is almost zero.
The average cost of making a payment thus falls as the number of payments increases. The
price per transaction that the producer can charge without running at a loss is therefore low.
Already established payment services that handle large volumes of payments therefore have
a cost advantage. The larger the volume the established service has, the greater is its
advantage. The situation for a new service is exactly the opposite. At least initially, a new
service will have a small number of payments to distribute the fixed costs between. In order
not to price itself out of the market, the new service will have to run at a loss until it has
achieved a sufficiently high volume. A new service thus has a significant cost disadvantage
compared with an established service.
Second, a new system has to compete against the so-called network effects. The classic
example of a network effect is telephony. Being the first person to have a telephone offers no
advantages. If two people have telephones they can at least call each other, which has a
value. For every new telephone owner that is linked to the telephone network the benefit of
having a telephone to those who are already connected increases as the number of people
that can be reached has now increased. This reasoning about telephony can easily be
applied to payment services where everyone wants to be able to send payments to and
receive payment from everyone else, for example a service for payments between private
individuals (P2P).
The reasoning becomes more complicated when we talk about payments from consumers to
companies (P2B). Payment service markets with two distinct sets of customers for payment
services and payment flows in only one direction are usually called two-sided markets. The
market for point-of-sale payments (POS) is one such two-sided market. The payments on
this market go from the private customer to the company and not the other way. The card
market is only attractive to merchants if there are a sufficiently large number of consumers
with cards. Similarly, it is only attractive for consumers to have cards if it is possible to use
them in a sufficiently large number of shops. A new payment service on a two-sided market
must solve this "chicken and egg" problem, that is ensure that sufficient numbers of
consumers and merchants start using the service. Launching a product that is not
fundamentally based on existing payment services thus entails major problems. The banks
managed to solve this problem for card payments, but just consider how long it took to
achieve the volumes that we see today. Consider also the fact that the banks did not manage
to solve this problem for an e-money product called Cash Card that was finally phased out a
number of years ago.
A natural consequence of network effects is that those who are already connected to a
welldeveloped network, for example for card payments, will think carefully about whether it is
worth connecting to a new network that is currently much smaller but might in the future be
as large or larger than the existing network. There is a risk of not being able to reach as
many payers and payees in the new network. It may thus be better for consumers or
merchants to wait and perhaps join the network later when a critical mass of users has been
achieved. Launching a service that is not based on an established network is therefore much
more difficult and more costly than adding new services to an established network.
Third, it is easier and less costly for established payment mediators to launch new products
as they have the advantage of having already attracted a circle of customers that buy their
services. These customers can easily be reached through the relationship that is already in
place. The customers also already have an account with the mediator, usually a bank, which
can be used as the basis for new payment services.
The established players also have an advantage in that their relationship with the customers
gives rise to a certain lock-in effect, that is changing from one service supplier to another, for
example from one bank to another, may entail certain costs for the customer. It may be the
case that the local branch of the new bank is further from the customer's home, the legal
terms and conditions governing the payment services may be different, the customer service
centre may be slower, the personnel may be less friendly and so on. Getting private
individuals to change their bank has proved to be much more difficult than expected. The
new alternative service must be better than the existing payment service by a broad margin
in order to make changing from one service provider to another an attractive prospect. This
affects what innovators will be able to charge for their new services, and thus reduces their
incentives to launch such services.
However, despite such difficulties, there are examples of very successful launches of
innovative payment methods. One such example is the introduction of M-PESA in Kenya in
2007. M-PESA is a mobile payment service based on SMS and was launched by the leading
mobile operator, Safaricom. One of the points here is that a large part of the population had
mobile phones but not bank accounts. The mobile operator thus had a large, well-established
circle of customers and thus an advantage. By first launching M-PESA as a service for
payments between private individuals, the company was able to focus on getting one group
of customers to connect to the service. This made it possible to exploit the existing network
effects immediately and completely. Once the private customers were connected and were
using the service, the time was ripe to also offer it to merchants. In this way the company got
around "the chicken and egg" problem. Finally, the company already had access to the
required IT platforms and communications equipment as part of its standard business
operations. This made it possible to avoid high investment costs and to exploit advantages of
scale by producing payment services using the existing infrastructure. Nor was there any
competition from any other product. A well-developed business concept thus made it
possible to overcome all the barriers I mentioned earlier.
Cash usage in the future
But what does all this mean to the use of cards and cash in the future? Will cards be
outcompeted by new products and will cash gradually disappear entirely? I don't think so.
Assume that someone wants to launch a new payment service for everyday payments and
that this service is not based on any existing payment service. If it is to be anything more
than a niche product it will have to compete with cards. However, high initial costs combined
with the strong position of cards in terms of low costs, extensive networks and a reliable
circle of customers at the banks who are used to handling cards present strong barriers to
such genuinely new payment services. Remember that M-PESA's success is based on the
fact that only a small part of the population had bank accounts and that cards were unusual.
The situation in Sweden is entirely different and as far as Sweden is concerned I do not think
that the threat to cash (or cards) comes from a genuinely new product.
One alternative to building an entirely new payment service is to further develop an existing
service. This could relate to a new way of initiating card payments, for example by using
mobile phones. In this way the new service would benefit from the advantages of scale and
network effects provided by the existing service. The initial investment would also be lower
as the infrastructure is already in place. The barriers to such payment services are lower
than for genuinely new payment services and it is probable that development of this type
would primarily be pursued by the existing players on the payment market, possibly in
cooperation with an external party such as a mobile operator. Swedbank and Payair are
currently running a pilot project in Uppsala on the initiation of card payments by mobile
phone. Such solutions may reduce card usage in the retail sector if they are perceived to
safe and easy to use.
The role played by cash in payments from customers to companies is declining steadily, but
the position of cash as a means of payment between private individuals is still strong. Unless
cash is superseded in this area of usage, it will continue to play an important role in our
payment system. I therefore believe that the major challenge to cash will come if a new
payment service appears that could be used to make quick and safe payments between
private individuals. There are interesting projects and products that may threaten cash in this
respect. Sweden is well to the fore in this field and the Swedish banks are working on an
interesting mobile phone-based service for person-to-person payments in real time.3 Square
is another interesting product, as yet only available in the United States, that allows card
payments to be made between private individuals by connecting a small card reader to a
mobile phone.4
Whatever path technological development takes, it will probably mean that the use of cash
continues to decline. We will have more payment services to choose between and
competition will increase. How far the use of cash is pushed back will depend on what
alternative payment services are established. The same barriers that protect cards against
competing products will also protect cash to a certain extent. But, above all, cash is simple
and easy to use as a means of payment, especially for small transactions. This is
appreciated by the consumers and it has proven to be quite difficult to change consumer
habits. It will be exciting to follow developments. Evolution will follow its inexorable course.
However, cash will survive, like the crocodile, even though it may be forced to see its habitat
gradually cut back.