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McKinsey on Payments

McKinsey on Payments

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07/12/2013

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As we have argued previously, continued re-duction in cash payment volumes will re-quire better alignment among variousstakeholders in the payments business. Ear-lier articles have examined the high cost ofcash to merchants (“Mission impossible?The cashless payments proposition for‘small-ticket’ merchants,”
McKinsey on Payments 
, February 2008) and suggestedthat banks, merchants, consumer groupsand governments should work together toimprove electronic networks (“FightingCash not SEPA,”
Payments: Charting a Course to Profits 
, December 2005).ATMs contribute significantly to the cost ofcash, and we urge banks to target thesecosts side-by-side with cash volumes. Out-lined below are the ATM strategies cur-rently available to banks for this dualattack. The precise strategy any bank fol-lows will vary according to the maturity ofelectronic payments networks and con-sumer payments behaviors in the marketsthe bank serves. To identify a winning strat-egy, banks must understand both theirbranch and ATM costs, as well as the fac-tors influencing their customers’ paymentpreferences. If they act aggressively, banksin Europe stand to reap
11.5 billion in re-duced costs.
Cash is expensive
Reducing cash volumes is essential to lower-ing the economic burden of cash to society.Europe
1
spends an estimated
60 billion to
100 billion each year processing 237 bil-lion cash payments out of a total volume of313 billion payments transactions. Thisamounts to 0.5 percent to 0.8 percent of Eu-rope’s gross national product (GDP).
2
12
McKinsey on Payments
November 2008
1
Our analysis in this article includes theEU 27 excluding Luxembourg, theBaltics, Malta and Cyprus and includingNorway and Switzerland.
2
Based on total costs of cash to allstakeholders, i.e., merchants, consumers,banks, government. These costs includefully loaded direct costs, such asprocessing, theft/fraud, security,transport, time, cost of producing notesand coins, etc. They do not includesecondary effects, such as lost income forthe government due to the grey economy.
ATMs: Complex weapons in thewar on cash
At the very moment when cash payment volumes have started a gradual decline,many countries face an unexpected rise in the absolute cost of cash processing.In 2006, European banks spent a total of
28.2 billion on cash operations, eightpercent more than in 2002. In the same period, cash payment volumes declinedby six percent. This article examines the dynamics driving these divergent trendsin four distinct European “theaters” and recommends strategies for reducingbanks’ costs in the war on cash.”
Olivier DeneckerFlorent IstaceMieke Van Oostende
 
For merchants in Europe, the cost of cashequals, on average, 1.3 percent of the valueof each cash transaction. Levels of cashusage vary from country to country, as doesthe absolute cost of cash to merchants. InFrance, for example, where consumers usecash less frequently, the average “small-ticket” merchant with annual sales of
400,000 pays cash processing costs of
2,900 each year. A similar merchant inGermany pays
4,100.Banks in Europe pay
28.2 billion annu-ally for cash-related operations, whichamounts to 30 percent to 50 percent of so-ciety’s total cash costs and represents 0.23percent of GDP. This expense comprisesthe fully loaded direct costs of cash opera-tions, including the processing of cash atthe front office and back office, teller time,installing and maintaining the ATM net-work, security, fraud and theft, transport,etc. The impact to banks is a 3 percent to5 percent charge against their cost-to-in-come ratio (Exhibit 1).
Cost of cash is increasing
The reduction in cash volumes raises logicalexpectations of lower absolute cash costs,but, perversely, the total cost of cash has ac-tually risen. As shown in Exhibit 1, branchand ATM costs represent the lion’s share ofbanks’ cash costs. Allowing a customer toaccess cash through branches is expensive,and banks can substantially reduce theirbranch costs by making ATMs the primarychannel for cash distribution.But ATMs are complex weapons in the waron cash. Consumers in many countries pre-fer to access cash at the branch, despite thewidespread availability of ATMs. Conse-quently, the expense of building and main-taining ATM networks, added to alreadyhigh branch costs, drives the total cost ofcash upward. Even in some of the countriesthat have sharply reduced cash transactionsin the branch, the cost of cash has stillrisen, primarily due to the expansion ofATM networks at a faster pace than growthin ATM usage.
13
ATMs: Complex weapons in the war on cas
Exhibit 1
Netwo
k costs,namely ATM andb
anch costs,
ep
esent ove
 90% of the totalcost of cash
Sou
ce: McKinsey Payments P
actice
Back officecostsNetwo
k costs(ATM and b
anches)67Administ
ative costsT
ans
p
o
t to/f
om b
anchesCash
pr 
ocessin
costsFloat in b
anchesOthe
b
anch
elated costs241044919
Pe
cent
 
Another trend pushing cash costs higher isthe gradual increase in the number of with-drawals. We have found that in many Euro-pean countries the number of cash depositsand withdrawals is increasing and the aver-age transaction value (relative to the cost ofliving) is decreasing. Consumers are with-drawing cash more frequently to spend rap-idly.
3
Absent incentives (and penalties),simply increasing the availability of ATMscan actually enable the “cash habit.”It is a perverse phenomenon: Gradual de-creases in cash payments in Europe are gen-erally accompanied by rising costs to banks(Exhibit 2). These increases are erodingbank profit margins across Europe, and insome countries, including Spain, Irelandand most of Eastern Europe, banks’ cashcosts have risen by over 3 percent annually,for the period 2002-2006.
Best practices point the way to costreduction
To be sure, some countries (The Nether-lands, Switzerland, Scandinavia, Belgiumand France) have managed to reduce theiroverall cost of cash at an annual rate of 1.5percent for the same period.
4
These coun-tries, which together account for around 20percent of European banks’ cash costs, paid
5.6 billion for cash processing in 2006. Byfollowing the best practices of these costbusters,” banks in other countries can re-duce their total cost of cash by at least
11.5 billion, cutting the total cash cost forEuropean banks from
28.2 billion to
16.7billion (0.14 percent of GDP).
5
If they have not already done so, banks needfirst to attack cash costs by implementinglean structures in branches, streamlining theflow of cash through the branch networkand shifting the balance of cash transactionsfrom branches to ATMs. These measures
14
McKinsey on Payments
November 2008
Exhibit 2
Despite dec
easingcash usage, thecost of cash keeps
ising
* EU27 excludin
Luxembou
rg 
,the Baltics, Malta and Cy
pr 
usand includin
No
way andSwitze
landSou
ce: McKinsey Eu
o
p
ean PaymentsP
ofit Pools
237243251200220042006
Total Cash T
ansactions Eu
ope*
billions
-1%57%43%26.1200255%45%26.8200455%45%28.22006B
anchATM+2%
Total cost of cash fo
banks in Eu
ope*
billions
3
The Average Transaction Value (ATV) hasrisen nominally, but when corrected forinflation and GDP growth, ATV has decreasedin real terms relative to the cost of living.
4
Weighted average of 2002-2006 CAGR forall countries except France for which we takethe 2004-2006 CAGR.
5
In most of Europe, the cost of cash to banksranges from 0.16% to 0.43% of GDP. Byreducing cash costs to 0.14% of GDP (theamount paid by banks in the cost buster”countries), European banks can eliminate
11.5 billion in costs.
It is a perverse phenomenon: Gradual decreasesin cash payments in Europe are generallyaccompanied by rising costs to banks.

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