Comparison of efficiency and costs of payments:

Some new evidence from Finland

Kari Takala and Matti Viren

Bank of Finland

We intend do the following things:

• Discuss some principal and conceptual issues of payment media

• Illustrate the Finnish system of payment media, institutions and recent trends

• Provide some new Finnish estimates of costs of cash & cards, and the social costs of payment media

Efficiency of the payment system

• Social costs vs costs of different market players: the Central Bank, banks, merchants and the consumers

• Costs vs net benefits: more appealing measures create progressively more measurement problems (without making huge difference in basic results).

• Still, the const side is somewhat controversial (consider the role ATMs)

Comments on previous results

• Even on the cost side, there are large differences between different countries/studies

• In terms of unit costs for different payment media, they follow the same pattern

• On the top, we have David Humphrey’s claim of something like 1 % gain form more efficient payment system

Caveat 1: Efficiency gap

Caveat 2: Economies of scale

G

MC

volume

How the Finnish cash cycle differs from other euro countries?

• 1. Banknotes put into circulation is low with respect to GDP or private consumption, which points out that cash is not anymore the dominant means of payment (by value) in retail payments.

• 2. The number of bank branches and ATMs is low in comparison to population and the amount of cash in circulation. ATM distribution of cash is the dominant channel for consumers to receive banknotes. About 80 % of cash is distributed out of ATMs, but only 20 and 50 euro banknotes available in ATMs.

• 3. The Finnish cash supply system is extremely concentrated, NCB has 5 branches, one company (Automatia Ltd.) is governing the united single ATM network, 2 CIT companies operate in 23 cash centres. BoF has only two clients in cash services.

• 4. Even though the banknotes put into circulation in Finland has doubled after the euro changeover, it has been estimated that about a third of the value of these banknotes have been migrated outside Finland, and mainly into euro area.

Additional features of the Finnish cash cycle system

• The frequency of ATM withdraws per machine and by population is very high, but the average amount of cash withdrawn is not among the highest (below 90 euros per withdrawal).

• The amount of cash held in bank branch offices is currently very small due to dominance of ATM distribution of cash and improved logistics within the cash service network.

• The key element in the concentration of the Finnish cash supply system is also that as a small country only 3-4 bigger deposit banking groups govern the money market, and they noticed quite early the savings in cooperation.

• Automatia is owned by 3 largest commercial banks, but BOF and competition authorities forced them to allow other banks in joining the cash distribution network. Later on also ATM network has been merged into one single network.

Central bank

Automatia CIT centres

Consumer

Retailers Commercial Banks

Rough outline of the Finnish cash distribution Rough outline of the Finnish cash distribution systemsystem

Circulation of euro banknotes by value in Finland (2004, billion €)

Bank of Finland(5 branches)

Automatia CIT centres

(Falck & Securitas)(19 centres)

Bank branches (Nordea, SHB, Sp, Op, ÅAB, Samlink)

1585 bank branches

Otto. ATMs(1723 cash points)

13.244

11.529

2.819

2.659

18.576 2.470

Households (2.4 million units)

Net withdraws 16.106(20 & 50 € banknotes)

Retail shops and corporates

Mainly 5 &10 € notes and coins)

Larger 100-500 € notes over-the-counter, net withdraws 0.299 bill. €,gross withdraws 2.175 bill. €

(20 – 40 bill. €)

Rekla Oy(2 centres;

Lohja & Kuopio)

Cash payments

0.733

0.733.05014.551

(Not known)

The number of bank branches in EU15-countries in 1995 – 2005

0

200

400

600

800

1 000

1 200

BE DK DE GR ES FR IE IT LU NL AT PT FI SE UK EU15

Bank branch / million inhabitants

Source: European Central Bank.

Postgiros added to bank branches

The number of ATMs in EU15-countries in 1995 – 2005

0

200

400

600

800

1 000

1 200

1 400

BE DK DE GR ES FR IE IT LU NL AT PT FI SE UK EU15

Number/ million inhabitants

Source: European Central Bank.

Bank branches and ATMs per million inhabitants in 1995 and 2005 in EU 15

0

200

400

600

800

1000

1200

1400

BE DK DE GR ES FR IE IT LU NL AT PT FI SE UK EU 15

Bank branches/million inhabitants 1995 Bank branches/million inhabitants 2005

Number of ATMs/million inhabitants 1995 Number of ATMs/million inhabitants 2005

Number per million inhabitants

0

50

100

150

200

250

300

1985 1990 1995 2000 2005

0

2

4

6

8

10

12

14

16

18

20

Amount of cash withdrawn from ATM, billion euro

Number of cash withdrawals from ATMs, million

Sources: Federation of Finnish Financial Services and Automatia.

Number and value of ATM withdrawals in Finland, 1985 - 2006

Number of withdrawals in millions Value of withdrawals, billion euro

ATM banknotes in Euro area countries from the start of changeover

500 € 200 € 100 € 50 € 20 € 10 € 5 €

Austria x x(2004) x

Belgium x x x

Finland x x

France x x x

Germany x x x x x

Greece x x

Ireland x x x

Italy x x x

Luxembourg x x x x x

Netherlands x x x x

Portugal x x x x

Spain x x x x

0

1

2

3

4

1988 1990 1992 1994 1996 1998 2000 2002 2004

Median of ATM networks

Most common means of payment in daily goods purchases

71

17

3 2

9

65

21

3 2

8

58

30

2 31

7

49

41

2 31

3

48

41

3 3 2 3

46

43

4 31

3

4543

53

1 2

4345

7

4

1 2

39

48

8

31 2

0

10

20

30

40

50

60

70

80

Cash Bank cards Visa Electron -card Credit cards Retail shop card Account

1999

2001

January 2003

October 2003

April 2004

October 2004

April 2005

February 2006

May 2007

Source: Federation of Finnish Financial Services, Saving and use of credit, May 2007

% of respondents

0

1

2

3

4

5

6

7

8

9

1947 1952 1957 1962 1967 1972 1977 1982 1987 1992 1997 2002 2007

Sources: Statistics Finland and Bank of Finland.

Banknotes put into circulation ratio to GDP in Finland, %

%

Finland continued

• Most retail payments are currently made with cards according the Finnish Bankers’Association questionnaire. However, no exact figures about cash payments by transaction or value exist. Finland has the highest number of card payments per inhabitant in EU15.

• Retailers also prefer debit card payments (national bank cards) instead of cash payments. Debit card commissions are low in comparison to credit card commissions. One company (Luottokunta Ltd.) owned by banks and retailers) takes care of the card services.

Payment card transactions in Finland 1997 – 2006, million

178 191 217255 291

362415 445

498567

12

14

3361

100

151

54 5858

6265

68

70

73

76

91

4048

4953

55

59

60

62

66

68

273297

324370

412

502

577

640

740

878

0

100

200

300

400

500

600

700

800

900

1000

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Retail Cards

Credit and Charge Cards

Online Debit Cards

Bank Cards

7,3 7,8 9,1 10,312,2

13,8 14,816,2

17,819,60,0

2,0

2,9

2,73,4

3,53,7

4,0

4,14,2

4,3

4,5

5,6

1,91,7

1,7

2,5

2,4

2,52,5

2,6

2,9

3

0,71,3

0,311,912,9

14,2

16,4

18,6

20,722,3

24,4

27,2

31,1

0

5

10

15

20

25

30

35

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

Retail Cards

Credit and Charge Cards

Online Debit Cards

Bank Cards

Value of Payment card transactions in Finland 1997 – 2006, 1000 Million

Trends in cash and card payments in Finland

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

50000

1975 1980 1985 1990 1995 2000 2005

Typical cash payment items (food and beverages, leisure and culture)

Typical electronic payment items (housing rents, household bills, traffic and health etc.)

Source: Statistics Finland.

Typical cash and electronic payment expenditure items

Million euro

Computing the costs: cash

• Very few market players which provide relatively accurate data

• Both banks and merchant have delegated most cash-related tasks (counting and sorting, transportation, ATM operations) to professional cash handlers (Automatia)

• Cash is used relatively little in Finland

Computing the costs: cards

• Again, very few market players. Bank’s own company, Luottokunta Ltd., takes care of most of card-related operations

• At the level of fees and commissions, we know things pretty well but in terms of resource costs it much difficult to get reliable data

Table 8 Total costs of cash in Finland 2000 – 2005

Agent\Year 2000 2001 2002 2003 2004 2005

Central Bank 50.534 68191 31.265 14.549 13.633 15.657

ATM company(Automatia Ltd)

42.745 63.151 59.070 56.789 50.907 51.338

Cash transit companies

-Falck services Ltd 24.351 27.997 35.452 29.853 30.340 26.695

- Securitas Ltd 5.500 6.387 14.911 14.039 14.332 14.474

- Rekla Ltd 0 0 0 0.611 3.165 3.345

Cost of professional cash handlers

123.2 165.8 140.7 115.8 112.4 111.5

Bank branches 23.0 25.0 36.0 25.0 21.6 27.0

Retail sector 40.7 55.6 53.8 48.2 46.9 46.6

Total costs 186.9 246.3 224.5 189.0 185.3 185.1

Total costs/GDP, % 0.141 0.176 0.156 0.129 0.122 0.117

Total costs of payment cards in Finland 2002 – 2005

Table 11. Total costs of card payments in Finland 2002-2006, million euro

Costs of card payments for card users (transaction fees, provisions and annual fees) in Finland

YearTransaction

costs of merchants

Provisions paid by merchants

Annual fees of card holders

Total costs of payment cards

GDP annual value, million euro

Total cost of card payments vs. GDP,

%

2002 12.6 37.8 93.2 143.7 143974 0.1002003 14.3 40.0 106.6 160.8 145938 0.1102004 15.2 42.7 117.9 175.8 152345 0.1152005 16.9 46.7 131.0 194.6 157162 0.1242006 19.1 59.4 150.3 228.8 167062 0.137

Some estimates of social costs

• Total costs of cash and cards is around 0.3 % of the GDP

• Employment share of payment related workforce 0.12 - 0.20 per cent

• Unit costs of cash and cards are not terribly different 0.30 vs 0.26 €

• Altogether costs seem to be much smaller than e.g. in the Netherlands and Belgium (but close to recent Swedish estimates 0.36 – 0.40 %)

Further policy implications

• Moreover, on an average unit costs for different payment media do not seem to differ very much, not so much that the difference would require some government intervention.

• It seems that we arrive at the same result if net benefits instead of costs were used as a point of reference

Pricing the use of payment media

• Cash is seemingly free consumers and for cards, typically a fixed fee has to paid

• Merchants pay the costs of cards (fees and commissions) and the also partly the cash operations.

• Introducing a complete set of tariffs seems a remote possibility; it is also analytically much difficult than it seems at the first sight.

Competition policy

• If we have only one payment instrument we may face competition problems especially in a monopolistic set-up (maybe, we too often model the banking sector in a perfect competition world).