Cost dynamics, again

[Dave Birch] The Swedish central bank published some detailed figures on the cost of payments and they provide useful input to the debate on the future of payments. They show that on average the variable cost of an ATM cash withdrawal to the issuing bank is around 1.3 SKr, compared to 0.23 SKr for a debit card payment, but that is still less than credit card transactions. As in the case of the Norwegian study we discussed before, the central bank study highlights the fact that consumers get very little information through the price structure on the costs that banks have in the provision of payment services. In particular, they say that

the problem is that for a large number of payment instruments the variable fee is set to zero, although our study indicates that marginal costs are above zero

On the whole, with the exception of debit card transactions (on the acquirer side) and direct debits, variable costs and fees differ significantly. Private customers only face transaction fees when making payment transactions at the bank branch-office or when using cheques (although cheques are hardly ever used). Transaction fees are almost exclusively taken from corporate customers, particularly merchants.

Technorati Tags: costs, payments, retail

Delving into the figures further shows the extent of the cross-subsidy to cash. The Bank estimates that average large retail bank’s payment service profits are around 155m SKr and also that all payment services except cash generate a profit. Remember that the Scandinavian payment systems are much more efficient that in the rest of Europe (or the U.S.) because of higher e-payment usage, so the losses will be even worse in other countries.

• Credit transfers as a whole give a net revenue of about 160 million Skr.
• Card payments, in particular from acquiring services for charge and credit card transactions, are much more profitable.. The average bank has an annual surplus of 460 million Skr.
• The average bank has an almost equally large annual loss from the distribution of cash to the public, of which two-thirds come from ATM services.

So, as is generally true, card payment transactions finance distribution of cash to the public so there might be considerable cost savings to be made by the banks through a more transparent and cost-based pricing This is because such a pricing strategy would lead to changes in the pattern of demand. Consumers would have economic incentives to shift to those instruments that are less costly to produce. According to the Bank’s cost estimates, they would use debit cards more and credit cards and cash less and they would increase their use of electronic credit transfers and direct debits at the cost of paper-based credit transfers. This ould mena in practice transaction fees on paper-based and electronically-initiated credit transfers and in the introduction of transaction fees for cash withdrawals. Fees for acquiring services would have to decrease.

One of our heroes, the governor of the Bank of Sweden, has previously noted that the fact that Swedish banks do not take any fees for cash withdrawals may very well be the explanation for our greater use of cash and lesser use of card payments. The Banl’s conclusion is that the banking sector could lower its variable costs by the best part of a billion SKr per annum by shifting to cost-based pricing.

This analysis is not limited to Sweden. If we look at the EU as a whole, in the context of the SEPA push, the big picture is straightforward, as shown below (using figures from McKinsey, July 2007). European banks lose a lot of money on the non-SEPA payment instruments (ie, cash and cheques), they make reasonable money on SEPA instruments and they make a lot of money on payment-related (rather than direct payment) revenues. These payment-related revenues (eg, interest foregone on current accounts) are significantly at risk if non-bank payment alternatives gain any ground. So if downward pressure on the profits from SEPA instruments together with downward pressure on payment-related profits by non-bank competitors become significant, then they money available to support the losses on non-SEPA instruments will simply not be there. In the case of cheques, the writing is already on the wall (I saw a notice in my local Sainsbury’s last week indicating that they will stop accepting cheques on 31st July). In the case of cash, where next?

These opinions are my own (I think) and presented solely in my capacity as an interested member of the general public [posted with ecto]