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The development of information technology has unprecedented
consequences on the banking industry. It has seen recently the
increased use of pre-paid card, e-purse, e-wires of money orders,
e-banking, e-loans. The Internet contributes by fostering further
competition, not only within the banking industry, but also coming non
banks. This paper will focus on the development of electronic money and
the consequences therein for monetary policy. The paper aims at
discussing the two following issues:
1- Does electronic money give rise to the
privatization of money issue?
2- If this is the case, does this situation threaten
the banking stability and does it challenge the control of the central
bank over money supply[1]?
SECTION 1- Do Electronic Money
and E-money give rise to the private money issue ?
First of all, it is necessary to give a brief definition of the
electronic means of payment. These cover a large range of instruments
starting from electronic money orders, debit cards and credit cards[2]
to smart cards or e-purse or more generally speaking store value cards
or pre-paid cards[3] (like Moneo[4] in France or MONDEX first launched
in Britain in the mid-1990's). The European Central Bank 1994 Report
focused its analysis on the multi-purpose prepaid card or
« electronic purse » which was defined as a plastic card
which contains real purchasing power, for which the customer has paid
in advance (card-based products). A second form of electronic money
products which employ specialized software on a personal computer,
typically allowing the electronic value to be transferred via
telecommunications networks, such as the Internet, has emerged since
then (software-based products) [5].
The second category represents technological improvements enhancing the
cost-efficiency of the payment system without truly challenging the
nature of the liabilities issued by banks. The new technology enables
the wiring of funds from a deposit account to another more quickly,
thus reducing the cost of processing payments: the cost of processing
electronic and e-payment is lower for the bank[6] and it also
diminishes for the customers both the length of the transaction and the
cost associated.
The first category represents cards containing real purchasing power.
The charge of the card is prior to any transaction and makes it final.
Indeed, cardholders just charge a certain amount of money and are able
to use it wherever it is accepted. The oldest and most widely developed
scheme is Mondex, first launched in Britain in the mid-1990's. A
similar card has been recently launched in France (Moneo) with the aim
of rallying other European countries (like Italy, Belgium) in order
rapidly to reach a critical size for the network. These pre-paid cards
represent a « more advanced version » of private notes
because like notes, they make transactions final. But why should
retail shops and consumers be interested in holding these cards over
notes?
The advantages of these cards are the followings:
- the transactions paid with these
pre-paid cards are more secure for retailers since the technology can
make counterfeiting more difficult and the risk for the retailers of
being robbed decreases dramatically ;
- for the consumers, the risk of
robbery may be reduced as well. It avoids any of the inconveniences of
carrying coins. Moreover, they could earn interest on the balance.
The main drawback of these smart cards for retailers is that they
prevent them from hiding income for tax purposes. As a matter of fact,
many experts expect a massive success as soon as the technology
develops to make them non-traceable. In any case, these cards are held
in place of cash and from that point of view « privatize »
small transactions.[7]. In addition supermarkets, retailers, airline
companies already offer cards to make payments easier, in conjunction
with a reward program. They could easily offer pre-paid cards at the
same time, to be used within a network of partners.The development of
electronic payment could not only threaten the ability of the central
bank to control money creation but also seriously challenge the
position of commercial banks in their traditional market.
SECTION 2 : Does the
development of private monies threaten both the stability of the
payment system and the ability of the central bank to control
money creation ?
Many authors[8] try to predict the outcome of a system where more than
one form of money issued privately co-exist. Two main problems are
underlined :
1- interoperability of rival networks
2- exchange rates between the different e-monies
issued privately[9]
The main concern here is the cost incurred through the existence of
exchange rates between the e-monies. Issuing e-money in competition
with notes does not require it to circulate at a different exchange
rate. On the contrary, since means of payment typically benefit from
large network economies, issuers would have a strong incentive to have
their money accepted at par and also to enhance the interoperability of
their system. This is a strong argument for convincing customers to
hold that new money in the first place. This can be further illustrated
by the case of Moneo, the French e-purse scheme, since Moneo is offered
as an option on the Visa/Master debit/credit card[10]. Network
economies can also be achieved by opening branches, developing brand
name and signing agreements with retailers for accepting notes on a
large scale.
On the other hand, if an exchange rate prevails, it does not
necessarily harm customers. It is worth mentioning the case of the Raam
issued by the Maharishi community in the Netherlands and in the US. It
circulates in Europe at an exchange rate of 1 against 10 Euros and
still expands its circulation.
The second major concern about the development of e-money is that it
could weaken the ability of the central bank to control the quantity of
money in the economy. This « privatization » of the quantity
of money would ultimately challenge the efficiency of monetary policy.
Indeed, the quantity of money privately issued would not be subject to
reserve requirements and its quantity would be the result of the
profit-maximizing private bank calculation.
The demand for base money by commercial banks is explained by reserve
requirements regulation and when those are not binding, by the clearing
settlements scheme and the demand by the public[11],[12]. In other
words, what is important to question here is whether or not e-money
reduces the demand for base money. If this is the case, it will
ultimately affect the money multiplier linking high-powered money to
the total quantity of money. This raises two issues for the central
bank:
1- e-money will lead to the shrinkage of its balance
sheet and it will also decrease seigniorage;
2- it will make the relation between high-powered
money and money created by the deposit-taking institutions looser and
less predictable, jeopardizing the efficiency of monetary policy. This
could lead to an ever-increasing rate of inflation.
The adjustment process may create some disturbances. In fact, the
central bank needs to predict the path along which it will take place
in order to adapt its supply of base money to these changes. This
discovery process could produce instability within the banking system.
As for determining whether the development of « private
monies » is a first step toward the privatization of the current
base money, this is a mere exercise in « science fiction »
for the time being. Anyway, the European Central Bank has already taken
action to ensure that this won't happen: e-money should be only issued
by banking institutions subject to reserve requirements. Moreover, it
requires e-money to be redeemable into central bank money.
Conclusion
The paper demonstrates that Internet and electronic means of payment
are far from seriously depriving the central bank of its power over
money creation. Under these circumstances the central bank does not
need to feel threatened by these developments, especially since the
unit of value used by electronic purses is based ultimately on central
bank high-powered money. This is what gives their value from a customer
standpoint. Nonetheless, central banks are right in being concerned by
the impact such developments can or could have on their ability to
control and fine-tune monetary policy. As a matter of fact, the
existence of electronic purses, and more broadly speaking,
technological improvements in wiring money and settling payments,
affect the velocity of money (increasing it) and lose the link between
money held by private customers, households and businesses, and the
high-powered money issued by the central bank.
In the short run, these trends jeopardize the ability of the central
bank to control its monetary policy. When observing the behavior of the
major central banks, it is worth noticing that this threat is not taken
equally seriously by all of them. As a matter of fact, it is striking
how the position of the European Central Bank contrasts with that
officially endorsed by the Fed. Indeed, the European Central Bank sees
the development of electronic means of payment as a major threat to its
(still) infant monetary policy meanwhile the Federal Reserve is still
observing the changes. It has taken no measures to restrict their
development to commercial banks only.
In any case, it seems that we are still very far from a cashless
society. Nonetheless, the central bank and the government need to
become accustomed to the idea that the seigniorage derived from issuing
money will irremediably erode.
BIBLIOGRAPHY
BANK for INTERNATIONAL SETTLEMENTS, « Survey of electronic
developments », Committee on Payment and Settlement Systems of the
central banks of the Group of Ten Countries, November 2001, pp. 1-112.
BOARD of GOVERNORS of the FEDERAL RESERVE SYSTEM, « The Future of
Retail Electronic Payments Systems : Industry Interview and
Analysis », Staff Study, 175, December 2002, pp. 1-35.
EUROPEAN CENTRAL BANK, « Opinion of the European Central
Bank », January 1999, pp. 1-7.
EUROPEAN CENTRAL BANK, « Report on Electronic Money », August
1998, pp. 1-47.
GOOD, B.A., « Private Money : Everything Old is New
Again », The Economic Commentary, Federal Reserve Bank of
Cleveland, April 1998.
HUMPHREY, D.B., L.B. PULLEY and J.M. VESALA, « Cash, Paper and
Electronic Payments : a Cross-Country Analysis, », Journal of
Money, Credit and Banking, Vol 28, n°4, November 1996, part 2, pp.
915-939.
KAHN, C.M. and W. ROBERDS, « Demandable Debts as a Mean of
Payment : Banknote versus Checks », Journal of Money, Credit
and Banking, Vol 31, n°3, August 1999, part 2, pp. 500-525.
OSTERBERG, W.P. and J.B. THOMSON, « Bank Notes and Stored-Value
Cards : Stepping Lightly into the Past », The Economic
Commentary, Federal Reserve Bank of Cleveland, September 1998.
SANTOMERO, A.M. and J.J. SEATER, « Alternatives Monies and the
Demand for Media of Exchange », Journal of Money, Credit and
Banking, Vol 28, n°4, November 1996, part 2, pp. 942-960.
SELGIN, G. and L.H. WHITE, « How would the Invisible Hand Handle
Money ? », Journal of Economic Literature, Vol 32, December
1994, pp. 1718-1749.
SELGIN, G., « The Suppression of State Banknotes : a
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pp. 600-615.
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of Money », unpublished, last revised draft December 2000, pp.
1-42.
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Oxford, 1999.
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[1] Indeed, central banks and in particular the European central bank
seem to be seriously concerned by the potential competition raised by
e-money: « The 1994 Report indicated similarities, in economic
terms, between sight deposits with the banking system, on the one hand,
and value loaded on prepaid cards, on the other. Indeed in both cases,
the customer entrusts part of his/her belongings to an institution.
Therefore, in many cases, electronic money comes into competition with
traditional bank money, a situation raising concern for the level
playing-field », European Central Bank, Report on Electronic
Money, August 1998, p. 8.
[2] In the US, the use of non-cash retail payments multiplied by 5
between 1979 and 2000 because of the dramatic increase in the use of
debit cards. Moreover, the proportion of non-cash payments made
electronically grew from 15% in 1979 up to 40% in 2000. Nonetheless,
the check still dominates non-cash retail payments because it is the
most used mean of payment in the business community (around USD 14
billion in 2000, Board of Governors of the Federal Reserve
System, The Future of Retail Electronic Payments Systems :
Industry Interviews and Analysis, Staff Study 175, December 2002, p. 1.
[3] Cf The Economist, « Dreams of a cashless society », May
5th-11th 2001.
[4] Moneo is issued by a consortium of banks and non banks called BMS
(Billetique Monetique Service), the shareholders of which are the
followings : BNP, BP, Caisses d'Epargne, CCF, CIC, Credit
Agricole, Credit Lyonnais, Credit Mutuel, la Poste, Societe Generale,
France Telecom, RATP, SNCF. Moneo needs to be charged at a specific
terminal at your bank for a fixed fee and for a maximum amount of Euros
100.
[5] Cf European Central Bank, Report on Electronic Money, August 1998,
p. 7.
[6] The experience in England of home banking and phone banking (also experimented in France) seems to be quite
successful in terms of cost efficiency for the banks.
[7] Nonetheless, it is important to remember that the use of e-money
and electronic means of payment is still restricted to retailers since
businesses are still heavily relying on checks It is worth noticing
that Citibank designed an e-payment system targeted to businesses but
this requires from the company an investment in technology.
[8] Cf in particular Osterberg and Thomson (1998).
[9] I have first to acknowledge that this concern is particularly
strong in the USA, given its banking history. Indeed, given the size of
the territory and given that long ago the different states introduced
laws refraining banks from branching out of the state, the US banking
system has always been very fragmented.
[10] Nonetheless Moneo requires a terminal different from the one used
for Visa/Mastercard transactions.
[11] Contrary to what certain authors may believe, the existence of
reserve requirements is not tantamount to the control of the central
bank over the reserves put aside by commercial banks. In many
countries, reserve requirements have almost been phased-out (New
Zealand for example that also started to give an interest rate on
reserves instead of having reserve requirements) but still the central
bank is in charge of the monetary policy given that the commercial
banks need base money for clearing settlements.
[12] Surprisingly cash still represents a fair percentage of the
transactions made by individuals in the major industrialized countries
(around 50%). This percentage would be much lower if the USA were not
included, even though the use of the credit and debit cards is widely
extended.
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