Impact of the Use of Cash on Demand for a Retail CBDC

A new IMF paper ¹ concludes that the main influence on the demand for cash, and why demand is falling, seems to lie in the demand preferences of changing population structures.

If CBDCs are issued, the demand for cash may continue to fall, but the demand for card usage may fall by even more.

The extent depends on the demand for CBDCs, and the incentives offered can play a determining role in their adoption and use. The key incentive being primarily transaction fees.

The paper starts with the usual list of cash being used as a medium of exchange, as a precautionary reserve and that cash is used to facilitate illegal activity. Their analysis of statistically relevant factors for what has been increasing levels of cash in circulation (CIC) include increases in household consumption, both cash and cards, falling interest rates and several indicators that point to tax evasion. A study of the data using different economic activities and interest rates showed that these were insignificant, but that age was actually significant.

The authors decided that knowledge of how and why cards have substituted for cash and other payment instruments provides information on the competitive environment that retail CBDCs may face, as well as suggesting attributes or incentives required to encourage consumer and merchants to use CBDCs.

That ratio of cash to GDP is an indicator of whether the stock of cash is changing relative to the value of all types of payment used to produce GDP. IMF data for 25 countries showed CIC rose in 20 countries, only falling in China, Russia, Norway, South Africa and Sweden. This at a time when ATM and POS devices were rising in number. 75% of the countries experienced an increase in CIC/GDP.

Only Turkey did not show a decline in relative cash usage. Brazil, because of its introduction of its PIX payment system and its 2015 financial crisis, India, because of its demonetisation of the two highest denominations, and Russia, due to the introduction of its MIR payment system, had special circumstances that explained their large falls in cash usage.

For many types of transactions, cash is seldom used, for example business- to-business payments for intermediate inputs, employee payrolls, international transactions and purchases of outputs by various categories of final demand. A different measure, therefore, is needed to show how the use of cash is changing in the market for cash.

In eight countries cash substitution had reached the level of 80-94% ². The paper posed the question whether these countries would readily switch to CBDCs because people have formed a habit of using their existing electronic payment methods.

Cash share measure

This paper focuses on where cash is usually used, which is also where retail CBDCs are focused.

It created a formula to measure the value share of the flow of cash relative to the flow of cash and its substitutes; cash divided by cash plus cards + e-money. Understanding cash substitution, ie. the direct indicators of the use of cash compared to substitutes, will help understand how competitive cash substitutes are in current cash markets, what is driving changes in cash usage and where retail CBDCs are likely to have a greater impact on cash substitutes rather than cash.

This new cash share measure, the value share of the flow of cash, was compared with CIC/GDP and the ratio of small value CIC to household consumption. Cash usage was reducing for 8/25 for CIC/GDP, 13/25 for the ratio of small value CIC to household consumption and 24/25 for the cash share measure.

Korea, Sweden and the US had the lowest cash share in 2019 but were relatively low throughout the period 2012-19. China, Spain and Argentina had the highest cash shares and experienced a greater decrease in 2012-19, showing that the downward trend is not linear.

Recently there has been a generally slow and relatively predictable annual average reduction in the share of cash use across countries of 1.7%. The authors thought a retail CBDC might speed this up slightly.

In 20/25 countries cards dominate payments and cards will be impacted by the introduction of a retail CBDC. The impact is likely to be less in the eight countries who are already low cash users, because the data shows that for many countries the cash share is already falling at a decreasing rate - presumably because fewer individuals are choosing cash substitutes once most have already made the transition.

Drivers to less cash

Although the work identified the usual factors driving change away from cash - convenience, relative cost, the availability of infrastructure for alternative payments and trust in electronic payments - the study focused on the preferences, not the multiple influences on payment choice.

The marginal revealed preference for cash substitutes by younger adults compared with older adults was observed in a set of payment study diaries in the context of the changing age structure of individuals in a country’s population.

In the light of the decline in cash already starting to slow and high uptakes of cash substitutes having taken place, additional incentives may be needed to encourage the use of retail CBDCs. It assumed that retail CBDCs match the benefits to consumers and merchants for card benefits such as convenience, speed of payment and fraud control. For CBDCs to be an attractive substitute for cards they may also need to have no user fees, as cash has, to match the transaction fees and costs of cards, particularly user fees, merchant interchange fees and merchant working capital costs (transfer of funds needs to be as quick).

The response from card companies may be to lower fees and introduce quicker settlements, or use faster payment services, so that person-to-person payments are at zero costs and person-to-business and B2B invoice payments are for a fee paid by the receiver.

1 - IMF Working Paper: WP/22/27. Falling Use of Cash and Demand for Retail Central Bank Digital Currency. Tanai Khiaonarong, David Humphrey.

2 - Korea, Sweden, US, Japan, Australia, UK, France and the Netherlands in 2019 had a cash share at 6-20% with an average annual reduction of 1.2% implying that within 5-17 years the cash share would be close to zero.