Is Physical Cash still used by Corporates? a Bank Notes practical guide
In today’s fast-paced digital economy, payment is much more than a simple exchange of physical cash, via bank notes for instance. It’s a fascinating journey of value transfer involving banks and financial institutions. Understanding how money moves and the role of different payment methods is essential for grasping the intricacies of the financial system.
In today’s article, Guillaume will guide us through the intriguing process of banknote creation and their entry into the economy. We’ll explore the challenges they pose for corporate treasurers and why your banking partnerships play a vital role in the seamless digitization of your cash.
In this article, you will discover:
- The intriguing path of physical cash: How does money move from one place to another?
- Unveiling the secrets of cash circulation: Spotting the intriguing differences between Europe and the United States.
- Behind the scenes of cash management: Exploring the vital role of corporate treasurers
- The liquidity puzzle: Why does physical cash pose unique challenges that must be solved?
- Building strong bank partnerships and achieving seamless reconciliation: The keys to smoother cash management
- Cash in the B2B world: Surprising advantages and disadvantages of relying on physical money
- And much, much more
Join us as we explore the fascinating journey of money and delve into the intricacies of cash management in today’s interconnected world.
(Before starting, We suggest you read What is treasury transformation and The Fundamentals of corporate treasury revised to enhance your understanding of Corporate Treasury concepts.)
What Happens to Money When We Make a Payment?
When we make a payment, we’re essentially transferring value from one place to another, usually facilitated by an intermediary like a bank. Guillaume explained this process using various payment methods, including physical cash, checks, debit and credit cards, and mobile payments like Apple Pay and Google Pay. Also mentioned were corporate treasury instruments like electronic transfers and SEPA payments. Let’s dissect these methods.
The Journey of Bank Notes
Physical cash—think banknotes and coins—still plays a significant role in our economy, especially in certain sectors and regions. Retail companies, for instance, depend heavily on cash transactions. In this context, we’re referring to tangible, physical money, not the concept of cash in broader financial terms.
Where does this cash come from? Well, it’s produced by central banks. If we take Europe as an example, physical money (banknotes and coins) is a collaboration between the European Central Bank (ECB) and the various national central banks. Every year, a certain number of banknotes are printed based on factors such as the need to replace damaged banknotes, changes in demand, or potential seasonality.
Here’s a fun fact: In 2017, the French, German, and Italian central banks produced about 1.7 billion units of 50 euro banknotes—that’s around 85 billion euros! These banknotes aren’t printed at the ECB but are outsourced to 11 high-security printing facilities.
So, How Does Money Move?
Once we’ve grasped where our physical money comes from, the next part of the journey takes us through the payment process. We’ll take a closer look at this in the upcoming sections. But for now, let’s say that the cash moves from us, the payer, to the receiver, often facilitated by banks or other financial institutions. This transaction might involve physical money changing hands, or it could involve digital transactions.
How Do Bank Notes Get from the Central Bank to Your Pocket?
Let’s demystify this journey from the European Central Bank (ECB) to you, the end user. Guillaume explained that while you don’t have a bank account with the ECB, your bank—whether ING, Barclays, or another bank—does.
The Route of Banknotes
Once banknotes are produced, they are distributed to the national central banks across Europe. These national banks inject banknotes into the market via the banking system, particularly retail banks. Retail banks request banknotes from their national central banks and then make them available to end users, typically via cash dispensers or ATMs.
To visualize this, imagine a relay race where the ECB is the starting runner, and you’re at the finish line. The ECB passes the baton (banknotes) to the next runner (national central banks), who then hands it over to the next runner (retail banks), and finally, the baton reaches you.
Banknotes on the Move
Let’s say you’re in the US and dealing with the US Treasury. The process is quite similar. The Central Bank distributes the banknotes to different national banks that have an account with them. These national banks then put the banknotes into the market. This occurs when you or a company withdraw money from an account, thereby circulating the cash within the economy.
Retail Banks: A Vital Link
So, retail banks, like ING or Barclays, are an essential intermediary between the national central banks and you. They receive physical cash from the national banks. But it’s not an all-you-can-grab situation. Retail banks can’t just order as much as they want.
Instead, when retail banks receive physical cash from national banks, the corresponding amount is debited from their account at the ECB or national central bank. In other words, they pay for the banknotes they receive. This ensures control over the money supply and prevents rampant inflation.
Then, these banknotes are distributed into the market via the retail banks. For instance, when you withdraw money from an ATM, your bank account balance decreases by the withdrawn amount, and you receive that amount in physical cash.
How does the Journey of Money Differ Between Europe and the US?
Now that we’ve walked through how money travels from a central bank to your pocket let’s see how it works in different regions. While the concept is the same, the structures vary, especially when comparing Europe with the United States.
Federal Reserve: The US Answer to the ECB
The US Federal Reserve, commonly known as the Fed, plays a similar role to the European ECB. However, it doesn’t directly print money. Instead, it delegates this task to the Treasury Department’s Bureau of Engraving and Printing (BEP). For example, in 2020, the Fed ordered the printing of 5.2 billion Federal Reserve Notes (the official name for US banknotes), estimated at a whopping $146 billion!
From the Fed to the People
The process doesn’t involve national banks in the US as it does in Europe. Instead, the Fed has 28 cash offices spread throughout the US. These offices receive the money (transported via armoured vehicles for safety reasons) and distribute it to over 8,000 banks, savings and loans associations, and credit unions. The system is essentially the same as in Europe – the money is debited from their accounts with the Fed, just like it is with retail banks in Europe.
Injecting and Extracting Money
Just as money is injected into the economy, it can also be extracted. When you deposit money into your bank account, it doesn’t necessarily go straight to the ECB or the Fed.
What happens to your money largely depends on who you’re paying. For example, if you’re buying something from a small business or an individual, the cash might be used immediately for another purchase, never even reaching a bank.
On the other hand, if you’re paying at a supermarket or another large business, they have processes to take the physical cash to a bank branch. This is where things get intriguing. Depending on the demand, the retail bank might send the money back to the central bank or re-inject it into the market via ATMs or other means.
In essence, the path of money in an economy is more than just a straight line. It is a complex system of checks and balances carefully designed to maintain a stable financial environment. Whether it’s the ECB, the Fed, or another central bank, each plays a crucial role in this journey.
How Does Cash Circulation Work Back to the Central Bank?
Understanding how money returns to the Central Bank can be confusing, but let’s break it down together. The discussion between Hussam and Guillaume delves into this process and sheds light on the responsibilities of a corporate treasurer when dealing with physical cash.
Getting Cash Back to the Central Bank
In the discussion, Guillaume explained to Hussam that Central Banks don’t intentionally collect all the cash but manage the supply and demand of it. Imagine a situation where everyone uses cash for transactions, and after a week, the vaults of retail banks like Barclays, BNP, and ING are full. Suddenly, people don’t want to use cash anymore. So, the banks have loads of paper money they can’t inject or invest electronically.
What do they do, then? They return the physical cash to the Central Bank. This is similar to you depositing cash in your bank. The Central Bank credits their non-physical bank account, and they can use this money in the financial markets.
Role of Retail Banks and Businesses
Businesses and retail banks play crucial roles in this cash circulation process. Hussam understood that when you pay cash in a grocery store, the supermarket deposits it in their bank. If the bank finds too much cash, they deposit it with their National Bank or the Fed’s cash office.
The Role of a Corporate Treasurer in Managing Physical Cash
Let’s dive into how corporates manage physical cash and a corporate treasurer’s vital role in this process. Let’s demystify it a bit more.
When a business decides to accept banknote payments from customers, they need a secure place (like a cash register or a vault) to store the cash. They also need a process (preferably a safe one) to transport this money to a bank branch. This transfer is usually done by a specialized third party that uses armoured vehicles for safe transportation.
However, managing this system isn’t as simple as it sounds. You’d be responsible for setting up this system as a corporate treasurer. You would determine how often the cash from the cash registers needs to be transported to the retail bank. Once it reaches a certain scale, you need to put a cash collection and management system in place.
Now, here comes another interesting aspect – investing excess cash. As Guillaume rightly points out, how do you invest a banknote? You can’t unless it’s in a bank account and available digitally for bank transfers. This is where the corporate treasurer’s role becomes even more critical. They manage this transition from physical cash to digital, enabling investment.
The Liquidity of Bank Notes, Bank Partnerships, and Reconciliation in Corporate Treasury
Here Hussam and Guillaume explore complex topics related to corporate treasury, such as the liquidity problem of bank notes, bank partnerships, and the reconciliation process. Let’s break this down in an easy-to-grasp manner.
The Upside-Down Liquidity of Bank Notes
As a treasury professional, your understanding of liquidity might be challenged when we talk about bank notes. You might think you’re quite liquid when you hold a stack of bank notes. But for you, as a corporate treasurer, that’s not the case because it’s not digitally available to invest. Remember, liquidity is not just about having cash. It’s about being able to use that cash conveniently and quickly.
Small businesses often see bank notes as very liquid. Why? They mostly deal with physical payments for supplies and projects. But for big corporations, cash can become troublesome. The larger the scale, the more important it is for money to be digitally accessible.
The Need for Geographically Distributed Bank Partnerships
Guillaume then touches on the importance of bank partnerships. Say you’re a retail business with a hundred shops throughout the UK. You wouldn’t want all the stores to bank at a single branch, would you? No! Ideally, you’d want a bank branch for nearly every shop you have. This way, you optimize your cash collection process and ensure your money is more readily available.
Hussam gives us a great example. If you have branches in New York, San Francisco, and California, you need a bank with branches in each city. Otherwise, you’ll be stuck with the unnecessary cost of driving truckloads of banknotes nationwide. It’s all about having a bank partner as geographically distributed as your corporation.
Reconciliation – Matching Cash Flow with Corresponding Items
Finally, Guillaume introduces the concept of reconciliation. Picture this: You run 10 cafes, all receiving payments in physical cash (bank notes for instance). At the end of the week, they bring this cash to the bank. But how do you know what this cash paid for exactly? This is where reconciliation comes in. It’s about matching a flow of cash with its corresponding item.
Let’s take a look at the hypothetical Hussam’s Cafe. To understand what was paid for, you need a cash register that accurately matches each physical cash transaction to a sale. So, when you sell a coffee and a pastry, you should be able to pinpoint exactly which sale corresponds to a particular cash payment. This helps you keep track of what your clients are buying.
At the end of the day, as a corporate, you need to ensure your retail shops can easily get cash and change from their bank branch. Your banking partner should be able to provide you with coins and petty cash to facilitate smooth transactions.
Cash Management in B2B Entities Compared to B2C Entities: Advantages and Disadvantages of Bank Notes
A Look at B2B Cash Management
When dealing with a B2B setup, like selling steel pipes to other companies, things tend to differ from the B2C scenario. While cash might not be the most common payment method in a B2B scenario, Guillaume mentions that it’s not entirely impossible but not recommended.
Cash, as a payment method in B2B, often depends on where the business operates. Some countries lagging in technology and infrastructure might still use physical cash in their B2B transactions. But this trend is slowly changing with less demand for paper cash due to the obvious drawbacks of such payment methods. These include:
- It’s physical and needs to be transported
- It’s relatively unsafe compared to other payment methods
- It poses a challenge to automate the reconciliation process
- It requires a bank branch near your business
Advantages of Using Physical Cash
Despite the drawbacks, cash use has a few benefits, even in today’s digital age. Unlike most other transaction forms, physical cash incurs minimal fees. Unlike other instruments, this is great for businesses as there isn’t a fee per transaction.
Also, cash transactions don’t require internet access or any form of technology, making it a feasible option in certain countries where technology access is limited. It’s also worth noting that in some cultures, dealing in physical cash is quite common, and a company operating in such environments must be ready to accept cash as payment.
Counterparty Risk: A Notable Consideration
An important consideration when dealing with cash transactions is counterparty risk. Counterparty risk refers to the potential for loss if the other party in a contract fails to meet their contractual obligations. In cash transactions, the government, as the currency issuer, is the only counterparty involved.
Businesses need to trust that the cash will hold its value and that the government will back it. Businesses depend on other entities, such as banks or payment providers, when transacting online, potentially increasing counterparty risk.
However, counterparty risk is not exclusive to digital transactions. It’s present when dealing with banks, too, as the value of a bank lies in others accepting its payments. If trust in the banking system falters, as can happen during a bank run in a recession, counterparty risk becomes evident.
So, while cash might seem safer concerning counterparty risk, businesses must also trust the broader financial system. Cash is gradually losing prominence as digital transactions gain popularity and technology advances, particularly in B2B scenarios.
The choice of cash management strategies for businesses, whether B2C or B2B, should be informed by an understanding of these pros and cons and should align with the nature and location of their operations.
Wrapping Up:
In conclusion, cash management in today’s global and digital economy extends beyond the basic principles of managing inflows and outflows. It now encompasses a wider spectrum of considerations, particularly the shift from cash to digital payment methods.
For businesses operating in a B2B context, understanding the dynamics of cash transactions versus digital payments is key to optimizing their financial operations. While seeming antiquated in certain markets, the use of cash still holds relevance in others, particularly those with limited access to digital infrastructure or where cultural practices favour the use of physical cash.
However, cash’s inherent risks and logistical challenges cannot be overlooked. Counterparty risk is also a significant factor that businesses must consider. While cash transactions may reduce counterparty risk, trust in the overall financial system remains indispensable.
In essence, an effective cash management strategy should balance the traditional and digital, taking into account not only the operational needs of the business but also the economic and cultural landscapes in which it operates. By doing so, businesses can better navigate financial uncertainties, optimize cash flow, and ensure financial sustainability in an increasingly interconnected world.
