in banking, government

Why does it cost so much just to buy and sell something?

Late last year, the ECB issued a press release and  this document about the cost of making a payment (like handing over cash, writing a cheque or sending a payment by direct debit). The question it prompts is ‘why does it cost so much to do something as simple as making a small payment?’ More worryingly it makes you wonder, ‘Why is cash still the cheapest way to do payments, despite all the problems of security, handling and so on that go into a cash payment’? The document is as as infuriating to digest and understand as it is interesting in its subject matter and approach.

As is often the case with the ECB of late, a lot of questions and issues are raised, but there are very few answers. There is some analysis of whether increased volumes would drive down costs of electronic transactions, but there is no clear answer even on that.

(It is worth understanding that the ECB’s report is an ‘economic’ rather than a ‘business’ document. By that, I mean that it is about all the costs of making a payment, not just the fees you have to pay the bank and other players like the credit card processor. It also states things in terms of the overall GDP of the countries and the EU, rather than in raw money terms, for much the same reason. Rather than thinking of the costs in this report as measuring actual money, it is better to think of them as a measure of the amount of resources and physical effort that go into the payments system.)

Ireland happens to be in the group of the countries with the highest costs (1.2 percent of GDP) for transactions (see page 40). Just to put that in context, if the resources that currently go into handing transactions could be halved, that would free up enough resources to cover the running costs two major acute hospitals, or alternatively, to build a major piece of infrastructure, such as a metro tunnel, every single year. At a Europe-wide level, these savings would be enough to allow us to bail Greece out twice a decade (were we to wish to do that).  It’s a massive amount of resource to spend on something that should be much cheaper as a result of developments in telecommuncations and electronics.

The reality, unstated by the ECB  is that payment systems across Europe are hopelessly inefficient for two reasons. Firstly, cash is simply an expensive thing to deal with. There is no really cheap way to secure it, handle it, and ship it around. That said, cash is still in many cases cheaper than any of the electronic methods (see Table 9 on page 28, which gives an idea of what the unit costs are for the different types of transaction. Highlights – average 41c for a cash transaction, 81c for a debit card, and then upwards from there for other types of transactions, up to €3.86 for a cheque).

Why is this? The reason this document is so obfuscated in its conclusions is not that the authors cannot write coherently or are stupid. The reason for its inscrutability and failure to point fingers is that the ECB is politically constrained from presenting its views on what it thinks of bankers and EU countries. I am under no such constraints, so here’s my explanation. Ordinary people cover most of the cost of cash handling, and as a result the system has become more efficient and costs are lower. Electronic transactions, on the other hand, are managed by a coterie of specialists, working in banks, and as a result, the costs are high.

So what do we have to do? Well, I think we should look at finding a way to reduce transaction costs from 1 percent of EU GDP to 0.1 percent. It is eminently feasible using all this fancy new technology that has become available. Re-engineering existing systems is not really what is needed. It needs whole new systems, that completely transform the accessibility and the unit costs of making payments.

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  1. This is exactly what disruptive companies such as Stripe, Braintree and Square are trying to achieve.

    Problem – Ireland is so insignificantly small as a market that these disruptive services and market waves take a long time to arrive here as these companies (quite rightly) do not consider Ireland in their tactical or strategic roll out plans until other bigger markets are serviced.

  2. Those companies are really just more of the same for the same high (or higher) prices. The sales point is convenience, not price. It would be imprudent to develop a payment platform for the Irish market. I think stuff could be done though.

  3. I am abhorred at the lack of financial transaction service here in Ireland re., VERY VERY FEW shops take debit cards never mind credit cards! It is atrocious and inhibiting any sort of growth or economic turn around. If 41c is the true cost then why are the shopkeepers charged 5 – 8 Euros PER TRANSACTION! GREED