Review of Banknote Distribution Arrangements: Issues Paper Box A: The Evolution of Systems of Cash Distribution

Previous models of cash distribution in Australia

The cash distribution model used in Australia has evolved over time. Prior to the late 1990s, distribution activities were largely carried out by the Reserve Bank, which issued banknotes directly to commercial banks from its cash depots in each of Australia's eight capital cities. This changed in the late 1990s, with the establishment of Note and Coin pools. Under this arrangement, Reserve Bank-owned banknotes were held in the depots of CIT companies rather than at Reserve Bank-owned depots. These pools allowed commercial banks to more easily access cash. However, this particular arrangement was relatively short-lived. The introduction of polymer banknotes reduced processing volumes substantially due to their greater durability, creating inefficiencies and prompting a rationalisation of the Reserve Bank's role in cash processing. Due to this, and requirements to meet competitive neutrality provisions, the ownership of these cash pools was transferred to commercial banks in 2001 (Carlin 2004).^[6] These changes were formalised in the Cash Distribution Deed (CDD) – agreements between the Reserve Bank and eight commercial banks, and a precursor to the current BDA arrangements.

With the ownership of Note and Coin Pools transferred to the private sector, the Reserve Bank began to pay interest on these privately owned cash pools. The interest payments compensated commercial banks for interest forgone on their holdings of physical currency, which are used by banks for meeting day-to-day cash demands, as well as for contingency and risk management purposes. The new arrangement encouraged commercial banks to trade banknotes between each other, rather than always dealing with the Reserve Bank directly. This increased efficiency by reducing excessive transportation and processing of banknotes (Wakefield, Delaney and Finlay 2019).

Banknote quality sorting was also outsourced, with commercial banks required to quality sort banknotes to the standard set by the Reserve Bank. However, the CDD did not stipulate how to measure the quality of a banknote, nor the extent of financial implications if quality-sorting requirements were not met by the private sector. These shortcomings, combined with declining banknote quality in circulation, led to the introduction of the NQRS in 2006 (Cowling and Howlett 2012). After consultation with the industry, the NQRS formally articulated the banknote quality standards expected by the Reserve Bank, introduced metrics to measure banknote quality, and assigned financial outcomes (positive or negative) associated with quality sorting. The scheme's aim was to incentivise the circulation of good-quality banknotes and support investment in the cash processing industry. With the introduction of the NQRS, the quality of banknotes in circulation improved substantially and has remained at a high level since.

These changes brought cash distribution arrangements to roughly their current form in Australia, although various adjustments have been made since then. In 2008, limits on interest compensation were removed, in response to a large build-up of banknote stocks within approved depots during the GFC (Cusbert and Rohling 2013). The BDAs were officially created in 2011. A number of other adjustments have occurred over the years, including to reporting requirements, incentive payments made for the transportation of unfit banknotes, provisions for the new banknote series, updates of fees and charges, and to operationalise the purpose-built NBS in Melbourne as the primary location of banknote purchases and returns. These adjustments, however, have not fundamentally changed the system of cash distribution in Australia. Commercial banks and CIT companies continue to play a key role in the distribution of cash.

Cash distribution in other jurisdictions

Towards the end of the 20th century, many central banks around the world began outsourcing some of their cash distribution and/or processing functions to private banks, CIT companies and other institutions. As a result, large differences have appeared in cash distribution arrangements globally.

Internationally, the CIT industry has been characterised by a number of stylised models (Scholten 2017). The ‘traditional CIT model’ involves CIT companies being primarily focused on transport services. This model continues to have an important role in many jurisdictions (Table 1). In some countries, however, CIT services have become increasingly integrated into the cash distribution process. In these cases, CIT companies own the physical cash infrastructure, and therefore have taken on the processing role in addition to transport (‘CIT as a handler model’); sometimes, CIT companies also act as an agent for commercial banks to provide some banking services for retailers (i.e. they provide all-in-one cash services to retailers; ‘CIT as an agent model’). Finally, CIT companies can also hold cash on their own balance sheets, effectively becoming an owner of cash (‘CIT as an owner model’).

Most jurisdictions operate a combination of these different CIT arrangements. The traditional CIT model remains common in countries with relatively centralised distribution systems, and is still relevant even in countries with substantial private sector quality sorting (such as the Netherlands). In Australia, CIT services have become highly integrated, with transport companies handling the majority of wholesale cash processing and storage, and more recently retail cash distribution through ownership of ATM networks. Such arrangements have appeared in many jurisdictions with outsourced distribution activities. The arrangement with CIT companies as cash owners, however, remains uncommon, given the need to fund these cash deposits and the regulatory costs that may arise from holding cash deposits.

A number of countries have moved to a shared-service utility model for certain cash distribution functions. In these utility models, resources and infrastructure are pooled by industry participants, which can reduce costs and improve efficiency. Variations of these utility structures are common among the Nordic countries, including in Sweden and Norway. The Bank of England, along with industry participants, is actively considering a utility model for cash distribution in the United Kingdom (see Box B).