An essential function of the financial system is paying for things. We take for granted the ability to move money from companies to employees, from customers back to companies and for a myriad of daily transactions. This aspect of the system is a bit like plumbing – essential but largely ignored until it goes wrong. So, having neglected the plumbing in favour of more exciting topics like inflation, government debt and exchange rates, let me pay homage to the one thing our banking system does remarkably well. Unlike plumbing, the payments system very rarely goes wrong.
Which is just as well, because in the UK, Bank of England data show that the total of electronic bank payments through what is known as the BACS system was £18 billion in 2011. This is mainly salaries, direct debits and internet banking. Settlement of financial transactions through the CHAPS system (including payment for house purchases) was £255 billion, gilts and equities payments through CREST were £479 billion and settlement of foreign exchange transactions through CLS was £3 trillion (source).
Out on the high street, the total of retail card payments was £477 billion the same year (source). This includes a small but growing share of contactless payments, where you wave your card at a reader and don’t need to enter a PIN, for transactions up to £20 ($25 in the US). It’s quick, easy and reduces still further the need to carry physical cash. (It also shortens the queue compared with people paying with their card for one coffee and a croissant using traditional PIN entry).
Customers get easier payment, though it seems they are slow to change their ways. As we know from Charles Duhigg’s very interesting and readable book The Power of Habit, our lives are far more driven by habits than we realise. The key for retailers is to get us to learn new habits that make us spend more (or differently).
Curious about how contactless payments were growing in the UK, I decided to do some detailed market research. Well, my research consisted of a long chat with a barista in an otherwise deserted Caffè Nero. She said that a lot of people still paid cash even though they had the cards but usage was certainly growing. From an employee point of view it’s not a good development because people no longer put their change into the tips box.
But is there a benefit to the retailer? I said that I was sure I’d seen research that showed people spending more, the further away from cash was the payment type. Somehow the “pain” of handing over cash is more than using a card and, all else being equal, the customer spends more in the cashless economy. I said unfortunately I couldn’t find the reference for that research. She replied that they didn’t yet have enough data for a statistically significant analysis of whether people were more likely to add a pain au chocolat to their coffee when paying with contactless cards. That’s not exactly how the conversation went. We did discuss other things but they’re not relevant here.
This is an interesting area of financial innovation. Card companies, banks and phone companies are all competing for a share of the payments fees, which are tiny per transaction but add up to many billions across the economy. The first contactless payment card was introduced, not by a bank or by Visa but by the oil company Mobil. The customer is unaware of and uninterested in this competition. Some of the most interesting developments are taking place in emerging economies where most people lack a bank account and the mobile phone has become the main means of payment. It is too soon to tell who is going to win the technology arms race: the banks, Visa, the phone companies, handset manufacturers, Google, Tesco?
Meanwhile Caffè Nero recently raised the price of an Americano by 5%.