The Drop in Demand for New Banknotes – New Predictive Models Needed

Whilst we have reported in the last two issues on broadly positive financial results for the cash management sector, the same cannot be said of the banknote production side of the industry, as De La Rue’s recent trading update shows.

It is predicting a sharp downturn in profits for the current financial year due to the downturn in demand for banknotes, the lowest in 20 years.

De La Rue, as the only listed company in the industry whose main business is in banknote production, may be the highest profile company to suffer from the effects of falling demand, but it’s not the only one.

Even Giesecke+Devrient, despite overall stellar results, noted in its 2022 Annual Report that the Banknote Solutions Division recorded declining demand for new banknotes, and consequently recorded a year-on-year decline in sales.

Over in the US, banknote demand has also affected the performance of Crane Currency, according to the company’s Q4 report for 2022, with sales flat and a 17% drop in operating profit as the US government diverts production capacity and testing for the ‘Catalyst $10’ bill redesign program. Demand is expected to rebound in 2024, with substantial potential for growth from the New Series redesign of the $10, followed by the $20 and $50.

At CCL, meanwhile, the financial results of the polymer substate division CCL Secure are not reported. However, in its 2022 annual report, parent company CCL Industries stated that CCL Secure had an ‘off year’ after an unusually weak fourth quarter, as many developed world central bank vaults were full of banknotes after a run on cash during the pandemic.

Notwithstanding specific vagaries in demand in individual countries, the comment in the CCL annual report points to one of the key factors behind the recent performance of De La Rue and, indeed, the problems other banknote producers are facing – namely, the build-up of banknote stocks during the pandemic (according to Crane, COVID drove additional surge in demand for cash of 10-20%), and the resulting drop in demand for new notes.

Part of this surge was due to ensuring resilience, and part of it, as is typical in times of crisis, was people using banknotes as a store of value as opposed to for transactions. Conversely, the post-COVID surge in both interest rates and inflation has reduced the attraction of cash as a store of value, resulting in a flow of banknotes back to central banks.

Putting those specific factors to one side, in general terms demand is driven by three factors – growth (GDP related), replacement (use and circulation policy related) and special initiatives (new note series, new clean note policies, inventory changes).

Worldwide, GDP has been depressed - reducing the growth component. Transactional use of banknotes is down, reducing wear and extending average note life – lowering the replacement component. And special initiatives such as new notes series introduction are, perhaps not fewer, but less frequent on a country basis.

Note life is linked to how hard banknotes ‘work’, how often they are used, and this is determined by factors such as note velocity, local or central sorting and reissue and how people look after the banknotes.

If consumers make fewer cash transactions, then cash is likely to work less hard and to last longer and central banks don’t need to order as many new notes. The move towards longer-lasting substrates – not just polymer but composite and more durable paper as well – is also reducing the need for so many replacement notes.

Added to this is the question of whether the trend from cash to digital payments, accentuated by the pandemic, is also behind the fall in demand. With increased e-payments, the significantly higher transaction limits on debit and credit cards and the public’s new familiarity with contactless payments, it appears to be.

Against such a background, perhaps the current slump in demand was inevitable. The question, however, remains - to what extent will the changes and trends indicated affect banknote and coin production and circulation levels in the next few years?

In other words, is the current slump a temporary one, in which COVID-induced demand is simply rebalancing, or is lower demand likely to be a permanent fixture in the future?

Either way, central banks, and the industry, need a much better predictive model of cash demand based on cash in circulation, cash usage, and new cash print orders.