Cashless in Cyprus

We are delighted to announce a new addition to our collection. The paper written by Leonidas Efthymiou and Sophia Michael (both at Intercollege Larnaca) entitled ‘When Cards and ATM’s are the only choice: A fortnight in Cyprus with no banking system, nor trust’ continues with our aim of informing the debate around cashless society and mobile payments, by detailing the events around the suspension of the banking system in Cyprus.

A brief introduction contextualised the discussion by enumerating the deployment and use prior to the crisis of ATMs, mobile and internet banking as well as some data on Point of Sale (POS) terminals in this small, open economy (where tourism is one of the main sectors of economic activity). The interaction between these elements of the payment ecosystem is even more clear when considering new technologies. For instance, Leonidas and Sophia note:

1) The only bank which offers a Contactless visa card is the Bank of Cyprus. Their 18-25 Youth card is the first card in Cyprus with contact-less technology and can be used for transactions below 20 euros, without having to insert a PIN in front of the POS. For transactions above 20 euros, you can keep the card in front of the POS, but you have to input your pin.

2) There are approximately 1460 enterprises across the island with contactless technology. Some of these enterprises include cafes such as Costa Coffee and Starbucks, pharmacies, bakeries, supermarkets, petrol stations and shops in malls.

3) JCC, the main payment system provider in Cyprus, is currently running a campaign at Nicosia cafes. All contactless transactions that take place at Nicosia cafes are eligible to participate in three monthly draws for 3 IPAD minis.

Essential to the 15 day closure of the banking system in March 2013 (similar only to the US in 1933 and Argentina in 2002), was that all electronic transactions and money transfers were frozen with the exception of credit/debit cards and ATM withdrawals. Leonidas and Sophia adopt a ‘sequence of events’ method to discuss an intensification in the use of cash during this period as ‘people can sustain themselves only by queuing at the long lines of ATMs to withdraw cash, or stay cashless and use their credit cards.’ Interestingly, during their research, they were unable to provide evidence to support rumours that ‘IOU’ notes replaced cash and cards as means of payments during Cypriot banking crisis.

Shortly after the central banks’ announcement that that banks will remain closed, long queues begin to form in front of the cash machines (18-III-2013)

In spite the Central Bank of Cyrpus’s instructions to banks that they should keep re-supplying the ATMs with money several times, by March 22nd (seven days into the crisis) long queues have formed at almost every one of the bank’s ATMs island wide. This was partly a result of panic and partly a result of the rejection of card payments by merchants. In other words (and like was the case in New York during Huracain Catrina), the payments ecosystem suffered a massive blow ‘as every card transaction directs the retailers’ money into a bank account. With a bank system under the threat of bankruptcy, or levy as the best option, most retailers prefer to turn down customers rather than accept their cards.’

In summary, the paper of Leonidas and Sophia offers a detail reach account of the Cypriot banking crisis, with a focus on the effects on the retail payment system but without loosing its connection with institutional stakeholders and macroeconomic developments. This narrative is enriched when the authors compare and contrast with developments in the US and Argentina, as it enables to ascertain the unique features of the crisis in Cyprus.

Transparent Pricing of Payment Services?

Bernardo recently sent me a link to a blog post that advocated for transparent pricing of payment services. The post is a bit of a rant about unnecessarily high interchange fees, which is the fee the merchant’s bank pays to the card-issuing bank for a credit or debit card transaction. These fees are set by the system as a whole, and they naturally set the floor for what a merchant pays to accept credit or debit cards. The trouble, the author argues, is that these fees are much higher than they need to be, and because consumers are generally unaware of these fees, they continue to use the most expensive, least efficient payment instruments, ultimately resulting in higher prices for goods and services.

The solution, the author contends, is to make these fees transparent and visible to the consumer. The author reasons that if the fees charged by the payment networks are passed on explicitly to consumers, they will naturally choose less expensive payment instruments, and probably exert pressure on the payment networks to lower their fees across the board.

VISA and Mastercard have traditionally prohibited such surcharges via their merchant agreements, but various lawsuits might soon give merchants in the USA the right to pass on their merchant discounts more explicitly (merchants in Australia and New Zealand have been able to do this for a while now). Although very focused merchants such as gasoline stations are allowed to offer a “discount” for cash transactions, they are not allowed to impose any kind of “surcharge” for transactions involving cards. In real terms, these are just two different ways of looking at the same thing, but the card networks, which have always been very savvy at marketing, know that consumers don’t see these as equivalent. A “discount” is a reward, something you might want to take advantage of, but not something that will really hurt you if you pass it up; a “surcharge” is a penalty, something you should do everything you can to avoid.

Psychologists refer to this phenomenon as “loss aversion,” noting that most people are motivated more by the threat of a potential loss than the promise of a potential gain, even if the net result is the same. Thus, if you were offered a discount to pay in cash, you might take advantage of it, but wouldn’t be as motivated to do so as you would if you were told that you would have to pay a surcharge if you wanted to use your credit card. Theoretically, a surcharge would motivate more people to choose less expensive payment instruments, forcing the card networks to lower their fees.

All of this sounds great in theory, but the trouble is that surcharges would be only one of many considerations that ultimately influences a consumer’s choice of payment instruments. Human beings are complex creatures; we are motivated not only by prices, but also by convenience, the status something might afford us, the extrinsic rewards it might provide us, the desire to be treated fairly and with respect, and expectations formed by years of prior experience.

Imagine if the next time you went to the grocery store, you were told at the checkout that you could pay one of four different amounts depending on which kind of payment instrument you used. Would you be happy that transaction pricing was finally transparent, or would you just be confused and angry that you had to pay 3-4% more because you wanted to use your air miles credit card? If you are reading this blog, you are probably already more aware of these issues than others, so imagine how someone who has no idea these fees even exist would feel.

Historically, consumers have tended to react very negatively to this kind of unbundling and pass-through of fees, especially when they’ve been conditioned for many years to assume that the service should be provided for free. For example, when most of the airlines in the USA started charging for checked bags a few years ago, consumers responded with outrage, and tried to carry on enormous bags, delaying boarding, which made everyone even more frustrated. In Seattle (my hometown), the city council just passed a law requiring stores to charge their customer 5 cents for a paper bag; the intent was to incentivize consumers to bring reusable bags for environmental reasons, but it has resulted mostly in anger towards the city council.

Although these kinds of moves are intended to draw consumer’s attention to the real costs of providing a good or service, they instead tend to focus consumer’s dissatisfaction and anger towards the organizations imposing the change. This provides a good opportunity for competitors to jump in and steal customers, as Southwest Airlines is attempting to do with their “bags fly free” policy.

Banks in the USA have been playing this game of chicken for many years with regards to checking and debit/ATM card fees. Traditionally, American banks have offered checking, ATM, and debit card services for free in order to lure more and more consumer deposits. These services, of course, have real costs that are not being passed on transparently to consumers. At various points in history, a few banks have tried to unbundle these costs and pass them on explicitly to their customers, but they have almost always reversed their course in response to customer backlash. The most recent example was Bank of America’s attempt to impose a $5 fee to use their debit cards; after a large number of customers left the bank, they were forced to abandon their plans.

My point is that imposing surcharges might not achieve the results the blog author expects. As opposed to directing attention and indignation to the card networks and their interchange fee, it may instead direct that anger towards the merchants themselves, especially if their competition starts advertising a “no surcharges” policy. In that scenario, consumers may see the surcharge as something capriciously imposed by the merchant, and not something that is being passed on from the card networks.

The larger question here, however, is how we should think about transaction pricing in general. How much “should” it cost to process an electronic transaction, and how much of that should be paid by the merchant vs the consumer? That depends in many ways on what you think a payment card network like VISA or MasterCard actually is. Are they like public utilities, whose fees should closely resemble their underlying costs, or are they for-profit businesses, whose fees should be set according to market conditions? Many people seem to think of them as the former, but the card networks are neither structured nor financed as public utilities, and they certainly don’t think of themselves as such.

But we are now heading into another, very complicated topic, so I will leave that to another post. For now, what do you think about the idea of making card transaction pricing transparent via surcharges? Do you live in a country where this is already happening, and if so, what has been the general reaction?