It has long been recognised that high value euro banknotes are handy for money launderers as they enable large payments to go unrecorded. Several millions worth of €500 notes can fit into a small suitcase. A billion euros takes up less than 3m³.

The value of €500 notes currently in circulation is over €300 billion. So if the European Central Bank (ECB) prohibits further issue of these notes, as it is considering, this should help in the fight against criminal activity. But the EU already has a well-established set of rules to combat money laundering and terrorist finance. So why is the withdrawal of large value notes only being considered now?

It might just be a coincidence, of course, but high value banknotes also interfere with the ECB’s latest policy of negative interest rates. Instead of paying out interest, the ECB is charging other banks 0.3% interest on their “excess reserve” deposits – the deposits that are over and above those that banks are required to hold at the ECB. Meanwhile, the ECB has made sure that banks have large amounts of reserve deposits, as a result of its quantitative easing programme, where it has created “new money” to purchase eurozone government debt. The ECB has, so far, bought €600 billion-worth of debt under this programme.

The idea of all of this is to encourage banks to lend, to increase private sector spending and to drive the inflation rate higher. But, although there is doubt about the effectiveness of these policies and their possible side effects – both in the eurozone and in other countries (notably Japan) – the ECB is expected to reduce its negative interest rate even further to 0.4% or 0.5% at its regular meeting on March 10. It may also announce an extension of its asset purchases.

A flight into banknotes?

Banknotes neither pay nor earn interest. So if the ECB’s charge on banks' excessive reserve deposits exceeds the cost of transport and safe storage of banknotes, banks can gain by withdrawing their deposits as banknotes. Alternatively the banks could take the unpopular step of passing on the interest change to their own retail depositors. But in this case individuals and companies that have bank deposits will have more incentive to withdraw them and hold banknotes instead.

Granted, companies may have cash floats in the millions of euros that they would not want to keep in the cellar, but then the opportunity would arise for the creation of banknote storage businesses which could offer transaction services more cheaply than the banks. And the existence of large denominations like the €500 make this much more feasible.

If there is widespread flight into cash, this will surely defeat the negative interest rate policy. Nobody knows how negative the ECB’s interest rate has to be before this happens, but it could certainly be more negative if the €500 note did not exist. The ECB might also think of withdrawing €200 notes. Then the largest remaining note would be €100, closer in value to the largest notes in other major currencies, and far less convenient to store.

Bundesbank resistance

In view of the money laundering argument, it seems hard to justify the continued existence of high value notes, particularly as more payments are becoming cashless. However, the Bundesbank, the German central bank, has questioned the extent to which high value notes are used for illicit payments and emphasised the virtue of “anonymity when conducting payment transactions”. This point might be valid for everyday retail payments but, surely, if the aim is to counteract crime, anonymity for large value transactions is hardly desirable.

Another reason for German resistance might be that, although banknotes are issued by the central banks of all 18 eurozone countries, the Bundesbank has been responsible for issuing nearly half of the high value notes in circulation. Surprisingly, a fifth has been issued by the central bank of one of the smallest countries – Luxembourg.

A simple process

When banknotes are withdrawn from circulation, they can usually be redeemed for an indefinite period. The Bank of England, for instance, will accept all old issues of notes – you will receive full value in current banknotes or as a bank deposit if you hand in some old ten-shilling notes. The ECB might be expected to follow this practice.

But if the ECB is serious about helping to fight criminal finance, it could set a time limit for redemption. There are precedents; for example, the French central bank stopped accepting old Franc notes in 2010 and the Swiss central bank stops redeeming all withdrawn notes after 20 years.

Why wait 20 years? If the ECB stops issuing €500 notes and gives holders a year to exchange them, this would be tiresome for legitimate holders, particularly those outside the eurozone. It would also succeed in flushing out some money launderers. And besides helping the ECB with its negative interest rate regime, there would be an added bonus – any notes not handed in by the deadline would register as ECB profit.

 

This article was originally published on The Conversation. Read the original article.

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Disclosure statement

John Whittaker does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond the academic appointment above.