Whither Loose Change: The Diminishing Demand For Small Denomination Currency

Bolt and Chakravorti study the ability of banks and merchants to influence the consumer's payment instrument choice. Consumers participate in payment card networks to insure themselves against three types of shocks - income, theft, and their merchant match. Merchants choose which payment instruments to accept based on their production costs and increased profit opportunities. The authors' key results can be summarized as follows. The structure of prices is determined by the bank's cost to provide payment services including the aggregate credit loss, the probability of theft, and the timing of income flows. They also identify equilibria where the bank finds it profitable to offer debit or credit cards or both. Finally, they compare welfare-maximizing price structures to those that result from the bank's profit-maximizing price structure.

Carbó, Chakravorti, and Rodriguez study the impact of lowering interchange fees on consumer and merchant adoption and usage along with bank revenues during a ten-year period in Spain using bank-level data. Using cutting-edge econometric techniques, they are able to test two-sided market model predictions about payment card pricing policies. They find that the lowering of interchange fees over a ten-year period in Spain resulted in greater payment card usage because merchant adoption increased significantly from a relatively low base. They caution that such policies may only be effective if the merchant and consumer adoption are far from complete. Furthermore, they remain agnostic on any transfers between merchants and banks.

In this article, Chakravorti asks why have general-purpose stored-value cards been unsuccessful in penetrating the U.S. market? Three necessary conditions for a payment instrument to be successful are discussed: consumers and merchants need to be convinced of its advantages over existing payment alternatives for at least some types of transactions; payment providers must convince consumers and merchants simultaneously of its benefits to achieve critical mass, and assure them that adequate safety and security measures have been implemented. This article discusses the credit card industry’s success in meeting these necessary conditions and general-purpose stored-value issuers’ failure to meet them to date.