The Note Circulation Scheme (NCS) was introduced in 2001. It replaced the Notes Held to Order Scheme (NHTO) which ran between 1982 and 2001.
The Bank does not distribute banknotes. Instead, members of the NCS – wholesale cash operators – distribute notes in response to demand from financial institutions and retailers. The current members of the NCS are G4S Cash Solutions UK Ltd, Post Office Ltd, Royal Bank of Scotland Group Plc and Vaultex UK Ltd (a joint venture of Barclays Plc and HSBC Plc).
The NCS seeks to reduce operational costs and risk for the Bank by reducing the number of cash centres and cash-in-transit journeys the Bank is responsible for. In exchange the Bank permits the NCS members to hold some notes off-balance sheet, thereby reducing the cost to industry of wholesale fitness sorting, authentication and storage. The Bank’s direct involvement in wholesale cash distribution is limited to issuing new notes, withdrawing notes when a new series is launched and destroying notes that are no longer fit for circulation.
There are five main stages in the note issuance cycle.
NCS members purchase new banknotes from the Bank at face value. The Bank invests this money in interest bearing assets, such as UK government bonds. The Bank deducts the costs of printing banknotes from the income on these assets, and the balance is returned to HM Treasury. This income is known as seigniorage. Total seigniorage in 2014-15 was £576 million, of which £70 million was spent on printing and issuing banknotes, with the remaining £506 million paid to HM Treasury.
Banks, building societies, ATM operators and large retailers source notes from one or more of the NCS members, and from one another. They typically pay face value plus a commercially negotiated fee for processing and delivery. These notes reach members of the public when they withdraw cash from their bank accounts or receive change in a shop.
Notes received by retailers and financial institutions at tills and counters are returned to an NCS Member either directly (by primary customers of the NCS members) or via other financial institutions.
Retailers and financial institutions return excess notes for fitness sorting and authentication, as well as to reduce storage and funding costs. Banknotes need to be stored securely. They are also a non-interest bearing asset, so holding excess banknotes means that the retailer or financial institution would be foregoing the opportunity to hold a profitable asset instead.
Sometimes, retailers and financial institutions will use notes received from customers to fill their note-dispensing machines, such as ATMs and self-service checkouts. This is known as ‘local recycling’ and can in some circumstances help to reduce costs e.g. through fewer deliveries. Since July 2013 an industry Code of Conduct for the Authentication of Machine-Dispensed Banknotes (the Code) helps to ensure that notes which are re-issued in this way are authenticated (i.e. confirmed to be genuine) notes. These authentication checks must be carried out using a machine which has been approved by the Bank.
Framework for the Testing of Automatic Banknote Handling Machines
NCS members sort the notes returned by their customers. This is to check the quality and authenticity of the notes and to identify and remove any unfit notes, counterfeit notes or other non-valid items, such as gift vouchers and old series notes. Notes are sorted using high-speed note sorting machines which can sort up to 1,800 notes per minute. In total, NCS members sort around £200 billion of notes each year. The Bank sets quality standards for NCS members which determine whether a note is fit for redistribution, for example the maximum amount of soiling permitted. The Bank also provides NCS members with examples of counterfeit notes which are used to calibrate the note sorting machines and ensure they are detecting all counterfeit notes.
Nearly all notes are fit to be recirculated – between 85% to 97% of notes that NCS members sort. Paper £5 notes were the least likely to be fit, as they are commonly used as change items, suffered the highest wear and tear and were less frequently returned to the NCS members. Since September 2016 the £5 note has been replaced with a polymer note and are expected to last 2.5 times longer than paper. When NCS members deem the notes to be unfit, they send them back to the Bank for destruction.
The amount of notes in circulation varies depending on the time of the week and time of the year.
The weekly cycle involves a peak in note use at weekends, with a corresponding fall at the start of the next week as retailers bank their weekend takings. There is also an annual cycle where note use is higher at holiday times – Easter, bank holidays, summer and, especially, Christmas. The weekly and annual cycles can be seen in the graph below.
Before the NHTO was introduced in 1982, commercial banks (who were responsible for note distribution at that time) returned all excess notes to the Bank. They did not want to store the notes themselves because of the funding cost. This system was inefficient because it required a large number of daily journeys between the commercial banks’ depots and the Bank.
The NHTO allowed commercial banks to sell excess notes back to the Bank – so reducing their funding costs– while storing them in their own secure premises. This system has evolved under the NCS and is called ‘Bond’. At the end of each day, NCS members tell the Bank how many notes they are going to sell back. The Bank pays face value and takes ownership of these notes, without any physical transfer to the Bank. These notes form a common pool from which any NCS member may draw, regardless of which depot they are stored in.
There are strict controls in place to ensure that the notes are stored securely and that the NCS members have declared the correct amount of notes. The Bank conducts regular inspections of NCS members to ensure that its standards are being met.
The Bank also offers NCS members an overnight off-balance sheet facility for notes which are being sorted (known as the note recirculation facility). This facility has a lower limit than Bond and NCS members must re-purchase the notes the following morning.