This May, the European Central Bank (ECB) decided to phase out the printing of € 500 banknotes. The rationale given was the pressing need to curb illegal money flows — leading to crimes including tax evasion, drug smuggling, human trafficking and, of course, terrorism. These are the same reasons Prime Minister Narendra Modi gave while announcing the withdrawal of Rs 1,000 and Rs 500 notes earlier this month.
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The ECB decision drew from a detailed study at Harvard University that strongly advocated the withdrawal of high denomination notes in order to put a check on criminal activities around the world. “Our proposal”, the study authors said in the abstract, “is to eliminate high denomination, high value currency notes, such as the € 500 note, the $ 100 bill, the CHF 1,000 note and the £ 50 note”, which “are the preferred payment mechanism of those pursuing… tax evasion, financial crime, terrorist finance and corruption”. Without these big notes, the authors said, the “bad guys” would face higher costs and greater risks of detection, and a disruption of their “business models”.
According to the authors, tax evasion robs the public sector of between 6% and 70% of legitimate tax collections, depending on the country under consideration. Global financial crime flows are estimated to amount to over $ 2 trillion annually; corruption amounts to another $ 1 trillion. The paper makes the following points:
High denomination notes in legitimate economy:
While cash remains the favourite method of payment in almost all countries, it is preferred in small transactions. The bigger the size of transaction, lesser the need to pay in cash. In the latter case, people generally make electronic transactions, doing away with the need to carry large quantities of physical cash.
High denomination notes in illegitimate economy:
Here, the opposite holds true. Big ticket transactions in criminal activities take place in cash — and high denomination notes remain the preferred mode of carrying them out because of the ease with which the currency can be transported, the anonymity they carry, and their universal acceptance.
The study refers to the € 500 note as “Bin Laden” note — a reference to its use in terror financing. The equivalent of $ 1 million in € 500 notes weighs about 5 lbs, and is easy to move. On the other hand, $ 1 million in $ 100 bills — the highest available denomination — would weigh about 20 lbs, making it that much more inconvenient to transport. The Islamic State’s average turnover of between $ 500 million and $ 2 billion is almost entirely in cash — in the Iraqi dinar, Turkish lira, Syrian pound and US dollar.
Impact of eliminating high denomination notes:
Illegal ventures won’t stop completely, but it will definitely make things difficult for the “bad guys”, the study says. As cash is eliminated, criminals might try to find a substitute, such as banking frauds, bitcoins and diamonds — but inconvenience will be higher and transactions will be more traceable.
However, the effectiveness of eliminating high value notes would depend on a few factors. First, the availability of the next highest currency value. Second, collective action by all countries to do away with big notes would have greater impact than only one or a few countries acting. The “bad guys” must not have the option of turning to the currency of another country.