Review of Banknote Distribution Arrangements: Conclusions Paper Box A: Current Arrangements for Quality Sorting

There are four main mechanisms the Reserve Bank uses to incentivise the industry to quality sort banknotes to its preferred standard.

Mechanism 1: Interest payments

The Reserve Bank makes interest payments to BDA participants on the value of quality-sorted banknotes they store in approved CIT depots. The purpose of these payments is to encourage BDA participants to maintain sufficient stocks of quality-sorted banknotes throughout the country, by removing any disincentive relative to electronic cash holdings with the Reserve Bank. Between 2001 and 2006, this was the main mechanism used by the Reserve Bank to manage quality; however, it did not generate good sorting outcomes, as the quality of banknotes in circulation during this time remained substandard (Cowling and Howlett 2012).

Mechanism 2: Note Quality Reward Scheme (NQRS)

Introduced in 2006, the NQRS is an incentive-based scheme that encourages banks to put only high-quality banknotes back into circulation. The core features of the NQRS include:

• The definition of different levels of ‘quality’ for banknotes, based on the absence or presence of defects such as tears, folds and ink wear. This allows banknote quality to be quantitatively ‘scored’ and provides guidance to the banks about whether a banknote can be recirculated or returned to the Reserve Bank for destruction.
• The paying or penalising of banks according to how well banknotes in their CIT depot holdings are sorted to the NQRS quality standards. To do this, the Reserve Bank samples quality-sorted ‘fit’ banknotes at cash depots and makes payments to the banks based on the assessed quality score of the worst 15 per cent of the banknotes sampled.

A revised NQRS quality standard and payment framework was agreed in 2021, with implementation on hold pending the outcome of this Review. The aims of the changes are to:

• calibrate the scores more fully for the NGB series of banknotes (in addition to the previous polymer series)
• reduce the number of defect categories and, in doing so, adjust the minimum quality standard slightly to avoid the destruction of good-quality banknotes.

Mechanism 3: Payment of transport costs for the return of unfit banknotes

The partial payment of transport costs for the return of unfit banknotes to the Reserve Bank helps to encourage the removal of unfit banknotes from circulation. In 2016, the payment shifted from complete reimbursement of transportation costs associated with returning unfit banknotes to a payment that covers part of the cost, prompted by inefficient transportation practices observed at the time.

Mechanism 4: ‘Fit-in-unfit’ fee

The ‘fit-in-unfit’ fee is paid by banks (or CIT companies to whom the banks have subcontracted their sorting obligations) when fit banknotes have been incorrectly categorised as unfit and returned to the Reserve Bank for destruction. It is imposed when the proportion of incorrectly categorised fit banknotes is above a certain threshold.