Surviving the Payments Squeeze

Payments in financial services is becoming very fragmented with disruptive innovation through new business models occurring across the value chain taking the share away from the banking industry. Next generation technology players and non-financial institutions through a combination of innovative products, data analytics and open APIs have exploited market discontinuities. So what's the future of bank payment? How should the banks respond to survive this squeeze? 

Read my point of view published in the Nov 2014 edition of the Australian Banking & Finance. Please feel free to leave your comments. 

Payments initiation (consumer facing part of the payment value chain) is increasingly getting fragmented with highly competitive technology-led platform players, non-financial institutions and crypto currencies (operating as wholesale currency), taking the share away from financial institutions. Consolidation in the payments clearing space with players like EFTPOS in Australia and crypto-currencies is also slowly gaining ground. Some players will provide a shared service cross border and white labelled clearing and settlement capability at a lower price point through greater economies of scale across the industry. This will compress margins further and likely drive smaller financial institutions out of the market unless they can provide additional value-added services and capabilities.

If banks do not act fast enough within the next 3 to 5 years, this squeeze from market participants across various facets of the value chain will confine them to at best, being efficient, cost effective payment processors. To transform themselves, banks will need to reassess their engagement and participation to the wider e-commerce and m-commerce value chains.  

What should banks do?

·        Move from a ‘transaction managed efficiency’ paradigm to a ‘rich, data flow’ e and m-commerce paradigm. Today, the payments value chain does not commence when the consumer is deciding on the method of payment but commences when they think about what to purchase, where and when. The traditional benefits of greater insight around customer spend patterns banks have enjoyed are slowly getting diluted. Technology firms (Apple, Facebook, and Amazon) and telecom providers have circumvented the advantage banks have held through a deeper insight into location specific and consumer behavioural patterns. To respond effectively, banks need to move from playing the role of a payment processor to being an influencer or advisor in the e-commerce value chain. The future of bank payments will lie in the experiential partnerships they build with retailers or large businesses to understand customer behaviour demographics, items of interest, and spending correlations.

BoVA, for example, helps the car purchase lifecycle by providing customers with an estimate of the sell price of a car. By playing in the non-financial part of the buying process, BoVA increases the number of conversations with its customers and get better insight into buying patterns. Garanti (a Turkish bank) has a free M-app for personalized offers based on location and past spend, and estimates balances at the end of the month.

·        Open loop digital wallets. The digital wallet will increasingly become a reality. Some banks have responded to this trend through proprietary bank controlled apps. This however, fragments the digital experience, making it inconvenient for consumers to transact through multiple wallets. An efficient response would be to create an open loop digital wallet which is device, channel agnostic and bank product agnostic (incorporate products of various banks) - with merchant localization as necessary, to enable convergence and greater convenience. Additionally, tying open-loop wallets to an ‘individual’ merchant loyalty program will benefit both banks and merchants by providing a greater understanding of consumer behaviour. This insight can be used to roll out location specific offers for a combination of goods and payment methods. This can be done through a simple and configurable methodology, improving speed to market and allowing unique value propositions to be developed.

·        Use the information opportunity presented by real time payments. On the payments clearing and settlement side, the advent of regulation around real time payments infrastructure will strive to remove discontinuities in the payments value chain around low value payments, remittances and trade finance by reducing time for funds in transit and improving straight through processing rates. Along with that, the real time, information rich capability will help banks deliver value added services more effectively. Take for example the requirement for an enterprise-wise cash position for a corporate organization for better inventory and working capital management, or additional remittance data being provided with the payment to allow the recipient to automatically apply the payment to the appropriate invoice(s) in their accounting systems.

·        Embrace Bank Payment Obligation (BPO) trade flow to effectively integrate the trade flow and the supply chain business processes with the payments value chain.

How do you get ready for it?

Since the evolution of payments is difficult to predict, it is important for banks to embed certain key considerations and design principles in their technology implementations to prepare for the next wave of change.

·        Flexible/generic definition of payment flows. Currently, the payments landscape is dominated by a legacy IT infrastructure. There are different payment processing systems for individual products and channels like credit, debit, cross border, ACH, and cheques that reduce time to market for new products and bring in payments resilience issues. Banks will need to adapt their systems to being more channel and product stream agnostic by building generic payment flows to achieve platform stability and efficiency whilst ensuring faster product introductions.

·        Message agnostic configuration and abstraction of risk and fraud services from channel and product systems is a prerequisite. Currently, risk and fraud business rules are embedded in the product systems which will need to be extracted for horizontal integration to ensure financial crimes stay within manageable limits.

·        Open systems API-led payment services design where banks need to commence exposing services like execute payment, balance enquiry, etc., for better service commoditization. New regulations like PSD2 for payment services are being proposed to open customer bank accounts and payment services to third party developers and providers. This will enable banks to progressively expand their role into the e-commerce or m-commerce value chain instead of being confined to a payments processor role.

·        Pre-defined and pre-configured platforms and systems to support multiple integration points across devices and channels with ERP, finance and accounting and treasury systems. This will improve straight through processing rates as well as enable real time fraud and risk management along with RT liquidity and cash management.

The industry is going through substantial disruptive innovation and will undergo a shake-up in the next 3 to 5 years where only few will survive.

Will your bank survive the payments squeeze?