It is widespread knowledge that payment systems form a vital part of a nation’s financial system, enabling funds to be transferred between corporations and individuals. Nowadays, the global payments industry landscape is undergoing radical changes thanks to the influx of new technologies that reduce costs for both financial institutions and customers, less strict regulatory frameworks for new entrants, and demographic trends, in particular among the youngest strata of the population.
The World of Payment Systems
Until recently only the “simpler” side of the payments industry was thriving with high levels of innovation (e.g. debit cards, and money transfers among users of the same platform), but now traditional banking institutions that once were dominating the sector are starting to face competition from small and medium startup-like companies in consumer banking-related areas.
Thanks to laws easing entrance into the retail banking and payments sectors, those new companies successfully gained a good market share by offering a more flexible, digitalised and customisable consumer experience, appealing to the youngest and least experienced in the sector: millennials, and the newly banked.
According to Capgemini consultants, these sudden disruptions, seen as shocks by traditional banking institutions, are occurring because of the lack of competition between large financial institutions in the past decades, that otherwise would have nurtured innovation and dynamism in the sector. Now, new opportunities in the payments industry in terms of adoption of Open Application Programming Interfaces (APIs), growth in digital payments, innovation in cross-border payments, and challenges from the entry of alternative service providers are dramatically impacting the industry, prompting traditional players to not only update their infrastructure, but to totally reinvent it, and develop a new business model.
However, the hardest challenge for bank managers, other than reaching a common vision of a new, effective business model, shared by stakeholders and directors, are the constraints typical of big organisations: creating a flexible and intuitive technological infrastructure that is easy to update and implement by the next generation, able to keep pace with the present and future competition, and still take into account the complex logistics, human capital, eventual financial constraints and economic trends, that underpin a project of such a scale.
In fact, delivering solutions in a rapidly changing environment is crucial for payment companies in order to keep satisfied, and enlarge their client base, especially since the mass adoption of cheap communication technologies and faster internet connections have provided a greater degree of convenience for customers. This has translated into a rise in the adoption of digital payments, in particular in emerging markets.
Also, it should be noted that banking giants are losing ground to new market entrants thanks to the downward pressure on interchange fees from card processors by merchants and the cheaper/faster alternatives offered by Fintech firms in major markets, like Uber in the taxi industry, and Monzo in the field of payments.
Still, possible downsides derived from this market fragmentation should be taken into account: initiatives such as the Payment Systems Directive (PSD II) and open banking that aim to open up the market to third-party providers can increase the levels of risk and fraud of customers and providers alike. For this reason, it is necessary to implement security tools such as fool-proof identity and authentication measures for customer protection in order to safeguard all the market participants, thus making it secure but still applying the principle behind open banking: the open access to customers data by developers in order to build applications and services around the financial institution.
The Role of Regulation
Markets across the globe are increasingly witnessing regulatory initiatives with the objective of enforcing standards and maintaining stability, while implementing frameworks such as sandboxes, with the objective of simplifying the process of compliance and decrease costs. Especially with the latest developments in complexity and scale of compliance frameworks like Basel III, such initiatives are attaining further prominence, especially among bigger players in the payments industry. And while the impact of regulatory initiatives might result in increased costs in the short run, liquidity management functions and processes will be optimized in the long run.
Regarding this, it should be noticed that while new entrants in the market of payment systems may have higher gains due to the momentum and the public’s approval, as their clientele number and corporate size increases, regulators will start requiring higher capital ratios, and, above all, new licenses to exercise similar, if not the same, duties of the more traditional banks, hence virtually putting them on the same playing level.
Moreover, since these institutions are and will be competing for the same customers, payments providers will start contending the best and most innovative intellectual capital, the only factor that can really make the difference between a firm with a winning business model and effective technologic infrastructure, and an average company. In fact, as the current success of new market entrants basically lays on a repackage and slight implementation of old products, made more attractive to the newer, larger generation of consumers, the next battle will probably be won by the company which contributes in an actual and innovative way to the customer welfare.
Still, in this changing landscape, senior managers at a prominent British financial institution pointed out that the biggest threat to their payments systems aren’t Fintech companies, but the big technology conglomerates such as Amazon, Google, Tencent, Baidu and Alibaba, whose real power lies in the billions of bytes of customer data. In fact, it is becoming increasingly easier and convenient for such companies to incorporate in-house payment systems to their business, in order to improve the customers’ experience, and also reduce dramatically transaction fees and time.
In the medium and long run, this new business model can erode greatly the client base of traditional and non-traditional banks, also because big conglomerates have the financial power to attract new customers with convenient offers and reward systems, not to mention the already existing, state of the art technological infrastructure. However, the only issue that may prevent such technology conglomerates to open actual banking businesses may be antitrust regulators, still easily circumvent by either lobbying or founding directly a new bank, like Tencent did by creating WeBank in 2015, China’s first online bank.
The revolution in the payments system, from being producer driven, has evolved to being customer driven, as a senior banker at a prominent British bank affirmed:
“nowadays innovation stays in the customer experience”.
Also, the implementation of traditional banks’ ageing payment systems in order to facilitate real-time initiation and reporting to customers, and keeping or increasing their market share, will imply a radical change on existing operating models, especially for institutions operating across different geographies and jurisdictions.
Still, while issues may arise on the compliance side of the business, with stringent regulations regarding liquidity management, the real disruptors in the payments industry are going to be the major technology conglomerates, with their already established client base and technological and financial firepower.
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