The US payments industry, as many other developed economies, is characterised by a challenging dichotomy. On the one hand, consumers are constantly demanding more choice and new payment types; however, behind the scenes there is a move towards greater standardisation and efficiencies to deliver cost savings. Finding the balance between these two opposing forces will be a crucial success factor for US financial institutions over the next few years.
Above the Water Line
The part of the payments process that is similar to an iceberg ‘above the waterline’, or visible to consumers, is currently undergoing some important developments. The trend towards cashless payments in the US is well documented. According to 2010 research on ‘Evolving US Payment Systems’ from the Mercator Advisory Group: “The move toward electronic-based payments will continue unabated and will constitute 68% of consumer payments by dollar volume in 2012 and almost 75% by 2017.”
On top of this, consumers will continue to demand more functionality and more choice from banks and merchants. Innovative payment channels, such as mobile and contactless, have yet to really take off in the broader mass markets; however, they are steadily growing in popularity in important niches. It is these developments that are likely to drive competitive advantage between financial institutions in the future, as they attempt to provide alternative payment solutions in the move towards a cashless society.
Below the Water Line
The issue that all this variety and choice causes for banks is the multiplicity of infrastructure that sits behind the point of payment interaction with the consumer, or the iceberg mass ‘below the waterline’. The consumer requires banks to provide a choice of payment options, features, and functions that, on the surface, appear to be completely distinct, and this problem is likely to be exacerbated in the future as banks continue to encourage the use of electronic payments.
While it is in the banks’ interests to encourage the use of multiple payment channels for customer service and differentiation, it is increasingly too complicated and costly to have disparate systems for different payment methods. For example, the major cost drivers in payment systems usually occur when dealing with the irregular: the disputes, exceptions, fraud and other events where a human within the bank needs to be involved to complete the process. Therefore, one way that banks can reduce the costs associated with payments is to consolidate and centralise the number of people looking after the various payments processes, in particular those that require manual intervention. In addition, while payments systems that are visible to consumers may be perceived as multiple and varied, the systems infrastructure that sits ‘below the waterline’ must become homogenised for banks to reduce their costs and improve consistent service levels.
Another challenge for banks comes in the form of the existing infrastructure. The current automated clearing house (ACH) infrastructure in the US is woefully antiquated and cannot cope with the rapidly rising volumes of electronic payments that settle in a batch. This escalation stems not only from the increasing use of electronic payments by consumers for account-to-account and bill pay transfers, but also from the continued use of cheques by consumers which are then ‘electronified’ by banks, as per the Check 21 Act.
The next generation of payment processing infrastructure will need the ability to cope with a convergence of volume, along with existing scaling issues, to provide a new set of functions based on electronic payments. It should also be able to process multiple payment types and standardise these, so that the bank can simplify its processes and different payment types can be settled through a rationalised set of networks, partners and activities.
This type of payment environment might look like a hybrid of the ACH and electronic funds transfer (EFT) networks, post-point of sale (POS) or ATM transaction, which provides ACH and cheque processing solutions for financial institutions and corporations throughout the US, allowing them to benefit from electronic cheque processing. To the consumer, above the waterline, this could allow for instantly available funds and real-time transaction confirmation, while also allowing payment settlements, including the anomalies to be processed in batches for efficiency.
A good example of this kind of convergence in payment systems is the Faster Payments Service in the UK, which acts as this type of hybrid between EFT and ACH. By reducing payment times between different banks’ customers’ accounts from three working days using the existing BACS system to near real time, this drives float out of the equation and provides a better experience for banks’ customers.
The US Example
The historical and geographical background of the US has led to the development of a unique payments landscape. The US is the largest national and contiguous economy in the world, with the largest domestic payments market. In this prosperous environment, multi-product mega-banks and monoline niche providers developed side by side. Financial institutions were able to successfully specialise on certain sections of the payments process, such as cards issuance or merchant acquiring, and those that were very good were able to gain market share and secure a competitive advantage. Ultimately, however, the marketplace could not sustain specialist providers with disparate systems. These niche providers had to either grow to become large enough to remain independent, or were acquired by the megabanks to expand their own significant payments portfolios.
In addition, a culture of light touch regulation in the US means that payment institutions have had the freedom to innovate and experiment with payment products as part of their entrepreneurial enterprise. Unfortunately, the competitive advantage gained through innovation is rarely sustainable. In fact, where various players innovated and gained advantage, the same innovation, now proven, is generally widely adopted by the rest of the industry almost immediately. The only competitive advantage available to financial services companies tends to come either from brand, scale or specialisation.
One good example of the strategy of a multi-product portfolio being employed is JP Morgan Chase. The financial services firm has regularly made targeted and strategic acquisitions to enhance its payments assets portfolio and to allow it to have a substantial share in areas, such as merchant acquiring, that it perceives to be strategic differentiators or that allow it to tap into a new customer segment. For instance, this allows the bank to better serve small business customers who may also need an acquiring relationship. Moreover, the recent merger with Washington Mutual has allowed the bank to expand its retail banking services, balancing the more corporate focus traditionally offered by JP Morgan Chase.
Investing in selected payments assets has allowed JP Morgan Chase not only to create competitive advantage in offerings such as ACH processing, but also to consolidate payment systems through increasing its transaction volumes through the same cost bases. In addition, this enables the company to provide a broader suite of capabilities to its target customers.
As the trend towards electronic payments continues, the US banking industry will either have to make a decision to invest in consolidating the redundant payment settlement networks (including ACH, cheque, EFT, and others) in order to improve the efficiency of the market, or look to newer alternatives for the next generation of payments. Moreover, finding the balance between supporting multiple payment methods for consumers and creating a universally available and efficient payments infrastructure in the background will be an enormous challenge for individual banks. It may be tempting to maintain the status quo. However, the day of reckoning is fast approaching and perhaps the decisive players will ultimately gain a sustainable competitive advantage. Can any bank really just afford to wait and see if they hit the iceberg?
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