The cost of implementing the single euro payments area (SEPA) falls mainly on the banks. With compliant transactions due to be live in 2008 and the final changeover by 2011, this cost is now a reality, as is the revenue already lost, and the imminent loss of the bank’s competitive edge, although they may gain some operational savings later. In addition, for some countries, more investment will be needed to bring the SEPA-compliant transactions up to the levels of service that customers currently get and expect.
But this situation may have a positive outcome for some. It comes in the form of the Payment Services Directive (PSD) that, instead of imposing price controls and minimum common standards, attempts to open up the payments market to competition by banning restrictive national regulations.
Banks with payment processing cost problems will welcome the licensing of pan-European payment service providers who are not banks.
There is nothing new about the problem of payment processing costs. Shifting money between accounts is a commodity process that is hard to justify a value-added charge for, and banks have been steadily grinding down the operational costs of doing so for decades, through mutual co-operation, standards and process automation. As with any commodity process, it is almost impossible for a bank to commercially justify a large investment in automating the last few percent of exception transactions, unless there is a premium price to be won, or money to be saved. EU cross-border payments are a small percentage of the total, and the SEPA price control and standard measures do not, in themselves, do anything to address this issue.
Full Cycle Outsourcing – A Step Too Far For Most
One classic solution to the problem of excessive investment requirements for limited operational cost savings is outsourcing to a common provider – the basis for the national automated clearing houses (ACHs). They have been phenomenally successful in capturing critical masses of payment volume and bringing down costs, but they have two major limitations; they have traditionally been founded on a mutual basis by the banks within a single jurisdiction and they generally only tackle the core value exchange part of the payment lifecycle rather than the payor and payee interface.
Most ACHs also only act as intermediaries between banks, but the whole payment lifecycle connects the paying customer to the receiving supplier. To outsource the whole of this transaction lifecycle has been a step too far for most banks in most jurisdictions, however attractive the cost reductions might be.
While payments are not what banks are really for, which is primarily borrowing and lending, they are absolutely key to the customer relationship. The flow of payments between banks yields a goldmine of intelligence about customers’ business, counterparties, and financial status as well as regular opportunity to contact them, work on the relationship and sell to them. This information is far too valuable and sensitive to put in the hands of a potential competitor.
As a result, the customer interface now represents by far the largest share of payment transaction costs, while the remaining cross-border value-transfers have often been outsourced to other banks or the STEP pan-EU clearing system, but their small share of the overall payments markets continues to make them expensive exceptions.
Relationships Cover the Cracks that Papers Cannot
It is a mistake in sourcing complex services to believe that concerns about competitive conflict of interest can be addressed by the contract terms and service specifications. It is true that they can contain non-disclosure agreements, database segregation requirements, non-compete clauses and so on. However, outsourced services always need to change over time, and no contract or specification has ever been written that defines the outcome of all eventualities over an extended time.
In contrast, the success of an outsourcing arrangement in fact depends most of all on there being recognised mutual gain and a relationship that supports that with trust, co-operation and shared objectives.
When the service needs to change in some unforeseen way, your sourcing partner is not going to make special allowances, extend a helping hand or take a risk on your behalf if they would benefit from your failure. At the very least, their duty to their own shareholders would not permit it.
PSD Opens Gates to New Partners
The provisions of the PSD, now approved by the EU Parliament, effectively impose common standards on the licensing of payment service providers throughout the EU. They also mandate the licensing of a new class of pure-play payments service provider that does not need to be regulated as a bank and can operate across the whole of the EU as a single entity.
By removing the barriers in this way, the PSD will allow a flood of new non-bank players into the payments market from whom banks can pick suppliers that will support the countries and payment services that they need without putting themselves in the hands of their most direct competitors.
These new players could be specialised banks or autonomous divisions whose business model is well recognised as not conflicting with mainstream banking; ERP software suppliers whose systems support both the financial and supply value-chain; telecommunications and IT suppliers; and existing ACHs or ACH consortia.
Many of these are already showing signs of shaping up to join the business, so we expect the EU banking industry to have plenty of choice once the PSD is adopted.
To find out more about the subject of outsourcing payments processing and the challenges and options available, read the following articles:
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