Tuesday, Jun 28

How the payments industry is being disrupted

How the payments industry is being disrupted

While we expect the payments industry to keep growing at a healthy rate,

powerful disruptive forces will begin to reshape the global landscape.

Global payments revenues have been growing at rates in excess of expectations. Asia once again— particularly China—is the primary engine propelling the global numbers, but all regions, even those where revenues have recently been in decline, are contributing to the surge.

Payments growth is currently a truly global phenomenon. Looking ahead, however, it is expected that global payments revenues will begin to reflect the flip side of Asia’s prominence as a growth driver. The expected macro¬economic slowdown in Asia-Pacific (APAC), in other words, is dampening expectations for payments growth overall.

However, the turnaround in other markets will make up for some of this decline. It is expected that this rebalancing of revenue growth between emerging and developed markets will lead to tem¬pered but still healthy revenue growth of 6 percent annually through 2019.

The most recent research reveals several additional trends of note. Although liquidity related revenues (those linked to outstanding transaction account balances) were again the largest revenue growth contributor (53 percent), transaction-related revenues (those directly linked to payments trans¬actions) climbed more strongly in Europe, the Middle East, and Africa (EMEA), as well as in North America, contributing more to revenues than they have in any year since 2008.

It is expected that the contribution of transaction-related revenues to continue rising through 2019, growing at a compound annual growth rate (CAGR) of 7 percent (compared with 5 percent for liquidity revenues) and contributing more to global payments-revenue growth for the period ($360 billion compared with $220 billion).

The impact of weakening macroeconomic fundamentals, primarily in Asia–Pacific (APAC), will mostly affect worldwide liquidity revenues; transaction-related revenues, more driven by payments-specific trends and the ongoing migration of paper to digital, will continue to grow at historical rates.

Further, the digital revolution in customer behavior and the intensifying competition will likely revive the “war on cash,” giving further impetus to transaction-related revenues. Still, with CAGRs of 9 percent in EMEA and 7 percent in North America, liquidity revenues should continue to grow as interbank rates recover from historically low levels. There is also an anticipation of a rebalancing of revenue growth.

During the last five years, payments revenues grew by 18 percent CAGR for APAC and Latin America combined, comparing favorably with flat revenues in EMEA and North America. During the next five years, however, these growth rates will be 6.5 percent and 6.0 percent, respectively. Setting aside changes in macroeconomic fundamentals that are difficult to predict, four potential disruptions have been foreseen that will alter the payments landscape in the coming years:

Disruption 1: Nonbank digital entrants are transforming the customer experience reshaping the payments and broader financial services landscape.

• The payments industry has recently seen the entry of diverse nonbank digital players, both technology giants and start-ups that are presenting increased compe¬tition for banks. While start-ups have generally not been a major threat to the banking industry in the past, it is believed that things will be different this time due to the nature of the attackers, the prominence of smartphones as a channel, and rapidly evolving customer expectations.

This shifting payments landscape might ultimately lead to consumers meeting their financial needs in very different ways. To maintain their cus¬tomer relationships and stay relevant banks will need to respond to these changes with new strategies, capabil¬ities and operating models.

In the next five years, increased compe¬tition will likely further reduce margins on domestic transactions while accelerating volume growth in electronic payments, reducing the use of cash and checks.

Disruption 2: Payments infrastructure modernization is underway

The industry is currently going through a wave of infrastructure modernization that is required to compete effectively with nonbank innovators and address evolving customer needs. This has resulted in players introducing new products, digital channels and technologies.

In fact, technology advances such as cloud com¬puting, agile development and advanced analytics are driving a convergence of payments, commerce and loyalty. To¬day’s consumers and corporates seek faster and more secure payments, quick access to funds and the ability to use their channel of choice.

And most nota¬bly, nonbank innovators are intruding on the payments turf by addressing these changing needs in new and unique ways, as discussed above.

The challenge is that most of the global payments infrastructure (e.g., clearing houses) leveraged by incumbent players (mostly banks) still operates on systems designed to accommodate the demands of the predigital era. Consequently, the industry finds itself at the beginning of an infrastructure modernization wave around the globe.

Large-scale infrastructure improvements can range from notification and con¬firmation upgrades to new clearing and settlement processes, and the benefits can range from reduced processing times to enhanced privacy and security. Although consumers and businesses expect such improvements, they re¬quire significant investments: the cost of modernizing one country’s domestic payments infrastructure is hundreds of millions of dollars.

In addition to this major cost burden—which needs to be agreed upon and shared by the banking community at the country level—individ¬ual banks face two related challenges: – They must develop a perspective on how they will use the new infra¬structure capabilities to design and commercialize the products consum¬ers and businesses are demanding. – They must identify the internal infra¬structure and operational changes needed to fully leverage evolving in¬dustry infrastructure. Infrastructure modernization—if well de¬signed and executed—could improve end users’ experiences, fulfill critical needs (e.g., emergency B2B supplier payments) and unleash a wave of market innovation.

As countries build new infrastructures, banks will need to modernize their internal legacy infrastructure and operations, which are often designed for batch, not real-time, processing. Banks’ core platforms will need to be updatable in real time, fraud platforms and processes will need to be very near real time, and clearing systems must be capable of handling exchange of information, posting of transactions to the customer and funds availability all in real time.

Without the right level of internal infrastructure pre¬paredness, banks face risk. To realize the opportunities presented by infrastructure change, banks need more than internal infrastructure and operations changes; they also have to think about how they will use the new infrastructure to design and commercialize innovative products.

Modernized infrastructure provides significant opportunities to develop end-toend solutions to address emerging consumer expectations. And it is these innovative solutions that will en¬able banks to retain their central position in the client relationship and to compete effectively over the long term.

To develop solutions that answer con¬sumers’ needs, it is important for banks to clearly identify the use cases and pain points they are trying to address. Most recent innovations building on modernized infrastructure focus on C2C, a segment in which cash (and in some countries, checks) often still holds a predominant position. Banks should be proactive on two fronts.

First, product developers should be thinking now about how to improve existing products and which new busi¬ness opportunities to pursue. This will also be important to inform infrastructure design.

Second, banks should develop a clear strategy for transforming their internal payments infrastructures to meet changing industry and customer demands. This means, for instance, pre¬paring to capitalize on new technologies when they become available, rather than several years later.

Disruption 3: Cross-border payments inefficiencies are an open door for new players

The entry of nonbank players and new infrastructure demands is not limited to domestic payments: they will also affect crossborder payments. Cross-border transactions, which include cross-border payments and documen¬tary business services such as letters of credit, documentary collections and guarantees, generate approximately 40 percent of the payment industry’s transaction-related revenues, yet they comprise nearly 20 percent of its total volume.

More importantly, while domestic payments have been migrating toward more efficient systems and products during the last few dec-ades, their crossborder counterparts have changed very little. Faced with significant margin erosion, banks have pared costs and pursued efficiencies in their domestic payments and other transactional products.

Nothing of note has been done, however, to improve the backend systems and processes that enable crossborder payments to work. An alignment of cross-border revenue margins to domestic level, driven by increasing competitive pressure, would cost the industry more than $150 billion revenues and put major cost efficiency pressure on banks cross-border pay¬ments operations.

As a result, cross-border payments remain expensive for customers, who also face numerous pain points (for example, lack of trans¬parency in pricing, timing and tracking, as well as slow processing times).

Obtaining trade finance can be even more painful, with high rejec¬tion rates for small and medium enterprise (SME) applications, lengthy manual docu¬ment verification and sanctions checks.

However, as nonbank players increasingly encroach on the traditional cross-border turf of banks— moving from consumer-toconsumer (C2C) to business-to-business (B2B) cross-border payments—they will force many banks to rethink their longstanding approaches to cross-border payments.

Disruption 4: The transition to digital in retail banking has important implications for transaction banking

• The digital revolution is now well de¬veloped in the consumer world and is spreading quickly into the realm of retail banking, causing significant changes in transaction banking. As customers grow accustomed to faster and more convenient payments on the retail side, they will soon demand similar conveniences and service levels in transaction banking.

Hav¬ing witnessed the impact of nonbanks in consumer banking, transaction bankers are becoming more aware of the nonbank threat in their own backyard and of the potentially major downside of failing to invest in digital infrastructures and services. To gain a strategic edge and fend off nonbank competitors, banks must recognize that digital technologies can do much more than simply automate processes.

They must invest to enhance specific aspects of their businesses, but they must go beyond this to institution¬alize a mindset of digital transformation, at the front and back end, that will make them more customer-centric and flexible.

Overall, it is expected that the payments industry will continue to grow at a moderated yet healthy rate during the next five years. But amid that growth, there will be a rebalancing of revenue sources, and, more important, powerful disruptive forces will begin to reshape the global payments landscape.

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