27 June 2010 Features

 

Roundtable: changing times in payments

At the recent EBAday event in Luxembourg, Banking Technology gathered a group of banks and technology providers to discuss the changes that are taking place in the payments market, and where the opportunities and threats will be coming from in the coming few years.

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Whenever those in the payments and transaction banking world are gathered together, the conversation quickly turns to the progress of the Single Euro Payment Area and the Payment Services Directive. Equally inevitably, it also revolves around the relationship between banks and corporate customers, and the threat of new entrants to the market disintermediating the banks.

These discussions have been going on for some time, but with the introduction of the PSD last year, things have started to move, and they are taking on a greater sense of urgency as players align themselves with partners and begin to restructure themselves for the increasingly competitive challenge ahead.

"Certainly in the last year we have seen a massive sea-change in perspective from both the banks and non-banks in terms of where they are focused, and that is a direct reflection of corporates' requirements," says Michael Burkie, market development officer at Bank of New York Mellon. "Corporates are struggling with liquidity - many of the banks that they would have typically would have worked with in the past will have gone home - so they are curiously under-banked. Whereas the big theme a few years ago was to actively reduce the number of banks they worked with, treasurers now are looking to for more banks to work with, so it has done a complete 180 degree turn."

Underlying this is a change in the way that corporates perceive banks, stemming from the credit crisis, that is making then review their relationships. "I'd agree that the balance has changed: corporates do still look at the number of banks they bank with, because the streamlining and reduction in complexity still counts, but they really want to reduce the dependency on one bank, particularly on one major cash management bank," says Karoline von Richthofen, global head of payments at Deutsche Bank. "We have seen corporates over the past two to three years who did at least their core cash management with one bank globally. Now they know that too-big-to-fail doesn't work so they are more aware of being dependent on one bank."

Thomas Meyer, TSS business executive, JP Morgan Germany, says that they are not simply looking for a single banking partner in each region, but for a common set of services that they can use globally. "If you're talking about Tier 1 corporates, I don't think that they are looking simply to change the number of bank relationships; they are looking for something else," he says. "Typically, a multi-national corporate would have three regional cash management banks - one in Asia, one in Europe and one in the US - who they work within different time zones or currencies. That is turning 90 degrees - now they are looking for global providers, across all time zones and currencies for efficiency, transparency and ease of doing business."

This, at least in part, stems a greater understanding of what the new opportunities are as banks roll out SEPA services, particularly their SEPA Direct Debits, says Taco Dirks, Euro product management at ING. "Customers are linking their cash management and payments more and more, and you're seeing a shift from operational excellence towards liquidity management and forecasting," he says.

"In the past year, PSD has come alive, as has SDD - not the easiest scheme in the world. Corporates in some markets are seeing these products and where a couple of years ago they were quite reluctant to see the advantage of SEPA, now they see that SDD has some features that they didn't envisage, particularly from a risk perspective."

But this is going to come at a cost for the payments industry: the simple fact is that banks can no longer rely on the kind of cross-border fees income that they have in the past, and this is starting to have a big effect.

"The PSD has killed many of the banks from a payment perspective," says Burkie. "They have huge infrastructural costs in the back office, and PSD has removed any fees from payments - there is no money in it. From a payment or transaction banking perspective, it is a zero-sum game: because they have that huge infrastructural cost - and all the regulatory costs that go with it - it pretty much balances out.

"The reality is that there is an implosion going on for many financial institutions: they have to decide - are they going to be a major wholesaler of financial services or are they going to be a distributor?" Do they want to stay in the payments business or make money somewhere else?

Lee Fulmer, global payments executive at IBM, himself a former banker, says that this shift is going to involve looking closely at what actually happens, and making a number of adjustments in perspective. "There is a need now to identify the indirect revenues from payments," he says. "Non-bankers - and quite a lot of bankers - often think that fee revenue is what drives payments, but it's not: it's always the deposit capital; it's what you can do with the treasury and capital markets aspects of the money that you are transiting, and getting that forecasting further in advance. When you bring that back to the relationship with the customer, the more intertwined you can get with your corporates and understand their money movements - and understanding it further in advance - the more capital that you can leverage."

Burkie agrees where the value lies, but says that it still leaves banks with hard decision to make. "The snag is that banks themselves have to raise Tier 1 capital," he says. "The transaction banking parts of organisations have been left alone in a darkened room, producing annuity revenue, and all of a sudden they are being starved. That is leading some very interesting discussions: Tier 1 institutions are now not sure that they want to be in this business anymore because it is not core to giving advice to high net worth individuals or being an asset manager."

The shift is happening and banks are waking up to it, says Brian Hanrahan, executive vice president for business and product development at payment systems specialist Sentenial: "That's exactly what we are seeing as a supplier to banks - they are starting to revisit their stance on what actually is their optimal role within this market. Tier one banks that were looking to provide solutions to all of their clients' needs, and banks that previously might have had aspirations to be major wholesale players are now starting to realise that the best way to realise their ambitions is by partnering to offer best-in-class solutions."

Perhaps one of the reasons that it has taken time to come to the fore as an issue is that it goes right to the heart of the matter of what it actually means to be a bank: if you outsource your payments systems, are you still a bank? The human reality is that faced with such questions, people find all sorts of rationalisations, many of which are actually irrational. "Institutions outsource almost everything else - custody, asset management, foreign exchange - what's wrong with outsourcing payments?" asks Burkie.

Fulmer is quite clear: "The answer to that is what makes a bank a bank is the ability to initiate a transaction: if you can't get the money from A to B, then you're not a bank, you're just a credit union or a building society or whatever - it's a psychological thing for bankers."

This psychological aspect is easy to underestimate. "It still remains a very hard decision on the part of those making it, says von Richthofen. "It is very emotional. The feeling is that you have to have your own machines - and the cost of outsourcing is never as low as you think." It's not just the banks that have to come to terms with this, she adds. "The client also has to be comfortable using services that are not directly provided by their bank. There is a fear that if a bank outsources everything, then corporates will just go directly to the other bank. They have to understand the commoditisation of parts of the process."

 JP Morgan's Meyer agrees that the payments function is central to the self-image of a bank, but says that it should be looked at the other way around, and the threatthat will come from not addressing the issue of processing. "With the growing importance of technology, we will have to watch out for non-traditional players who may have the capacity to disinermediate traditional banks."

The arrival, post-PSD of new service providers is a spectre that has been hanging over the industry for some time, and PayPal has become a cipher that represents them all. But it is not all bad.

"The new market entrants are also an opportunity for new types of partnerships, says von Richthofen. "You've got much more segmentation of the value chain: some pieces of that chain may be provided by a PayPal and other pieces by a bank, or even by a technology provider."

Burkie agrees, arguing that, freed of the burden of transaction processing, institutions will be able to concentrate on such opportunities to improve customer service. "It is the kind of conversation that Tier 2 and Tier 3 banks are having internally, once they get over the hump of saying they don't have to do it all themselves: who else can they build into their offerings?" he says. "If I'm an agricultural bank in Italy, what else can I offer my farming community? PayPal is something I could use - and, more importantly, only pay for it as I use it."

Dirks says that this kind of strategic partnership is a step his bank has taken already. "That's exactly what we are doing with Sentenial at the moment. At ING we're piloting using Sentenial for our corporate customers - and in the future, probably, for our FI customers, and for the customers of those FIs. It's an interesting experiment that has been quite successful."

It works in the opposite direction too, says Hanrahan: "Someone like a PayPal may have a great technology platform, but they don't necessarily have relationships with the kinds of customer that banks have. If they can be willing to partner with those banks, their reach multiplies dramatically - they win, and the banks win. Technology providers are realising that it is all very well having the best technology in the world, but if you don't have the customer relationships to back it up, you're not going to fulfil its potential."

Fulmer points out that there can be a unintended consequences: "The things about PayPal that could make it a threat is not that they will go after bank customers - they don't want to do that - but the fact that they have become a deposit taker." He points out that many of the people receiving payments through PayPal for transactions don't take the money out of the systems, as the charges are relatively high - and there is no reason to take the money out if what you want to use it for is available in the system too, as it is for traders on eBay," for instance.

"The real reason PayPal needed a banking licence wasn't to offer banking services," says Fulmer. "It was so that they could leverage the deposit capital in the interbank markets."

There are other parts of the chain that offer potential partnerships for the banks, says von Richthofen: "For me, who banks would potentially outsource to, that already does some of it to an extent, are the clearing systems - VocaLink, for instance, They have the capability, but there is an expertise that sits in banks that they lack, so they would only ever be able to take some of the business.

Fulmer takes this further: "Is there going to be someone who can provide the processing more cheaply or more innovatively? I could see a role for someone like Western Union which has the reach and the networks to provide clearing or messaging as a counterpart to Swift. We're always talking about how we can leverage global reach for low value payments: it is too expensive to do it with Swift, but Visa has a proposition, and Western Union has a proposition."

To a large extent, the arguments come down to where a particular institution draws its boundaries, and what functions it sees on either side of those boundaries.

"How do you delineate it?" asks Fulmer. "As with segmentation: if you take that end-to-end value chain and break it down, from the time you initiate it to the point where you do a sanctions check to when it leaves the gatekeeper, there are many points where you can say, ‘this isn't my business'."

There are many such examples, says von Richthofen: "We hold databases of IBANs that we already get from external sources, and there are other pieces of the chain - everyone has their own OFAC databases for filtering, for instance. There is no reason in principle why that couldn't be an external resource that everyone could access."

The notion of industry utilities is an attractive one, but the question comes back to a simple point: if these processes are of so little value, why are banks still sitting on them?

Fulmer puts it down to complexity and legacy: "The systems have grown organically, so inevitably there are multiple payment channels, multiple core banking systems - pulling the processing out is actually a massive integration project, and the cost-benefit is never going to stack up. You can't spend Ä50 million to homogenise those systems and then outsource it, because you'll never get the scale in the outsourcing."

External changes could ease this in the future, he says. "This is why the SEPA end date is so important. If we could, in the eurozone countries, start to shut down the domestic ACHs, then a lot of the little systems that we've got still ticking over will also start to close down."

The closure of some legacy systems will help to remove one of the distinctions between the existing banks players and the new entrants, which is that they are perceived to be able to start from scratch, using the latest technologies to quickly build new, innovative - and ultimately threatening - products and services.

While this is true to an extent - many of the innovations in the market only exist because of technology developments - it is not always the case, and banks could look at it another way: they have made investments worth, collectively, billions in any currency, that are hard for new entrants to replicate.

The entrance of supermarket chain Tesco, for instance, has been seen as an opportunity to build shiny new systems from scratch, but it still has the legacy of existing accounts and products from the period when it was simply a brand name being operated by an established retail bank. Migrating customers' accounts and their products to the new systems is a major headache in its own right.

The issue of legacy systems - both internal, and as in the case of the ACH, external - is something that the notion of partnerships and taking different parts of the value chain can help address, and it is having the effect of turning banks back into specialists - either in terms of skill sets for particular groups, or on a geographical level. The choices here are not limited by existing legacy systems.

Burkie says that corporates are suffering the effects of an economic downturn and face similar problems across the board "What are corporates facing? They are looking inwards at how they can make the most of trapped liquidity or trapped working capital," he says. "And who do they turn to? A local bank, for local risk assessment and for local services that their local customers also have access to. But at the same time, they will want someone to help with their operations in Sao Paulo, so they will want an international bank."

This is more than just a variation on traditional correspondent banking, he says, and argues that it is changing the nature of the business for banks. "Many banks are still lagging - you have to be asking how you extend your value to your client base by hooking up with a bank in, say, Brazil," he says. "You can't just be a little agricultural bank, or a high net worth specialist in Switzerland." That said, he cautions against trying to offer all things to all customers: "There was a feeling that if the bank next door offered a service, you had to as well. That is not the case, if it ever was, and it is not what you should be doing."

Meyer says that the relationship between bank and is customer is changing, with the bank no longer in charge. "The drivers are upcoming customer communities (ie Web 2.0),that are bringing transparency to each bank's capabilities, which is enabling customers to be selective," he says.

For von Richthofen, this is part of the fragmentation that is happening across the market. "What we see is that there are systems developing, and again it is a value chain that is split between different parties," she says.

So after all this time, has the SEPA/PSD project been a good thing for the banks? Are they crying out for an end date simply to turn the page and move on?

Fulmer compares it to the introduction of the Faster Payments scheme in the UK, which was mandated by legislators and adopted with varying degrees of enthusiasm by the banks. "It was originally meant to be for one-off, low-value payments, but what happened was that some of the banks said started to say, if we are going to invest this much in it then we are going to add our corporate to the system, or we're going to put all our standing orders through the system, or any number of different things," he says. "It became a bragging contest, so what started as a project that should have cost the industry £250 million wound up costing nearly £1 billion between the central infrastructure and the banks' costs - and it was late. There is a parallel with SEPA where we've delayed and delayed because we have too many people trying to get things into the system."

The cost of SEPA has been a source of pain for the banks. "Let's not forget that it has cost the industry a lot of money investing in it and in legacy systems to have dual systems, and there has been no real return," says Dirks. "But from a customer point of view, we together as an industry have already added a lot of functionality that I think will for the basis for the true SEPA in the future. We're there, and we'll continue on with it."

"It's going in the right direction," says Burkie. "Not only are clients going to be able to see that they are getting better services, but the banks are going to be able to turn round and say there's a margin in it. That's going back to banking as a business - as long as our margins are healthy and the customers are getting the services they want, that is healthy."

PARTICIPANTS

• Thomas Meyer, TSS business executive, JP Morgan Germany
• Taco Dirks, SEPA product manager, ING
• Michael Burkie, vice president, market development officer, Treasury Services, BNY Mellon
• Karoline von Richthofen, global head of payment markets, Deutsche Bank
• Lee Fulmer, global payments executive, IBM
• Brian Hanrahan, executive vice president,
  product & business development, Sentenial