SEPA: Migration from 2008 to 2010
There has been more conjecture over the coming of the single euro payments area (SEPA) than over any other pecuniary issue in Europe for many years. Many pundits would say this is with good reason. After all, the true harmonisation of payment schemes across the eurozone – an idea driven by the European Commission (EC) and the European Central Bank (ECB) ever since the adoption of the euro – would be quite an accomplishment. Such a pan-European payments platform for corporations and consumers would, in theory, offer cross-border payments functionality at the same level of cost and efficiency as current domestic-payments schemes. Transaction prices, which now cover a wide spectrum across Europe, would converge to the level of the lowest-cost countries. Businesses and consumers, should they desire, would need just one bank account in order to carry out all payment activities throughout Europe.
These features represent decided advantages over the current fragmented system. But there’s more to the story. Indeed, we need to look at SEPA through several lenses to see it clearly.
A prerequisite for a lucid perspective on SEPA is to take note of its two distinct phases. As the EC plan currently stands, by 1 January 2008, European banks must be equipped to handle – that is, to receive and process – transactions involving products such as pan-European direct debit (PEDD) and debit cards alongside their domestic schemes (which currently vary widely from country to country). The focus for banks is on establishing connectivity to and compliance with the SEPA schemes – and on not breaking the network should SEPA-based transactions come their way – rather than on mandatory usage of the new standard. In essence, the SEPA schemes and current domestic schemes will co-exist. By the end of 2010, however, the situation will become more demanding: the domestic schemes are expected to be eliminated or converted, leaving only the SEPA schemes in operation. We refer to these two phases, which have significantly different ramifications from the point of view of costs and benefits, as SEPA 2008 and SEPA 2010, respectively.1
Both our client work and a series of detailed interviews with leading players across the payments spectrum suggest that a wide gap exists between the investments that will be required for the two phases of SEPA – as well as between the benefits that each set of investments is likely to bring.
We estimate that being SEPA compliant by 2008 will cost European banks and payments processors roughly €500m. Banks will bear most of the burden because they will be required to replace or adapt their core processing systems – most notably for cross-border payment transactions (handled by multinational, regional, and large national banks). Processors will also need to scale up their core processing systems and develop the capacity to accommodate new interfaces among various schemes. Indeed, banks must not only take the brunt of the initial investment but also cope with the increased margin pressure that the overall decrease in transaction prices will create, especially in countries where transaction prices are currently high.
Taking the long view, however, the collective investment by banks and processors to deliver SEPA 2008 has a sound rationale, given the benefits to consumers and the effect of introducing a set of pan-European products. It can thus be reasonably argued that SEPA 2008, despite the fact that it only partly addresses consumers’ payments needs, will bring a general benefit to society at large. Simply put, SEPA 2008 makes sense. This is a crucial point.
Yet when the idea of full migration to the SEPA standard in 2010 is factored in, the jewels in the SEPA crown lose a good deal of their shine. Indeed, by moving out of step with the natural investment cycle, SEPA 2010 will incur significant additional costs. We estimate that banks, processors, and corporations will be required collectively to invest roughly €5bn – 10 times the amount necessary for SEPA 2008 – in order to scale up processing systems and overall IT architecture, migrate cards, and adapt mandates and contracts to a level that would permit the scrapping of all domestic-payments systems in favour of a fully harmonised, pan-European standard. Corporations, for instance, whose required investments for SEPA 2008 are negligible, would feel the pain along with banks and processors.
But this level of collective investment is unlikely to be justified by additional benefits. For example, gains for corporations and consumers stemming from the convergence of prices in high-cost countries to those in low-cost countries – and of prices for cross-border transactions to the level of domestic ones – will already have been reaped through SEPA 2008. The first phase of SEPA will also have made cross-border transactions and cross-border use of payment products faster and simpler.
Indeed, full migration to SEPA 2010 will in fact decrease efficiency and possibly reduce functionality by imposing unnecessary additional operating costs on banks, processors, and companies – compelling them to adopt pan-European products and to discard highly efficient domestic ones. The bottom line is that pushing for the full SEPA concept to be achieved by the end of 2010 will actually destroy value. A more workable and far less onerous solution would be to allow payments players to invest in the full SEPA requirements in accordance with their natural investment cycles for IT infrastructure, cards, terminals, account engines, merchant contracts, and related elements.
What is more, however rapidly the evolution of SEPA actually progresses; its implications for the profitability of payments players – and for the forging of their strategies – will be critical. Banks in particular will have to gauge the direction of the wind accurately, and steer their ships accordingly, if they are to reach their destinations safely and profitably.
Although banks and payments processors will feel both revenue and cost effects from the advent of SEPA, each group will face different circumstances as it seeks to improve its bottom line in this challenging new age.
The combination of lower transaction revenues and new, extraordinary costs to ensure SEPA compliance will place increasing tension on margins that already have been under pressure for several years. How can banks navigate their way out of this tempest?
A logical path might be to try to boost revenues through product innovation. But, in truth, the innovation opportunities for European banks appear fairly limited. Revenues can still be enhanced by such means as outperforming the competition at customer service, putting together creative bundles of existing products and services, and adopting pricing initiatives. But the overall revenue-pool game has largely played out in the European payments industry. That makes the effort to maintain (or enhance) profitability mainly a question of trimming costs and improving efficiency.
Although the extent to which cost cutting has already been achieved varies widely by country, as well as by individual player, nearly 70 per cent of traditional domestic-payments costs for European banks are typically in the labour-intensive areas of payment initiation and customer service. It is there, as well as in internal processing – areas about which SEPA has little to say – that the main cost-reduction opportunities lie.
European network banks and large national banks can still achieve substantial labour-cost reduction through optimising internal processing, although the potential is greater in less efficient markets than in more mature ones. Processing initiatives will typically involve off-shoring or outsourcing solutions. The sharing of infrastructure through commercial partnerships can also bring cost benefits, as can well-executed mergers and acquisitions – although the jury is still out on whether SEPA will actually drive a new wave of cross-border banking consolidation. It could very well do so, however, since scale under SEPA will become even more important than it is today. Cost benefits can be further captured by strengthening the push away from labour-intensive, paper-based payment instruments toward electronic ones, as well as by streamlining branch networks and improving sales force effectiveness.
Above all, European network banks and large national banks must carefully scrutinise their SEPA investments and align them with their own strategic goals as much as possible. Indeed, their top priorities should be as follows:
Both ACHs and commercial processors will face their own challenges and opportunities in the age of SEPA. ACHs, for their part, will be faced with some degree of mandatory investment, but they will also have new revenue opportunities by playing a larger overall role amid the shift from bilateral to central clearing – as well as by extending services to banks, such as PEDD handling and payments in-sourcing (for small banks).
Consolidation is also expected among the various national ACHs, as processors strive to achieve larger scale to reduce their costs in the hope of becoming one of the winning pan-European automated clearing houses (PEACHs). Commercial processors, such as FDC, Unisys, IBM, MasterCard and Visa, will also potentially benefit by in-sourcing the payments functions of local banks, and consolidation will occur among those processors that want to move into the clearing-house arena. Large ACHs should secure transaction volumes as quickly as they can, even if the parallel business cases do not materialize directly, while smaller ACHs are likely to have to find alternative business models.
In general, processors should take the following steps:
This article is adapted from the BCG report ‘Navigating to Win: Global Payments 2006’. To order the report, please visit www.bcg.com.
1According to the ECB publication ‘Towards a Single Euro Payments Area’ (February 2006), ‘It is possible that some elements of the [SEPA] project … will not be able to be fully achieved by the end of 2010. However, it is clear that the move has to be irreversible and that the phasing out of national instruments should be well advanced at the end of 2010’.
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