Fighting Cash Not SEPA: How European Banks Can Win With Debit Cards
Throughout Europe, the shift from cash and check payments to debit card payments is already under way. Debit card transactions increased by about 15% a year during the decade, while cash transactions decreased by 4% (see figure 1 below). Even in countries with relatively few cash transactions per capita (300 to 500 transactions a year) this trend has held.
Many consumers still believe that cash offers more control over spending than cards, that it lowers the risk of misuse, that it is cheaper to use than cards, and that it is more widely accepted. But those impressions seem to be shifting. Meanwhile, some experts predict that the economic break-even point between cash and debit cards could drop to €5 in the near future, down from €10 to €15 today. This would bring another 25% of the current cash transactions within economic range of debit card substitution.
Against this background, regulators, politicians and industry leaders are attempting to shape the future of debit cards. By 1 January 2008, the European Central Bank (ECB) wants to have a system and infrastructure in place for initiating a pan-European debit card solution – so that by 2010 all eurozone countries will have debit card solutions and infrastructures that are compliant with a single euro payments area (SEPA), see figure 2 below. Meanwhile, the European banks, through the European Payments Council (EPC) and its Cards Working Group, are defining their roadmap for cards in Europe. Finally, the EU Commission, which is the biggest driver behind all these harmonizing efforts, is working hard on a comprehensive legal framework.
For banks, the question is whether all this debit card activity is bad news and fraught with danger, or whether these initiatives can be leveraged into significant opportunities. The downside includes possible monetary losses for banks, particularly if pricing converges to the lowest common denominator, if the migration to SEPA is expensive, or if these changes heighten cross-border competition. Most European banks are already facing national debit card systems that are losing money on a transaction basis, while at the same time growing fast. This is hardly an attractive situation to be in.
On the other hand, the opportunities for banks include the chance to restructure their value chains (thereby achieving greater economies of scale and improving efficiency in processing) and, even more importantly, the opportunity to shift consumers away from the expenses of cash to the economies of electronic payments.
What should bankers do? Fight SEPA? Or join the debit card bandwagon and fight cash instead? In order to answer that question, it’s important to take a look at the other players involved in this debate and the stakes that they hold.
Bankers aren’t the only ones with a point of view: cardholders, merchants, national debit card processors, and MasterCard and Visa are all interested players.
Cardholders value the convenience of a universal SEPA debit card, but still conduct most of their transactions domestically. Pricing and functionality of the new cards would hold the most interest for them. Pan-European solutions for remote commerce and convenience features (e.g. contactless and prepaid cards) might make a SEPA product very appealing. But the question will still be, at what price?
Big merchants – large retailers, petrol stations, airlines and others – will eagerly await a pan-European debit card solution, with pan-European acquiring abilities. But euro-commerce businesses and many of the smaller merchants will be watching pricing implications closely. They will be hoping to see a convergence to Dutch/Belgian merchant service fee levels, which are five times lower than the European average.
National debit card schemes and processors, meanwhile, will face an industry consolidation that will see some survive and others disappear. The players have been determining whether they can work together in joint ventures, such as SiNSYS (Banksys of Belgium, Interpay of the Netherlands, SSB of Italy).
MasterCard and Visa will probably relish the move to SEPA, since they already have some of the possible pan-European debit solutions in place. They will make their case to the regulators and the banks with as much energy as possible, recognizing, of course, that some competitors will label them as overseas invaders, despite their local management teams and local member institutions.
With these players jockeying for position, how might the European debit card game come together?
One option would be to keep the domestic debit schemes in place, with the existing cross-border overlays (e.g. Maestro) accepted everywhere. The cardholder experience would be very SEPA-like. The challenge, however, would be in nurturing new ideas and products in such a complex environment.
A second option would be to encourage bilateral links between domestic debit processors, similar to the former BEST network. National debit card processors might like this option, as it would limit migration costs (for most parties), but regulators might argue that it does not deliver real economies of scale and cost savings. In fact, without a pan-European acceptance mark indicating acceptance of such national debit cards at foreign points of sale (POS), customers may wonder whether the card will indeed be accepted. To get there, alliances will be needed to solve branding and interchange issues.
A third option might transfer domestic cards to one or more of the international debit card schemes (e.g. Maestro, V Pay). This has the advantage of having many of its components already in place. But banks will be looking for governance solutions to limit the loss of control they will experience in the adoption of this solution. They will also want to guard themselves against excessive pricing by the international schemes.
The final option is the creation of a SEPA-specific debit card scheme with its own standards and rules. This would allow Europe to define its own secure and pan-European solutions. The downside, however, is that it would be quite expensive.
None of these options has been fully analyzed, but they all have their advocates. In fact, the debate runs the risk of becoming quite political and possibly ugly. How should banks react? We feel that they could choose to fight SEPA, or they could seek a win-win solution for themselves – and for the other stakeholders.
To be honest, banks have been dragging their feet, both in terms of SEPA and debit cards. But their reluctance is understandable: the potential pain is fairly obvious but, since cross-border retail payment flows are still minimal, the gains to be derived from SEPA are not. Bankers realize that the effort will require harmonizing many diverse parts:
Standards – Product definitions and standards differ dramatically across countries: chip only solutions in France, non-guaranteed ELV (Elektronisches Lastschriftverfahren – German direct debit payment) transactions in Germany, etc.
Infrastructures – These range from monolithic, bank-owned entities in the Benelux, to distributed systems in Germany.
Brands and schemes – Many markets have a single domestic scheme and brand; others have several brands (as in Italy) or only international brands (as in Austria and the UK).
Business models – In some countries there are three-party business models (merchant, card company, cardholder); in others, four-party models (merchant-acquirer-issuer-cardholder). Among the four-party models, the economics of issuer and acquirer differ dramatically from country to country.
The differences in markets create migration barriers and also a resistance to change. What should bankers do?
1. They can resist SEPA and try to get away with minimal changes. This is risky, since the EU or the ECB will very likely step in and mandate changes. The EU’s regulations on the pricing of cross-border transfers have shown how painful these edicts can be.
2. They can negotiate a compromise among the stakeholders, one that meets SEPA objectives and is not too difficult to implement. In other words, banks can make the best of the situation by collaboratively working out schedules and other details, and even requesting some concessions in return, such as some regulatory considerations on their interchange levels, which are currently under antitrust attack.
3. The best approach, however, would be to find a true win-win solution, one that goes beyond simple harmonization to offer all parties sufficient benefits to overcome the pain and costs of moving to a SEPA debit card world.
What could constitute a win-win solution? We believe that a ‘cashless society’ could be the answer. Cash is, after all, the number one competitor of debit cards. It is also quite inefficient as a payment instrument. By getting rid of cash, economic gains for all could be created. Banks could reap intermediation benefits by substituting cards for cash, benefits that could pay for some of the harmonization costs of SEPA.
Indeed, our profit pool analysis shows that if cash usage in the EU25 declines to approximately that of the most cashless countries, banks could save almost €10bn. This would not only pay for the SEPA migration investments but also allow the absorption of some of the costs of pricing harmonization. Merchants would gain as well, through reduced cost-handling expenses, while society as a whole would see fewer armed robberies and a smaller grey market economy.
To get there, banks should work proactively with their governments toward SEPA – obtaining, as a quid pro quo, government support for a cashless society. Governments, in turn, should ensure that cash is properly priced to merchants and consumers. They should also develop informative public relations campaigns and incentives to wean consumers from cash, such as tax breaks for merchants who accept and use electronic payments and electronic payments options for government services.
How realistic is this rosy win-win scenario?
Cross-country benchmarking along three key determinants of debit card usage offers some clues (see figures 3 and 4 below). If one were to assume that by the year 2010, debit card use will rise to 1.1 cards per capita; that they will be accepted at almost 90% of the POS accepting cash; and that consumers will use their cards 125 times a year (as they do in Iceland), then we could reasonably predict that by the end of the current decade Europe would see an additional 40 billion debit card transactions. Debit cards would then represent 20% of all retail payment transactions, up from 5% today.
Cash would still be important, but usage would drop from about 80% of all transactions today to about 60%. The average European would make 10 debit transactions a month, instead of the two or three we see today. This is not an unrealistic aspiration, and it could save society several billion euros in costs – enough, perhaps, to compensate for some of the losses accruing from SEPA-wide debit card harmonization.
This shift will not happen automatically. A concerted effort by government, central banks, banks, merchants, and consumer organizations will be required to achieve it.
First, the stakeholders must agree that substituting debit cards for cash is beneficial to society. This consensus will be hard to reach, as the parties involved do not agree on the true costs of cash and the other payment instruments involved.
Second, the debit product must be enhanced. Transaction costs must be lowered further, through features such as pre-authorized debit functionality. Furthermore, speed and convenience must be improved, through technologies such as contactless payments.
Third, acceptance of debit cards must be vigorously promoted, both in terms of personal acceptance of cards and in the world of remote commerce (mail and telephone order, e- and m-commerce).
Fourth, banks must develop segmented card offerings; for example, to push card penetration into high-risk/unbanked segments in Central and Eastern Europe. Fortunately, chip card technology is now sufficiently advanced to keep risk in such situations under control, and at a reasonable cost.
Fifth, cash needs to be priced appropriately. Today the pricing of cash is not in line with its costs. Consumers and merchants in most countries do not pay the real cost of cash, and so merchants and consumers have no reason to reduce their use of cash. One problem is that there is no clear ownership of cash. Another challenge is that governments often position cash as a public good – to be offered free by banks – thereby inhibiting an economic debate on cash versus other instruments.
Finally, we will need to see significant targeted marketing efforts to promote debit over cash. Only when all these levers are pulled, by all the stakeholders, will the war on cash be successful.
It is clear that governments and central banks must play a key role in making the war on cash possible. Once political consensus is reached, then banks and merchants must follow swiftly. The successful elimination of retail checks in countries such as Belgium shows that such a concerted effort can be extremely effective, and bring immediate results. There is no reason why a similar effort cannot be launched for cash substitution.
If successful, this could drive forward a smooth transition to a SEPA debit world. Today, as the political consensus forms, bankers should begin to develop a bank wide payments strategy. This means creating attractive current account/debit card packages that will lure people away from cash. In other words, instead of fighting SEPA, bankers would be far better off declaring a war on cash.
This article is from McKinsey & Company’s Payments Practice publication “Payments: Charting a Course to Profits,” published in January 2006. It is one of 12 articles providing an overview of recent trends in the payments landscape and offers approaches for various industry participants as they manage through these challenging times.