The Payments Services Directive: Great Idea, Unfortunate Timing?
The Payments Services Directive (PSD) seeks to increase harmony within payments throughout the EU. This is a worthy goal that will be welcomed by all in business because all will benefit from cheaper, faster payment services. But, from a banking perspective, the timing of the Directive could not be worse. As the old saying goes, it never rains but it pours, and now is not a good time for European banking. Indeed, the ‘credit crunch’ has become a constant headline in both the financial and general press. Most commentators agree that the worst has yet to come and the only real dispute is about how deeply it will bite.
Against this gloomy backdrop, banks seek to cut costs and become PSD compliant. On the face of it, this is a contradiction in terms. As all in banking know, legislative compliance is an expensive business: over 60% of banking IT budgets are consumed by mandatory projects. Moreover, compliance is an ongoing commitment, more akin to a journey than a destination. And it’s worse than that: banks that weather the current economic storm will have to compete for a shrinking revenue pool. According to the World Payments report from Capgemini, this will shrink from €47bn to €18bn by 2012. By then, new competitors will have entered the market, as the PSD specifically encourages the participation of non-bank payment institutions to promote competition and drive innovation. Will stability ever return to the payments arena? Probably not, for in reality the payments market has changed forever and the landscape will look very different as we enter the next decade.
It seems likely that, by 2012, fewer than 10% of banks will operate in-house payments services. Successful banks will be those that cut and control costs and find innovative ways to launch new services quickly. Customer engagement is all, and bank customers are better informed, more fickle and demanding than ever. Banks will have to increase their agility, capability and propositions just to stand still. How can they do this?
The PSD presents an opportunity for banks to do different things, but also an opportunity to do things differently. Banks must take time to examine and quantify their business processes to understand which components are core and those that are peripheral. At the same time, they must ascertain which components are profitable and which are not, because the two are not synonymous. All processes must be examined in the context of the business strategy, because the sole purpose of IT is to support and enable business. Activities that are peripheral or unprofitable must be scrutinised to understand the contribution they make to the overall bank strategy. If they are deemed essential, should they also be profitable? Profit may not be the name of the game but it certainly tells you the score.
It is a daunting task to decompose and evaluate the constituents of a payments business and getting started is not easy. But the longest journey begins with a single step and a thorough examination of payments processing should yield promising results. Above all, banks must resist the temptation to bear the escalating overheads of an unprofitable payments function on the grounds that it is an unavoidable cost of doing business. This argument usually runs along the lines that effecting payments is a fundamental banking function; after all, if a bank cannot effect payments quickly and efficiently, what can it do?
The fundamental nature of payments is not in doubt here, nor their critical importance to banks. But banks must look creatively for ways to provide profitable payment services in the post-PSD regime. For many, this will be a challenge. Many banks remain burdened with large legacy infrastructures that lack the agility of new market entrants. Banks must be fit to compete, but there is little time to plan a sophisticated fitness regime as banks that fail to comply with the PSD timetable will be effectively breaking the law.
A good starting point is to examine the key dynamics of a profitable payments business. Here we will consider three constituents of a successful payments business: efficiency, services and partnership. The three are not mutually exclusive and there is practical evidence that shows how banks can address all three simultaneously.
Despite the bleak economic outlook, the payments industry does have some highly attractive characteristics that other industries might envy. An efficient payments system is an integral component of any modern economy, representing around 1.3% of GDP, and the underlying growth trend is attractive with a CAGR of around 6%. So, despite the current economic uncertainty, payment volumes are likely to grow faster than the general level of economic activity. In all probability, growth rates will accelerate as new electronic instruments replace physical ones such as cheques.
The arrival of the single euro payments area (SEPA) and the PSD is both a blessing and a curse. As already mentioned, compliance costs present a significant barrier to entry in the payments business, but the rules are the same for all market participants. More importantly, the PSD calls for standardisation of information throughout the eurozone. At present, banks in all regions are undertaking similar projects to increase efficiency and achieve compliance. The cost of doing so is enormous and few will generate sufficient transaction volume to recoup their investments. It therefore makes sound business sense for banks to use common, shared utilities for transaction processing that are PSD-compliant and generate sufficient volume to earn a meaningful ROI. Ironically, the new age of competition is also one of cooperation. Banks can profit from collaborative processing without fear of disclosing commercially sensitive information: under the new regime, core payments will tend to become commoditised and are unlikely to be a major source of profits in themselves. The important thing for banks is to ensure that payment processing is done efficiently and is not a continual drain on cash. So, how do banks add value to core payment services?
Banks need to view payment services in the context of the business processes they support. To add real value, banks must support the needs of all interested parties throughout the payment value chain. Customers will look to their banks for services that increase convenience and improve financial control, such as the facility to submit payment files directly at a time that suits the business rather than the bank.
Banks must also focus on value-added services that increase customer engagement with the bank brand. It is important to offer customers a single channel experience: services must be customer-centric, rather than bank-centric. The success of SEPA is dependent on having highly functional SEPA instruments that offer customers a single ‘line of sight’ throughout the eurozone. It is only by achieving this, that business can achieve the real savings that are part of the SEPA promise, such as a single liquidity management platform and the establishment of payment factories.
As well as improving their own business processes, successful banks will be those that deploy new services quickly across multiple territories. This ‘single vision’ that is so central to SEPA will be achieved far more easily through collaboration.
The arrival of SEPA and the PSD represents the biggest shake-up ever experienced in the payments industry. Success in the new order will not emanate from merely remaining compliant but from customer focus. Customer needs move at a much faster pace than legislative compliance, so banks must add value to their payments propositions and that means much more than enriching payment information. Banks must look to their partners as a way of eliminating the burden of compliance and be willing to collaborate to increase the agility of the industry as a whole. In this way, communities of interest can drive the industry forward and commercial momentum will drive success. So much for the theory, but will it work in practice?
VocaLink has adopted a collaborative approach to SEPA and the PSD. This reflects a belief that many of the commercial challenges posed by legislative compliance are best met by solutions provided by a payments processor who can develop once and provide to many. Transaction processing is a scale business and only the largest organisations can justify the investment necessary to build efficient, compliant systems. VocaLink launched a euro clearing and settlement mechanism last July to ensure that all banks could benefit from the economies of scale inherent in its processing volumes. In practice, this has also brought democracy to the payments market: participant banks can influence and help shape future services, and all benefit from aggregated payments traffic. For VocaLink clients, this is also an opportunity to participate in the future of a world-class system without the risk and expense of going it alone. They are safe in the knowledge that services are menu driven, so banks can still compete through service differentiation.
VocaLink has recently become a partner of Bankgirocentralen (BGC) in Sweden. This means that, in due course, the majority of Sweden’s automated payments will also be processed on the VocaLink platform. Why? Following a major evaluation of the options available, BGC decided that it needed to find a partner with a proven modern infrastructure and necessary scale to provide transactions processing on a commercial basis.
For BGC, the outcome marked a transformation of its business processes, and the structure of the partnership is unique. For the first time ever, the processing of a national payments scheme will be conducted by a non-domestic provider. BGC decided that its core competences lay in managing its commitments to and relationships with the Swedish banking community rather than building and managing a complex processing platform.
The BGC example highlights the real benefits of collaboration. VocaLink and BGC have exploited the synergies of both companies while keeping the relationship on a firm commercial footing. BGC has reduced its costs, mitigated risk and accelerated the deployment of a new system, free from the burden of ownership. Now BGC can focus on key areas of its business where it adds most customer value, leaving VocaLink to provide processing, IT development and support. For the Swedish banks that had the foresight and courage to support this approach, they are able to avail themselves of a wider range of services, delivered to market at speed and highly competitive pricing.
As the PSD becomes reality, commercial pressure will continue to change the dynamics of the payments market. In all probability, there are more troubled economic times ahead and banks will have to focus strongly on new customer propositions. This means less time and money available to build and maintain back office systems. An increase in shared utility solutions seems both sensible and inevitable.