An Analysis of the European Payments Space
New government regulations, emerging messaging standards, various demands from customers and an increasingly integrated pan-European economy are among the key drivers that banks are keen to address in chalking out their plans for creating a robust payments infrastructure.
This article analyses the European wholesale payments landscape. It uses customised variants of two industry models in the analysis and suggested recommendations for the European payments industry. These are:
The findings accrued from the GE/McKinsey matrix formed the basis for formulating our recommendations for banks.
The forces that characterise the dynamics in the payments landscape are illustrated in Figure 1. The impact of these forces vary from low to very high.
The traditional Five Force Model refers to ‘new entrants’ as entities that enter into competition with existing players. There is always a latent pressure for reaction and adjustment for existing players in this industry. The model in its ‘as-is’ state does not factor in the influence of technology on the competitiveness of a bank. However, in the context of the financial services industry, technology has been the agent of change that reduces barriers of entry.
The evolving technology paradigms have the ability to render the existing payment infrastructures obsolete. Banks, which are nimble in adopting the latest technology developments in building flexible and scalable payment infrastructures, can respond to market changes much faster, thus eroding the market share of existing players.
The term ‘suppliers’ comprises all sources for inputs that are needed to provide goods or services. In the context of the payments industry, government regulatory bodies such as European Payments Council (EPC) and the Payment Services Directive (PSD), and standards organisations like SWIFT and ISO, take on the role of suppliers. Over the past few years these organisations have taken a proactive role in the payments area. Regulations such as the single euro payments area (SEPA) and Faster Payments are forcing banks to rethink their existing payments infrastructure and embrace compliant solutions.
It is estimated that SEPA, which will eliminate cross-border fees and float income, will result in a direct revenue loss to the tune of €18-29bn for banks. While SEPA should enable faster processing times for retail payments, it will also result in decreased float income for banks.
There is a general opinion that ISO XML will be the defacto messaging standard used by banks. This will force banks to invest in newer infrastructures that will enable them to migrate from standards such as EDIFACT and proprietary standards to XML.
Customers are playing a more proactive role in voicing their concerns and demands, especially in the following areas:
Among the key parameters in which customers want to improve their performance are:
Customers expect their banks to offer services beyond the traditional basic payment offerings. Efficient working capital management techniques, robust liquidity management tools and complex reporting solutions are among the services customers now expect from their banks.
Corporates want banks to offer solutions that mirror local payment conditions. Even though the advent of SEPA seems to have watered down this requirement, some corporates insist on having multilingual capabilities.
Most banks provide the payment types of automated clearing house (ACH), wires, cheques, direct debits, and batch payments in the standard initiation channels – browser, file applications, telephony and fax, and SWIFT. Transaction processing functionalities are also similar across banks – reconciliation, reporting, tracking and tracing. This leaves banks with little scope for differentiation due to product and service commoditisation.
New and innovative features offered by banks are replicated without much effort, leading to eroding profit margins.
Substitutes refer to alternative mechanisms that customers can use in transacting funds. Though disintermediation of banks seems more than a thought, it would be premature to predict that the traditional roles of banks in offering payment solutions will be usurped by other entities.
The analysis carried out using Porter’s Five Force model reveals that banks need to focus on certain areas more than others. While initiatives such as SEPA and Faster Payments are an absolute necessity which need priority focus, banks should also consider the gradual phase out of low opportunity paper-based areas.
The relative importance of focus areas for banks is determined by plotting these areas along two axes – industry opportunity and current imperativeness (see Figure 2). Industry opportunity highlights the future growth potential for a particular area, while current imperativeness refers to the current positioning of that area. Both axes are categorised into ‘high’, ‘medium’ and ‘low’ sections.
For example, implementation of ISO XML standard scores as ‘high’ in both the axes and therefore should be a top priority area for banks.
Figure 2: Focus Areas for Banks using the GE/Mckinsey Matrix
The analysis of the GE/McKinsey matrix reveals that the immediate focus areas for banks should be to put payment infrastructures in place for regulatory and compliance initiatives like SEPA and Faster Payments. There are a host of other initiatives that banks can actively work towards to gain significant market share. The main initiatives are listed below:
This allows corporates to decrease the costs associated with maintaining proprietary systems for connecting to the payment applications of their banks. Uniformity of standards also ensures that corporates’ enterprise resource planning (ERP) systems can seamlessly link to the banking systems. The advent of XML-based standards, such as ISO 20022, can go a long way toward increasing the STP rates for payments-related transactions.
Banks are making a concentrated effort to move from a transaction-based pricing model to a relationship-based model. Banks closely follow the transactions pattern of clients and try to create models that best suit them.
Banks should make continuous efforts to shift from the routine payment provider model to a partnership-based model with their clients. Some of the solution offerings that can help achieve this objective are:
Large banks can offer white labelling services to smaller banks. The benefits can be a win-win situation for both entities, as the larger banks can leverage economies of scale and scope in generating additional revenues. Similarly, smaller banks can increase the breadth of their services offered without any significant investments in technology.
In Europe, the use of traditional payment instruments (such as cheques and drafts) is in steady decline. SEPA, which calls for a pan-European payment instrument with the elimination of the domestic instruments, serves to only hasten the process. Banks should look to gradually decommission infrastructures and applications addressing these requirements since they will be redundant post-2011.
The ongoing upheaval in the payments business should be viewed as an opportunity for banks to redesign their legacy infrastructures. The theme should be to use the newly-launched initiatives as a springboard to build more efficient payment systems that are flexible, support larger STP rates, are robust and scalable. The ideal scenario is for corporates to work with banks and financial institutions in developing solutions and processes for the wholesale payments industry. The industry is already shifting in this direction, with the increasing interaction of the corporate treasurer with banks payments division. If current events are an indicator, then these trends are likely to continue.