Still in the payments game? (July 2007)

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Still in the payments game? (July 2007)

Are banks in danger of losing their hereditary role in the paymentsystem? You’ll get views both ways in this month’s cover story, but thereality is the payment system has changed greatly in recent years, andthe pace will only quicken. What are the implications for banks?

By Lauren Bielski, senior editor

As banks address a shifting payments space they question who has control and what that means

When vendors and early bank champions started making hay, or at least talking about it, regarding mobile payments over the last year, it represented a new intricacy in an already complicated sphere of a fundamental bank activity.

Mobile had come on the heels of other sweeping revisions in payments that include check modernization; increasing accounts receivable conversion volumes and emerging options for merchant processing. Also generating industry buzz: work from the Check ACH Coalition Steering Committee, which proposed to essentially simplify check handling in digital form. (For now, anyway, this last effort has been shelved.)

Fewer paper checks in the system and the introduction of remote capture services for small business customers and larger businesses had, by this time, also begun to affect revenue or expense portions of any given bank’s general ledger. On top of all this, being floated was the notion of “wave and pay,” using mobile phones at a Krauser’s, 7-Eleven, or the Gap. According to industry reports, $1.3 trillion in cash transactions are made each year for purchases less than $5. And, for retail purchases overall, 64.8 trillion were made in 2006, according to a Visa.

Sure, Citibank, Bank of America, and select others had “rubber hitting road” on the mobile opportunity. But for many banks, this was yet another option to take under advisement in the mad rush to avoid having mobile providers or others, in words of one executive, “define the space.”

At the same time, there are other spaces that need definition. Payments are, after all, a $200 billion business in the U.S. For the top 25, according to Dove Consulting and other sources, revenue related to fundamental payments activity contributes 30-40% of operating revenue.

Impact on costs and revenues
So mobile arrives at a time when nearly every aspect of how payments are originated, processed, promoted—and ultimately demanded—is under revision.

Richard Winston, director North American Payments practice, Accenture, based in Dallas, says banks are coping with new forms at the same time they transitioning off aging infrastructure and considering the impact on their brand of nonbank providers. “Whether you’re a bank or nonbank provider such as eFunds, First Data Corp., or Alliance Data, or TSYS you are trying to cut costs,” he says.

And, notes Richard Oliver, the quest for betterment comes at a time when the turf wars may be heating up, or at very least, some banks and nonbanks are recombining in the quest for market share.

Oliver and others who spoke with ABA BJ addressed these new competitive realities. As an executive vice-president for retail payments, Federal Reserve System, based in Atlanta, Oliver is responsible for check and ARC-related operations, including upgrades, for that organization.

“I’ve been in the field for 30 years,” Oliver says, dryly, with the air of a man who’s seen it all—and then some.

“For the payments system, this is the most change in the shortest amount of time I’ve witnessed,” he adds. “Consider this, it’s the first time in the system’s history that you have declining volumes in a form, namely checks.”

In fact, much has been made of this already, but usually in the narrow analytical confines of discussions about consolidating check-processing factories.

“It’s hard to have a reliable revenue stream in this sort of environment due to the redundancies,” concedes Gary Roboff, senior consultant, BITS, of the new competitive realities.

Staying relevant
To Oliver though, declining check volume should also be looked at in a broader context, and that is through a lens of the domino effect caused by new forms. Dan McCarty, who is based in Livonia, Mich., and is senior vice-president of treasury management services with $58-billion assets Comerica, agrees and amplifies Oliver’s point: “There’s a psyche shift out there, and what seemed out of reach in terms of consumer and business acceptance has been mainstreamed.”

So people are happy with plastic. Because of shifting usage patterns (to debit, stored value, EFT debit and others), there is a new pressure to be creative—and relevant. The idea? To beget payment types that support ever more convenient or compelling purchasing scenarios, partially internet-related, partially information-related.

Need to buy supplies on the road and have it expensed ASAP? Need remotely access corporate account data or to view consolidated spending on supplies or T&E?

Those are the kinds of capabilities sought by businesses and consumers.

Among payments experts the question is, will a kind of tipping point be reached when banks as a sector, and many bank brands, are no longer associated with these services?

Later for checks and cash?
A pause here for a quick sketch of the environment, per a report recently issued by Dove: In 1979, when there were 37 billion transactions, the world was paper, with traditional checks counting for 85%. In 2000, when total transaction volume was 72 billion, electronic payments accounted for 41%. Debit volumes have grown at an annualized rate of 35.1% and 28.7% for signature and PIN debit respectively, and in a different category, ARC volumes surged to 74 million in 2003 from 19 million the year before when it was introduced.

Check writing is very gently becoming “so last century” as older folks learn new online banking tricks and the handheld activities of the extremely young creates a kind of oblique demand, driving banks to seriously think about payment vehicles and services that have the appeal of MySpace and Web 2.0. Another factor is an influx of non-citizens that have money-handling requirements no longer in pace with a “bag and drag” check system that worked for so long.

All of this matters in no small part, because work related to payments, broadly defined, is the central driver of the banking relationship today, notes Bill McCrackin, CEO, Synergistics.

“Our research shows that 51% of consumers still consider the DDA to be the most important account and 30% say it is their most active account,” he asserts. “Today, banks have a monopoly on the DDA.”

And, it is still what brings customers in the door, literally or otherwise. It is also what gets them borrowing.

Who is generating concern? One candidate may be DebitMan, recently renamed Tempo Payments, an alternative PIN debit card network operator that has a business model that is beginning to generate controversy as it reduces interchange fees. While nobody really said much about the provider on the record, a few on background indicated that studies were being done to see what a pick-off of comparatively little market share could do to bank cost structures. Early indications were that a little bit of shift could do the banking industry a fair level of harm.

(Ironically, the threat has in fact materialized, but from a bank. See the adjoining box for Capital One’s surprise announcement.)

Could there ever be a time when banks and payments aren’t linked in the eyes of the general public? The short answer is, no one thinks so, really, but no one is certain on the other hand.

Is there really a problem?
Unsurprisingly, the industry feels fairly confident, or perhaps better put, it isn’t cowering. Jeff Jaggers, senior vice-president of operations and chairman of payments strategy for $13-billion assets BancorpSouth, Tupelo, Miss., points out that, 1. Many banks are taking active steps to explore emerging forms (including BancorpSouth, which is working with Firethorn on a mobile banking project and will support mobile payments), and 2. people like banks to handle their information, especially when they see companies such as TJX mishandling data.

At BancorpSouth, as elsewhere, Jaggers is seeing migration from paper to electronics with debit and ACH volumes and bill payment usage also ratcheting up. So it’s not like they are sitting still and letting the web revolution pass them by.

“Sure, I’ve heard that young people don’t have the same sense of risk,” he says of future demand. “Yet, when Generation Y gets a little older, does that mean they won’t come to appreciate safety and soundness? I don’t think it does.”

The Fed’s Oliver has his take. “Obviously, reduced float and, in theory, fewer insufficient fund fees will cut into revenues. But this business of banks losing a franchise in payments? I’ve never understood it, frankly.

There are just more options for businesses and consumers now is all.” Net net? His view is that banks will adapt.

Others in the industry are rapidly cultivating their own positions after several years of witnessing experiments that have competitive smack down potential, mostly internet related.

The ABA, for instance, basically has a stance that the playing field as it looks today with regard to entrants like PayPal anyway is unequal, with banks on the hook for safety and soundness. In response, ABA has created a payments working group to discuss PayPal and other nonbank scenarios. “Either the rules are essential to the system’s security and should be applied to all players, or they are ineffective and costly burdens that should be lifted from banks,” writes ABA Chairman Earl McVicker in his column this month (see p. 18).

Absent any change, many nonbanks will continue to win, as they have in the credit cards sector already.

“Over time, the payment industry will become even more fragmented,” says John Mateker, senior vice-president with Global Concepts in Atlanta. As if to get a leg up on what has been perceived as a threat, he says, US Bank acquired GenPass, an ATM provider, and Nova, a merchant acquirer—and these are just some of the deals in recent history.

“On the whole, banks may be late responders in some of these areas but there are always early entrants doing interesting things, and there is usually an effective response to nonbank competition,” says Mateker.

But one analyst was firmer: “This has real potential to be a new era of disintermediation,” notes Ed Batchelder director with Dove Consulting, a division of Hitachi Consulting. “Much of this has to do with who does the best job of connecting with the consumer or business customer from a branding, product capability, and customer service perspective.”

Said differently, according to Gary Roboff, take any aspect of the payments value chain from origination to settlement, and only settlement remains firmly in the banking industry’s grip in the strictest sense.

Embracing new ways
Considering the scope of expected change ahead as society goes checkless—and cashless (or, at least, uses less cash)—it won’t be enough to function traditionally and hope to maintain an edge, consultants say.

Early adopters are in agreement. Even corporate America is gradually, with stops and starts, letting go of paper checks and records. Comerica’s McCarty says that when it comes to B2B, his institution is developing and actively pushing various types of corporate cards now, including stored value cards for T&E and benefits transfer as well as payroll cards. Moreover, the bank is explaining the merits of cards to a lower tier of the market.

McCarty, who sits on the ABA’s Payment Systems Committee, thinks that while the industry shouldn’t panic in the face of potential nonbank threats, it needs to move now.

Moreover banks need to consider creating an operational environment that is flexible, more easily re-engineered, particularly in a “mixed processing environment” where 279 million images are being exchanged. As high-growth debit, ARC, and other forms overshadow it, banks want to make a smooth transition.

Unisys, for instance, is helping the Fed with the rollout of a second-generation modernized check processing environment, notes David Luther, vice-president of global service practice for the BlueBell, Pa.-based firm. The company’s SOA-based Open Payments Platform is designed to meet ISO 222 standards and is also designed to scale up—and down. “We can help the Fed and others change processing rules easily or accommodate new payment forms,” says Luther.

As the mechanics of processing become less of a differentiator, it will be the ability to supply customers with valuable information that will matter almost as much as the convenience that a card, chip card, or eventually a mobile device supports, notes Jeff Hale, chief marketing officer at ACI Worldwide, Omaha, Neb. “It’s the information about the payment that’s important.”

Getting competitive again
Among many consultants, the thinking is that banks that wish to keep strong ties to consumers or businesses down the road will have to get into the scrum in the way that, say, Chase Paymentech has stepped it up to offer internet based merchant acquiring capabilities for small business (see May ABA BJ p.56) or US Bank has already done with its operations.

The latter, particularly on the consumer side, impresses Richard Westelman, also a director with Dove Consulting, as having picked up the mantel of payments again and worked hard to make card services and modern processing a central brand feature. There is also a push to re-engineer internally, essentially creating a streamlined payment hub that handles transactions for many different account types. While many individual payment executives at banks have this knowledge, banks are still struggling to actually hammer out the work and make the changes.

“You just don’t shut down check processing factories or branches in a day,” Westelman points out.

Of course, banks will find ways to cope with it,” Richard Oliver says. “We at the Fed are running a profitable ACH processing operation charging a quarter of a penny per transaction, as one example. It can be done.”

As has been widely reported, the Fed shut down 23 check processing facilities in three years and plans to shut down four more. They have made other changes, such as scaling back the transportation route and consolidating check adjustment functions within their scope of operations. BJ

Just when you thought debit was predictable...

It took years, but debit as a payment form has finally become commonplace. Case in point? MasterCard’s May 29th announcement of a study it did with Yankelovich which showed that debit card usage among women has more than doubled since 2003, growing from 20% to 43%.

No tiny segment, women—specifically 77% who are under 55—are said to have primary or shared fiscal decision making responsibilities, so it’s one indicator of note.

“Debit is also extremely popular with Gen Y segments and ‘mobilizers’,” says Richard Crone, president of Crone Consulting. “It’s an endorsement.”

But when it comes to debit, there’s another potentially less positive dimension: which firms will, in effect, dominate the space and will cards with new features have the potential to destabilize bank customer relationships.

Capital One Financial Corp. made headlines last month when it announced the issuance of debit cards that could be linked to accounts at any bank with payments routed across the ACH. For the industry, it is the most recent example of trying to rethink debit, a payment form that should continue to keep the checking account relevant in an era of Google, PayPal, and MySpace.

As the announcement indicates, this card product essentially separates the debit card from the checking account. In the short run, it could threaten to cut into banks’ interchange revenue from handling debit transactions.

In the long-run? Crone sees it as a kind of PayPal for the physical world, quipping, the company who “enrolls ‘em, controls ‘em.” Calling PayPal a “free rider” on the banking infrastructure, he sees interesting times ahead for the field.

As reported in American Banker, other companies have tried to promote the use of cards that use the ACH network but have had little success, because few merchants will accept such cards. Capital One says it has addressed that problem by working with MasterCard Inc.

The cards bear the MasterCard logo and can be used at any merchant that accepts MasterCard cards. The Purchase, N.Y., card company forwards the transaction information to Capital One, which generates ACH debits to customers’ bank accounts. —Lauren Bielski

The electronic version of this article available at: http://lb.ec2.nxtbook.com/nxtbooks/sb/ababj0707/index.php?startid=24