Last year’s World Payments Report published by Cap Gemini and BNP Paribas, highlighted the emergence of a new payments ecosystem. This is driven by changing corporate and customer expectations for value-added services, a dynamic regulatory landscape and Fintech innovation and growth.
Plus of course an increase in payments-enabling technologies.
All of these factors are contributing to a very significant rise in the innovation, deployment and adoption of alternative payment methods (APMs).
And it provides a significant challenge to the mainstream credit card schemes like Visa, Mastercard and American Express, as well as the incumbent banks.
APMs include digital or e-wallets, such as PayPal, Alipay and Yandex.Money, mobile payments, such as Apple Pay, Google Pay and M-Pesa, prepaid cards and online bank transfers.
Rapid Growth of payments fintechs
The rapid growth in APMs looks set to continue. Factors including mobility, connected homes and devices, the proliferation of alternative payment channels such as contactless, virtual reality and wearables, and the adoption of new(ish) technologies such as Internet of Things (IoT) and Blockchain are all expected to drive up the volume of non-cash transactions in the next few years.
In the near future it seems very likely that the majority of payments will flow outside the traditional banking network.
Globally, payments regulators are supporting this trend by encouraging competition and innovation in the payments arena. This is helping Fintechs to flourish and collaborations with the incumbent banks continue to succeed. In Europe, the revised Payments Services Directive (PSD2) as well as equivalent Open Banking initiatives elsewhere, are forcing banks, when requested, to share their customers’ data with third party providers.
These reforms are aimed at boosting competition. New players are emerging such as digital-only challenger banks Starling, Revolut and Monzo. Plus, the US and Chinese tech giants also want a piece of the action.
Faced with this increased competition, do the traditional banks stand a chance of becoming the digital platforms of tomorrow? Well, the incumbents still have some advantages. The regulatory challenge of providing full-service banking is complex and expensive. Moreover, the cost of getting it wrong in terms of fines and reputational damage, can be high.
The new pan-EU PSD2 payments regime came into force on 13 January 2018. This was implemented in the UK by the Payment Services Regulations 2017. There are also myriad other regulatory compliance issues to be considered. In particular, these are in the areas of anti-money laundering (AML) and counter-terrorist financing, data protection (e.g. GDPR), cyber and payments security.
Although changing client demand, the rise of the smartphone and the introduction of new digital technologies appear to have replaced post-financial crisis regulation as the primary drivers of strategic thinking at global banks.
The banks and PSPs are also facing a tougher rule book, especially in Europe and North America. In particular, PSD2, and its regulatory technical standards (RTS) focus on strong customer authentication (SCA) and common and secure communication (CSC). This is intended to help banks collaborate securely with third parties. Similar initiatives are expected to follow around the world.
4th AML directive
In the AML space, the Fourth Anti-Money Laundering Directive has replaced the tick-box approach to checking new customers and monitoring existing ones. In its place comes a new risk-based approach.
This requires banks, PSPs and other entities to apply enhanced checks on everything from identity to beneficial ownership if they think a customer is a greater risk.
Also, faced with multiple AML failures within the payments arena, such as German regulator BaFin’s recent action to order Deutsche Bank to strengthen its client identification processes, and ING’s €775m settlement with the Dutch public prosecutor resulting from flawed customer due diligence policies, it has emerged that even tougher AML regulation is under consideration.
The EC plans to amend the Regulation which established the EBA to add AML supervision to the EBA’s regulatory powers. The proposal would see the EBA operating as a super-regulator across Europe.
It will have powers to ensure cooperation and exchange of information between the national supervisors, to ensure effective enforcement of the rules. It will also have powers to request that supervisors investigate alleged money laundering incidents.
According to a recent Economist Intelligence Unit report “if you don’t have a digital strategy, your bank is already dead”. In terms of a strategy for fighting back against Fintechs and other new market entrants, bankers see two main options.
Firstly: specialisation by market or product. Second; play the Fintech’s at their own game. The challenge for the incumbents is how to collaborate with the ecosystem of FinTech’s even as they present competitive challenges. All of this while undergoing digital transformation and updating and rationalising their branch infrastructures. And all against a back-drop of tougher regulations and increased fines.
Tim Wright is a partner at Pillsbury Winthrop Shaw Pittman LLP