The New Payments Revolution

Banks have a fairly privileged position. We trust them with our deposits. They turn these into loans in their capacity as financial intermediaries. In normal times, it’s a pretty good business. As the famous Citibanker, Walter Wriston, said, when asked to sum up the business of banking: “I borrow at three, I lend at six and I’m on the golf course at two.”

But there is another side to the business of banking that is thought of less but is perhaps even more important than lending and deposits – that is the world of payments.

Banks are responsible for the payments system and until now they pretty much had things their own way.

You make payments off a current account and you are likely to be charged per transaction. Own a credit card and you will be hit for fees and interest once you roll over. It’s an incredibly lucrative business.

The plastic card – more particularly the magnetic stripe card – was invented in the 1960s. It was American Express and American Airlines that in 1970 first harnessed its capabilities. It arrived in tandem with the Boeing 747 and it was intended to help cope with the large increase in passengers that particular new aircraft could carry.

In the AA/Amex application, the magnetic striped cards were used as transaction cards in all kinds of self-service operations: reservations, ticketing, cash dispensers, POS units and access devices, including employee identification and access control.

In banking, magnetic stripe cards were first used with self-service cash dispensers and, later, with Automatic Teller Machines (ATMs). Mag stripe cards were then displaced by the chip card or smart card, with better security and capable of holding far more information.

But the significance of magnetic stripe technology in banking was not just about an extension of services, but rather about modification of consumer behavior that had led to the realisation of massive efficiencies in consumer banking through self-service.

This primarily revolves around point of sale (POS). Magnetic stripe/chip technology acts in concert with the POS units used in just about every retail outlet. The process combines stripe/chip readers with barcode readers for item tags and identification. Sales and payment is therefore a relatively simple process that can be carried out easily by relatively unskilled staff. The information is easily captured and recorded.

The plastic payment card will be with us for some time to come but it is gradually – but increasingly – being displaced by the mobile device. In the developing world the effect has been astonishing and the mobile phone has opened up financial access to millions of unbanked who can now make payments through their mobiles without journeying for miles through difficult terrain while carrying cash.

But in the developed world it is the smartphone that is stoking the revolution.

It’s easy to forget the stunning array of qualities today’s high-end smartphone possesses and how they are positioned to make the world of banking and payments unrecognisable:

• It has a high resolution visual display with a considerable viewing area capable of displaying visual information legibly and in an attractive manner
• It has an Internet browser
• It can send and receive email messages and “instant” messages
• It has a camera and scanner capable of reading barcode and QR code
• It has navigational tools and can self-locate and transmit that location thanks to GPS positioning
• It has a host of applications ranging from calendar, notebook, address book to gaming and shopping
• It can make and receive voice and video calls

The nirvana of mobile payments – and mobile banking – is the mobile wallet, which is increasingly being deployed worldwide. Here, the smartphone doubles as an electronic wallet, replacing cash, credit and debit cards as well as other identification materials. In the smartphone-enabled world of payments, a simple wave or tap of the phone results in instant payment at point of sale thanks to NFC (near field communications) technology.

But the potential is much, much greater – for customers, merchants and (virtual) “card” issuers alike.

From a merchant perspective, particularly those competing with online retailers, the value of customer data is priceless and allows them to practice incredibly sophisticated and targeted marketing. In the new world of payments, customers who choose to opt in to merchant programmes will constantly be offered virtual discount coupons over the phone. You will enter a shop and immediately be offered deals based on your preferences because your card issuer or network knows what you like. You will be offered discounts based on your physical location.

So, while revenue from payments has in the past been lucrative for bank card issuers, it stands to be dwarfed by revenues from associated e-commerce – but it may have to be shared with many more parties.

It is vitally important for banks that they benefit from this new world. Regulators are putting pressure on interchange fees (the fees issuers get from each card-based transaction). But banks are certainly not the only players in the new payments landscape.

New entrants are piling in to the market and showing far more innovation than the banks. Facilitated by the EU’s Payment Services Directive that has lowered the barriers to entry, they are using the mobile device as the enabling technology to win over the customer.

One such outfit is Dublin-based 3V that worked on the O2 money card. For CEO Kieron Guilfoyle, it is now possible to set up a “quasi-bank” where the entity regulated under the PSD or the E-Money Directive can now handle client funds just like a bank – so long as client funds are lodged with a licenced bank (3V is in the process of being regulated).

These quasi-banks will – and are already – offer vastly more sophisticated financial services with a far more user-friendly, digital experience than banks at present – the only difference is that they won’t be able to lend.

But then again, as Irish banks have found to their cost, the lending business isn’t what it used to be.