The self-service tills at Home Depot, a home-improvement store, offer customers an unexpected payment option alongside cards and cash: PayPal, an online-payments service that is trying to muscle into the offline sort. Users simply enter their phone number and a personal code; electronic magic takes care of the rest. Money is deducted from the user’s PayPal account and a receipt with details of the transaction is sent to their e-mail address. Purses or wallets do not come into it.
In several countries customers at Starbucks do not need to reach for cards or cash either. Coffee in hand, they can open the firm’s app on their mobile phones, hold up a barcode for the cashier to scan and the job is done. Rewards for frequent custom are automatically tallied up in their online account.
An even more hands-off payment option in many shops in America involves a firm called Square. Among other things, it offers a “virtual” wallet that stores details of a user’s credit cards and loyalty-scheme memberships and can be accessed via a mobile phone. To buy things with it, a customer does not even need to touch the phone — just have it with him.
Square’s app can be instructed to turn itself on and “check in” when the user enters a store in the firm’s network; when he wants to pay, all he has to do is to tell the cashier his name and that he is using Square. Signatures, PIN numbers, cards and barcodes are all done away with. Instead, the cashier’s system brings up a picture of the account-holder, to make sure he is who he claims to be, and Square sends him a text message confirming his purchase to make sure the charges are correct.
The world of payments is changing: people are buying ever more things online and increasingly with their phones. Whizz-bang technology can make transactions effortless or embed them seamlessly into other activities, such as booking a cab or searching for a nearby coffee shop. The numbers are becoming significant: PayPal has 143 million active accounts and handled $180 billion in payments last year. And new services to make spending money easier are springing up all the time.
They are not confined to the rich world: in Kenya roughly 60 percent of adults — about the same number as have a bank account — use a mobile-phone payment service called M-PESA, And increasingly they cater to business customers too: services that integrate electronic invoicing and payments into a firm’s procurement and accounting system, or that help manage and raise working capital, are becoming commonplace.
Not surprisingly, the titans of the internet have started to eye up the payments business. Google offers a virtual wallet; Amazon recently set up a service to allow its customers to transfer money; Facebook and Apple have expressed interest in the field. There is much speculation that the latest iPhone’s ability to read fingerprints may be heralding a world-changing payment service. Telecoms companies (such as Safaricom, the firm behind M-PESA) and bricks-and-mortar merchants (Starbucks) are also dabbling in the field.
Yet banks are largely absent from this technological and commercial battleground. Payments are a huge business for them, bringing in $1.3 trillion in 2012, or 34 percent of their global profits, according to McKinsey, a consultancy. And these revenues have been growing steadily: by 3 percent a year in 2008-12, compared with just 1 percent a year for other income. As in their lending businesses, however, banks are finding that new regulations eat into their revenue from payments. The main target has been interchange fees, as banks’ charges for processing credit- and debit-card payments are known. The European Parliament recently adopted a law that would cap these at 0.2 percent of the value of a transaction for debit cards and 0.3 percent for credit cards. In America the Dodd-Frank act of 2010 curbed interchange fees for debit cards.
The American authorities have also extracted big settlements from several card issuers for inveigling customers into buying expensive and unnecessary ancillary services, such as insurance against missed card payments. A similar scandal has cost banks dear in Britain. In many jurisdictions the credit-card networks have been investigated by competition authorities.
All this is a worry for banks because credit cards account for a big share of their revenue from payments — 41 percent in North America, according to McKinsey, although less elsewhere. And their use is growing fast, especially in booming emerging markets. In China, McKinsey expects it to increase by 42 percent a year between 2012 and 2017. Brazil is already the world’s second-biggest market for card transactions after the United States, according to Capgemini, another consultancy.
At the same time the wealth of new services is threatening to disrupt the payments business. A few upstarts — most notably Bitcoin, a troubled virtual currency — are seeking to bypass the existing payments infrastructure altogether. Bitcoin has proved a volatile store of value, but as a cheap, reliable and transparent way to make a transfer it is a notable success.
For the most part, however, the challenge is not head-on. In fact, by making it easier to buy things, most new payments services are pushing extra business to the existing channels, dominated by banks. When a consumer buys something using PayPal, he must still find a way to settle his PayPal account. That typically involves either a card payment or a direct transfer from a bank account. Equally, customers at Starbucks top up their loyalty-card balances or online accounts by conventional methods.
Square is perhaps the best example of this symbiosis: its clever mobile wallet is merely an offshoot of its main business, which makes it easier and cheaper for small merchants to accept credit cards. It has been so successful that it has spawned a host of imitators, including a European service called iZettle and an offering from PayPal called PayPal Here, all of which are now pushing millions of payments though the credit-card networks.
Nonetheless, such services can nibble away at banks’ revenues. In some countries PayPal steers users towards bank transfers rather than card transactions by charging lower fees for them. Such transfers are much cheaper for PayPal (and thus not nearly so lucrative for banks); they cost only a small fixed amount rather than a percentage of the payment. Moreover, when users add funds to their PayPal account in one go to cover more than one purchase, they cut down on the number of bank-mediated transactions.
Perhaps more important, banks are losing out on the information that comes with handling customers’ purchases directly and can then be used to steer advertising or provide other services. An American mobile-payments start-up called LevelUp, for instance, considers that opportunity so valuable that it offers merchants a discount on the interchange fees that it pays to banks on their behalf. In exchange, the merchants give LevelUp a share of the money customers spend using promotions delivered through LevelUp’s platform.
Consultants like to speak of “purchasing journeys” in which settling the bill is only the final step. Other waystations include advertising, internet search, participation in loyalty schemes and so on. Innovators, the thinking goes, could afford to undercut market prices for payments in anticipation of greater rewards at some other stage in the journey. “I could see Google running the payments business,” says Lee Kyriacou of Novantas, a consultancy. “Advertising could pay for the whole network.”
Tech firms are not the only potential usurpers. Retailers, too, are understandably eager to increase their leverage in the world of payments. In America an alliance of household names, including Walmart, CVS and ExxonMobil, is in the process of setting up a mobile-payments scheme called Merchant Customer Exchange. Such firms may well use their clout to get the banks to reduce their charges on card transactions.
Many telecoms firms, too, see the growth of mobile payments as their chance to break into a lucrative new business. AT&T, T-Mobile and Verizon, three of America’s four biggest mobile providers, have formed a consortium called Isis to develop their own mobile-payments system and virtual wallet. Similar outfits have sprung up in many other countries.
In the long run, banks risk becoming the providers of a cheap, commoditized service, with most of the money in the payments business going to firms that make customers’ lives easier or provide new services. As Capgemini put it in a recent report: “The payments-acquisition value chain is splitting — with transactional components becoming commoditized and customer-engagement components becoming differentiators.”
A good example of this sort of thing is a firm called Simple. It blends online and mobile banking with tools to help customers organize their finances through an elegant website and app. Customers can easily check not only their balance but also the amount that it is safe to spend, taking into account pending bills and recurring payments. They can set goals for savings and budgets for different categories of expenditure each month. Simple tracks their progress and can answer questions like “How much did I spend on clothes last year?”
Cherchez la banque
The most striking thing about Simple is that it is not a bank. As its website notes, “the funds in your Simple account are held by our partner bank, The Bancorp Bank, Member FDIC.” These accounts generate revenue in the normal way: from the spread between the interest they earn when lent out and the interest Simple pays on them, and from interchange fees from cards tied to the account. Simple provides the interface and in return splits the revenue with Bancorp. But customers learn the name of the bank where their money is held only if they read the fine print.
Even worse for banks would be a future in which people begin to store more of their money outside the banking sector and make payments that are not tied to a formal bank account. In a small way that is already happening in the rich world. Customers of firms such as Starbucks and Shell keep billions in the firms’ prepaid cards. “Open-loop” prepaid cards, which can be used at any retailer that accepts card payments, are also becoming more popular. Transaction volumes have been growing by 20 percent a year, according to Capgemini. Mercator Advisory Group, yet another consultancy, expects funds loaded onto such cards in America alone to reach $80 billion this year.
The issuers of the vast majority of prepaid cards are not banks; indeed the cards are often explicitly promoted as alternatives to a bank account. They usually allow holders to deposit checks, make and receive electronic payments and use cash machines. Big American retailers, including Walmart and Walgreens, are getting involved in the business, promoting prepaid cards through their shops and allowing customers to deposit money at their tills and withdraw it from cash machines on the premises. In addition to this marketing clout, prepaid cards hold a regulatory advantage in America: they are not subject to the interchange-fee restrictions that apply to debit cards.
The threat to banks from novel payments systems is even clearer in poorer countries, since a smaller share of the population is using a bank in the first place. MasterCard, for instance, is co-operating with the Nigerian government to issue national identity cards that can double as prepaid cards, in a deliberate effort to provide financial services to those without bank accounts. Visa is helping to develop a mobile-payments system in Rwanda.
When such schemes take off, they can quickly supplant banks as the main local conduit for money. Some 43 percent of Kenya’s GDP is channeled through M-PESA each year, according to Safaricom. M-PESA itself cannot offer interest-bearing accounts, loans or insurance but provides them through tie-ups with several local banks. The products concerned are available only to M-PESA customers and can be accessed only via a mobile phone. As with Simple, the banks seem to play a secondary role.
One of M-PESA’s advertisements shows a herdsman in traditional dress, surrounded by milling cows and goats, smiling as he reads a text message with an update on the credit in his account. Then a Sikh overseer on a building site realizes he can make his life much simpler by paying his workers via M-PESA instead of in cash. Next, a businessman on a plane reaches for his phone to pay his son’s school fees. The idea being rammed home is that M-PESA caters to all Kenyans, irrespective of their income.
Tomorrow the world
Vodafone, Safaricom’s parent, has rolled out M-PESA in several other African countries as well as in Afghanistan and India. In March it announced it would offer the service in Romania, where more than one-third of the population does not have a bank account. It says other countries in Europe will follow.
Banks are not ignoring these developments. They are sprucing up their websites and mobile apps and trying to develop catchy products of their own. Barclays, a big British bank, signed up 2.5 million users for its mobile money-transfer service, PingIt, in its first 18 months. Erste Group of Austria has developed a system called Erste Confirming that allows businesses to haggle over invoices, securing discounts for buyers and cheap loans against unpaid bills for suppliers.
If necessary, banks can always buy the technology they need or the companies that create it. BBVA, a Spanish bank, recently bought Simple for $117 million — a heady amount for a service with just 100,000 customers, but a trifle for a buyer with a market capitalization of €50 billion. And an American subsidiary of RBS has teamed up with Bottomline Technologies, a firm that helps businesses pay each other electronically, to beef up its corporate offering. But acquiring such businesses from the people who invented them will not turn the banks into bold innovators.
©The Economist Newspaper Limited, London, May 10, 2014