Editor’s Note: Payments are an essential way bank providers, both big and small, keep a steady income and maintain customer relationships. With an increasing appetite to provide digital-focused financial services, the payments business that banks rely on is at risk of being controlled by new FinTech firms. Staying competitive in a digital market and modernizing payments at traditional banks requires the agility of cloud-based solutions and reliable network security.
It is difficult to overstate the importance of payments to the banking industry. Facilitating transactions sits at the center of the customer relationship and bank profitability, accounting, directly or indirectly, for up to 30% of some banks’ income. Now that position is under threat.
FinTech competitors have walked through an open door by exploiting digital-first business models and offering interesting payment solutions. These new rivals often target specific customer verticals (and their differentiated needs), employ new value propositions, and scale rapidly. Banks have been slow to respond to this competitive threat and have fallen behind.
The prospect of losing more of the payments business to FinTechs is emerging as a fundamental threat to many banking franchises. Simply put, banks need payments for customer interactions and profit pools. Without the payments business, banks risk losing important income streams, customer relationships, and ultimately the institution.
A rapidly evolving environment
The ongoing digital transformation is disrupting strategies and business models in many industries. The pace of innovation and change in customer expectations, accelerated by the COVID-19 pandemic, has placed a premium on embracing new ways of pursuing growth.
Payments, a high-volume transactional business, is well-suited to technological innovation. Payment methods that address new types of consumer needs, from buy-now-pay-later (BNPL) products to digital wallets that enable person-to-person (P2P) payments or offer consumer rewards, have grown in popularity. The competitive landscape in business payments also has created expectations of new capabilities, such as application programming interfaces (APIs) to embed payments in other ecosystems and global pay-outs. Real-time payment rails are about to unleash a whole new wave of use cases and opportunities.
Leading P2P payments firms now have more customers than the largest bank and are adding bank-like accounts and services to compete for what banks now have—status as customers’ primary financial relationship, with the profitability potential it affords.
“The goal for banks should be to make payments the center of how their companies run and grow their business—moving away from a commodity solution toward business-critical value-added services,” says Sara Elinson, EY Americas FinTech M&A Leader and EY Americas Payments M&A Leader, Ernst & Young Capital Advisors, LLC US Financial Technology Investment Banking, Senior Managing Director.
The market has noted the difference. Valuations of FinTech firms in the payments space grew at an annual compound rate of 27% between 2016 and 2020, according to an EY analysis. Over the same period, banks saw their market capitalizations decline by 1%. There are many reasons for the difference, but the loss of payments-related revenues and relationships is among the most significant factors.
How banks can position themselves for payments success
Competing in this new environment requires banks to embrace digitalization and transform their business models in ways that might, at times, feel counterintuitive—partnering with competitors, for example, or crossing organizational silos—but can create compelling benefits for consumers and merchants.
We believe banks can focus on five strategies to defend—and grow—their payments business going forward.
Focus on distinct verticals
Banks traditionally have operated locally, taking a one-size-fits-all approach to meeting the payments needs of all industries in their geographic footprints. While that made sense in an earlier era, the reach afforded by digitalization makes it more effective to specialize by offering solutions that meet the specific needs of customer verticals.
For example, JP Morgan Chase targets a distinct vertical—healthcare—with a unique payment solution that integrates payments into healthcare systems, standards and data.
In the US, there are at least 30 verticals that generate more than US$100B in consumer spending and at least US$250M in payments revenue. Each of those industries, ranging from restaurants to educational services providers and faith-based organizations, has distinct payment needs, driven by their customer bases, business models and payments systems. For example, small retailers might favor a solution that efficiently processes large volumes of small payments in-store while hospitals might value help with invoicing for larger payments and the associated insurance paperwork.
Banks can identify which industries align best with their broader strategies and customer bases, and then build distinct, dedicated value propositions to win their payments business.
Leverage partnerships and ecosystems
In a world dominated by e-commerce, the path to growth and relevance lies in aiding customers’ digital journeys by embedding payments and complementary capabilities, such as payroll services or online ordering, into other firms’ ecosystems. In EY’s 2021 NextWave Consumer Financial Research survey, 63% of consumers said they would “highly value” embedded finance solutions and open banking that integrate and personalize their experiences across third-party ecosystems.
Modularizing payments products and services, so they can be deployed via APIs on third-party platforms, is table stakes for participating in ecosystems. The bigger challenge comes in determining how to profit from those capabilities.
FinTech firms are adept at partnering with nonfinancial firms. For example, Stripe allows hundreds of partners to integrate industry-specific capabilities with a single click. Those capabilities range from specialized accounting software and fraud-prevention tools to point-of-sale and billing systems.
Banks can succeed by adopting targeted ecosystem strategies and business models that play to their broader strategic goals. They can act as a behind-the-scenes financial utility, for example, or target specific segments by using ecosystem data to create customized value propositions, such as personalized rewards programs or credentials for faster checkouts, to win new customers.
No payment provider today can survive on its own. Collaborating and working with other firms that serve the same client base to create customer-centric solutions will be an increasingly crucial driver of success.
Bring the bank into the payments proposition
FinTech firms are the primary innovators in the payments space, and banks struggle to keep pace. Banks can turn the tables by incorporating their inherent advantages—strong balance sheets, deposit funding, customer data, regulatory expertise and trusted local brands—to make the payments experience more personalized.
For example, banks can leverage the knowledge of their customer bases to provide data-driven insights on shopping and spending habits that can help merchants grow their businesses. They also can incorporate same-day funding, cash-flow loans, and other bank products into their payment propositions.
To win in payments, banks can find ways to offer value where FinTechs cannot: by bringing the bank and all its capabilities into the value proposition.
Organize around a commerce proposition
By creating more holistic payment propositions, banks can help merchants meet a variety of complementary needs. Already, some banks are including data-driven decision-making and post-purchase support, invoicing, loyalty programs, and other value-added services to make their payments offerings stickier, more profitable, and at the core of the customer’s ability to thrive. The goal for banks should be to make payments the center of how their companies run and grow their business—moving away from a commodity solution toward business-critical value-added services.
For example, India’s Paytm offers a merchant dashboard with real-time analytics to measure business performance and enable quick decision-making. Mastercard’s SessionM unit provides users with actionable information to help personalize customer experiences and make loyalty programs more impactful.
Organizing around broad commerce propositions that place the merchant’s needs first is critical to a holistic approach. Payments leaders work to expand across the value chain, often using data as the glue to bridge propositions. Approaching the payments business as something more than payments can enhance the experience and make those relationships more profitable.
Modernize technology and data capabilities
Successful payments business models are data-driven, automated and connected. Key enablers, such as APIs, microservices, artificial intelligence and cloud services, are now considered vital to building out competitive service offerings in target verticals or ecosystems.
Banks can take different pathways to modernization. For some, working around the existing core to enable orchestrated payments capabilities via APIs can mitigate transformation risk and enable quick, incremental updates. For others, it might make more sense to build or buy a greenfield core to help power a new ecosystem or vertical-market business model.
The number and types of capabilities required for a comprehensive offering are beyond most banks’ abilities to build. Often, the most effective way to obtain them is through partnerships with FinTech firms. Many banks employ a strategic build/buy/partner analytic framework to assess the costs and opportunities of each approach and inform their decision-making.
Regaining payments leadership can drive banks’ growth
Payments are a crucial part of bank growth strategies—a source of revenue and foundational to relationship-building efforts. While banks have been slow reacting to the competitive threat posed by FinTech firms and other innovators, there is still time to respond. By combining traditional bank strengths with new technologies, business models and value propositions, banks can regain their leadership position in payments.