Payments modernization reminds me of bathing toddlers. It could sometimes be quite a project at our house, when our boys were toddlers, with splashing, shouting, and arguments over bath toys. So why bathe both at once? Because the alternative is even more work, especially if you are the only parent available. The challenge of bathing two toddlers together is nothing next to the challenge of bathing one toddler while chasing the other around the house — twice.
Many financial institutions (FIs) are in the throes of modernizing their own payments infrastructures individually, and they are each figuring out how to develop and deploy systems that all do essentially the same thing. This is like trying to bathe two children separately, using the same resources each time, and missing the efficiency of accomplishing both jobs at once.
Where banks lose money on payment modernization
In some jurisdictions, FIs have collaborated to establish a common set of standards and processes for payment market infrastructures, such as NPP in Australia, Lynx in Canada, or TCH RTP in the United States, to name a few. Helping establish a new payments market infrastructure is only one aspect. For every new market infrastructure or change in payment message format, each FI still needs to build their own capabilities to connect to those new systems. As the entry points and gatekeepers for their end users into those new market infrastructures, does it really make sense for each FI to tackle the same problem separately in their own shops using essentially the same tools?
More specifically, the challenge is true for the payment technologies each FI uses in their middle and back-end layers for validating, processing, clearing, and settling payments. The costs involved in these developments, for a new rail or even just a new messaging standard such as the SWIFT MX standard, can be quite high. For many there is simply no business case that supports the necessary changes. There is little new, incremental revenue to be gained from developing a new payment system that will simply see existing volumes shift from one rail or format to another. The incentive for most financial institutions is that if they don’t modernize and their competitors do, they may lose customers to the competition, thus losing both fee revenue and the deposit balances that support those customers’ payments. Those deposit balances are what banks chase for their fundamental business of lending.
In some cases, when customers adopt a new payment rail, an FI may see lower revenue from fees than what they earned with an older payment method. Consider a business accepting real-time or near-real-time payments such as Interac e-Transfer, TCH RTP, Zelle, Faster Payments, etc. Those payments may have previously been made by credit card, a more lucrative form of payment for issuing FIs. In many jurisdictions, the FIs have offered these newer payment types for low or no fees, due to competitive pressures. The FI pays a high cost to build and maintain systems just to keep the client business they already have. It may even lose revenue, while tying up resources in the deployment process with essentially no return on the investment. The FI also faces the ongoing cost of maintaining and upgrading those systems over time. To invest in new systems at a high cost while forgoing revenue is a lose-lose proposition.
How banks can save costs and retain customers through payment modernization
The differentiating benefits of modernized payment systems for FIs and their customers are not found in the “back-office” processing, clearing, and settlement systems. They are found in the front-end features and functions provided to the customers, including retail, business and government clients, who initiate and receive payments. Those are what attract and retain customers. It simply makes economic sense to turn to a cloud-based payments-as-a-service, pay-as-you-go model to fulfill an FI’s back-end processing and operational needs, while spending more time and money on the front-end: delivering value-added services to their customers. Since some cloud-based payment services already exist, and are, in some cases, used by more than one FI, what’s left for the FI is the front-end and integration costs for the new system – costs they would have had anyway.
In a recent survey of 300 financial institution IT and operations executives from around the world, 84% said that their IT environment has changed more in the last 12 months than in the company’s lifespan. Moreover, 88% of those surveyed stated that short-term thinking has IT and operations teams choosing options of lower quality, partly hampered by inadequate budgets, resulting in poor system resiliency.
It’s becoming clear that financial institutions need to actively consider new models for payments that don’t extend or exacerbate their existing IT challenges — or introduce new ones — due to short-term thinking. Many other industries have shifted to cloud-based, as-a-service models that have helped them advance their interests and provide better value to their investors and customers. These models are used by multiple organizations, allowing them to share the same resources at a lower cost. It’s time financial institutions did the same with their payment systems.