March 27, 2024 By John David (J.D.) Penner 3 min read

Here’s an argument for modernizing payments: Profits from traditional payment types are caught in a death spiral. As usage of traditional methods of payments decline, the high fixed cost to maintain them begins to seriously hurt margins as the revenue from smaller volumes declines. Increasing the price for the remaining transactions only hastens the decline. If you or your retirement savings are a shareholder of a bank, you care. 

The decline of cash 

Exhibit A: Australian banks are trying to figure out how to handle cash as its usage declines.   

There are considerable costs to banks who handle cash, which is why they often charge businesses for each cash deposit by volume. The decline in cash usage, accelerated by the pandemic, has undermined the economies of scale in handling it. Handling cash costs more per cash bundle now, since the smaller volume is spread over a large cost base. There has already been a consolidation in Australia among the armored car/cash handling companies, and now the last one standing is losing money. The banks are all in a pickle, since, among them, they have a high fixed cost to handle cash through their branch and ABM networks, and for the handling of cash from businesses.  

This will only get worse. Until you implement a system where everyone has access to digital payments (and it would need to be 100% of the population), you can’t eliminate cash. But bank shareholders won’t be tolerant of a bank whose profitability is being challenged because it ends up being one of the last bastions of cash handling. 

The decline of checks 

Exhibit B: Check processing volumes are also declining in most countries where this is still an accepted payment method. Again, as with cash, there are high operational costs that are associated with check processing, even if you have moved to image exchanges.  

There was a time that some banks outsourced check processing to third parties, but regardless, with declining volumes, the economies of scale dry up. The cost of maintaining systems to support elements such as imaging, Day 2 operations (such as returns), and exception handling are fixed. Once again, as a financial institution, if you still offer checks as a service offering, you will face declining margins. You might, of course, raise the price, but that would likely only accelerate the volume decline.  

The aging bill payment system 

Exhibit C: Pre-authorized debits, also known as ACH Debits, also known as SEPA Debits, and bill payments. In the Canadian case of bill payments, the nationwide Canadian bill payment system is built on a backbone relying on Electronic Data Interchange (EDI). But every single direct clearer in Canada has a legacy platform for EDI that is not supportable indefinitely.  

The banks have been asking their service providers and the payments system overseer, Payments Canada, what the future of this EDI system is. Satisfying answers are slow to come, since the investment to modernize and maintain a legacy system is not strategic if one is also contemplating its inevitable replacement with a real-time rail. Note, though, that Canada isn’t the only region that has yet to figure out how to handle debits with a real-time rail that only pushes credits. And Canada isn’t the only country with costly legacy systems pushing debits. 

So, what are the solutions?  

For cash, the answer is to move to central bank digital currencies, but several hurdles must be overcome, apart from the problem with ubiquity for the population. In the meantime, costs will rise as volumes fall. 

For checks and other legacy payment methods, the banks can forestall doom by adopting payments-as-a-service platforms that don’t rely on every bank having the systems within their four walls. IBM® can help in this area: the IBM Payments Center® has already proven we can deliver check servicing on the cloud. 

For pre-authorized debits, bill payments and EDI, a real-time rail with service overlays can be adopted. Such as the PayTo service overlay riding on NPP, found in Australia (which works just fine, by the way—ask an Aussie). Existing real-time payment services can accommodate richer, structured data for things such as bill payments. In some cases and jurisdictions, it’s simply that not all financial institutions have agreed to use the data fields or read them all the same way, a problem that might be easily solved with a little effort. 

It’s time banks and market infrastructures heeded the warning signs about legacy payment types, and started actively moving to solutions that remove cost and friction. The future can’t come soon enough for bank shareholders, consumers and businesses. 

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