Payments

How Banks Are Disrupting Payments – Two International Models

MEDICIGlobal Head of Content

There is an outstandingly large community of over 10,000 FinTech startups operating around the world – shedding international borders, democratizing remittances in the name of inclusion, facilitating inclusion through economic identity on the blockchain, and a lot more.

The FinTech startup community is very diverse and rich in ideas and solutions. We track around 50 FinTech sub-segments into which the 10,000+ startups fall, but there are only two categories continuously at the top of their game in terms of capital saturation and entrepreneurial activity – lending and payments. No wonder. The role models – Stripe, Square Cash, PayPal, M-Pesa, Alipay, and Venmo – opened the floodgates into the world of social payments and efficient e-commerce, demonstrating opportunities that technology brings into this segment. Let’s look at PayPal’s 2017 operating results for some numbers:

  • Active customer accounts of 227 million, up 15% with growth of 29 million net new actives

  • 7.6 billion payment transactions, up 24%

  • $451 billion in total payment volume (TPV), up 27% both on a spot and FX-neutral basis

  • 33.6 payment transactions per active account on a trailing 12-month basis, up 8%

Once the way was paved and proven to be lucrative, enthusiastic entrepreneurs knocked down a lot of VC doors to launch the next best thing in payments. In fact, within the payments segment, mobile wallets/payments represent the largest pieces of the pie – over 30% of the companies, according to MEDICI data.

For a brief moment there, the bank-FinTech narrative was in the stage of the perceived competition and winner-take-all attitude. But the narrative evolved, and institutions went through a rich stage of exploration, collaborative relationships, and extensive learning when partnerships were formed and startups acquired. As we have entered the stage of the Hybrid strategy, an interesting process is gradually taking place around the world in some of the most advanced economies.

While banks were not as fast in making decisions and getting their hands dirty as startups (that had the luxury to do so for a long time), what really matters in the payments sphere is the endgame. That is because payments is the area where the ever-increasing granularity of the market is not in the interest of any party involved. And in certain nations, banks are ready to take over the innovation race with a radical response to traditional payments rails – Visa and MasterCard, for example – as well to the diverse startup ecosystem in this popularized segment.

Certain national banking ecosystems are ahead of the world with their approach to changing the rules of the game in payments – US (Zelle), Australia (NPP), India (UPI by NPCI), China (IBPS), Japan (MoneyTap), and a dozen more jurisdictions where central banks have real-time interbank payments solutions, powered by a range of institutions. Published in 2017, FIS Flavors of Fast uncovers the world of real-time payments that’s been boiling within the institutional financial system.

There are two interesting models I’d like to pay attention to: the first one – open model, where banks build and control the processing infrastructure, but leave the front-end competition to the market (hence enabling modular entities); and the second one – where banks are uniting into consortiums to control both parts of the business, processing and user interface, through their own solutions.

Modular framework (central banks are offering robust infrastructure)

Among the most impressive machines falling into the first model is China’s Internet Banking Payment System (IBPS), a part of an established second-generation payment system developed by the People’s Bank of China.

“IBPS connects the online banking systems of the various commercial banks. Payments between banks can be received in near real time, with acknowledgments within 20 seconds.

China offers credit transfers (push payments) and considers direct debits are considered as pull payments. IBPS is ISO 20002-based and is the latest service to operate on the foundation of the China National Advanced Payment System (CNAPS II) interbank clearing platform.

Over recent years, the use of IBPS has skyrocketed. By the end of 2016, there were 195 institutions with direct access to the online payment interbank clearing system. In 2016, the internet interbank settlement systems handled around 4.453 billion payments to the tune of about 37.46 trillion yuan. This represents a growth of over 50% in volume and 35% in value.”

FIS reports that going forward, the expectations are that banks and more interestingly third-party organizations will develop new and innovative products & services on top of the IBPS platform, leading to higher market penetration and dominance.

China’s IBPS is reminiscent of the NPCI UPI model, where the state builds a universal infrastructure, seamlessly powering payments across both sides of the industry – banks and compliant third-parties. UPI is a platform designed for the mobile age that helps with easy integration of various payment platforms. UPI is powered by a single payment API and a set of supporting APIs. It has a fantastic value proposition including a simple authentication process, simple issuance & acquiring infrastructure, national interoperability, and more.

UPI has reshaped entity-entity relationships (whatever entities those are – merchants, payment gateways, banks, network owners).

As Harshil Mathur, Co-founder & CEO of Razorpay, explained, “…instead of having to build 57 bank relationships a gateway has to build right now, it needs to build only one relationship with the UPI. So it will ease our efforts and help out the merchant.”

Australia’s NPP is also a very important example of how institutions are redefining payments framework on a national level.

As described by Nathan Lynch, Regional Bureau Chief, APAC, Financial Crime & Risk – Thomson Reuters, the Reserve Bank of Australia had insisted that the NPP platform be designed using a distributed layered architecture. This meant the system would be divided into a Basic Infrastructure (BI) layer and have a range of Overlay Services (OS) that could sit on top, allowing innovation and flexibility at the user interface level.

“The BI consists of distributed connectivity points (banks), message flows, a switch, a fast settlement service, and an addressing service. The OS, meanwhile, promises to allow NPP participants, approved third parties and “FinTechs” to develop payment services that sit on top of the basic layer. This forward-looking design means the platform can evolve while the underlying architecture remains stable.”

Infrastructure + front-end competition with proprietary solutions

The second model is a bit more radical than the first one: bank-owned front-end as opposed to the back-end infrastructure (or, in other words, the modular model).

There is one well-known – Zelle in the US – and another one that just made its debut in the news – Japan’s MoneyTap.

This Monday, Ripple announced that the Japan Bank Consortium (comprised of 61 banks covering more than 80% of all banking assets in Japan) will release a smartphone application called “MoneyTap” – powered by Ripple’s blockchain technology – to allow customers of the bank consortium to settle transactions instantly, 24/7. MoneyTap is the first mobile app of its kind to be developed and used by multiple banks in the country.

Three members of the Japan bank consortium: SBI Net Sumishin Bank, Suruga Bank, and Resona Bank will be the first to go live on the mobile app in autumn of 2018. This will be followed by a staggered roll out to the rest of consortium.

MoneyTap allows the bank consortium customers to make instant domestic payments and only requires a bank account, phone number, or QR code. What’s more, Ripple shares, MoneyTap helps shed the costs associated with existing banking and ATM fees that are currently applied to domestic money transfers in Japan, making those payments not just faster, but cheaper overall.

Zelle is the US equivalent of what Japan is doing. In 2011, Bank of America, Wells Fargo, and JPMorgan Chase teamed up to work on a digital payments solution that would allow their customers to send money to each other. The first product they developed, with the help of bank-owned company Early Warning, was called clearXchange. The solution was officially rebranded as Zelle in June 2017, with an emphasis on bringing as many financial institutions onboard as possible.

Under the covers, Zelle still functions by combining a directory of emails and phone numbers matched to bank account data along network rules for moving money along the ACH network. Thanks to bank agreements, the money is made available immediately to the receiving user, despite the overnight timing of the actual money movement.

With eventual cooperation from more than 30 of the leading financial institutions in the United States and the world, Zelle is successfully gaining ground. About $1.5 billion worth of payments were processed through Zelle just in October 2017, which is up 90% from the same month last year. At that time, Zelle counted 2.5 million active users, with thousands more signing on every day. At the end of Q3 2017, BofA had 23.6 million active users of its mobile app. The volume of mobile check deposits made on the app corresponds to the work of 1,100 branches.

There are significantly many more examples we could cover – variations of those models and their mix exist across a large number of jurisdictions. But all of this to make an important observation – banks are taking full control over payments. Here is why it’s important: the reality is that financial institutions in developed economies service a large part of the national population, and in economies with a significant number of underbanked, they are looking to offer the easiest way to get plugged into the world of digital financial services. Both models have their advantages and challenges for different types of economies, but one thing is clear – they are run or majorly controlled by banks, not by startups or processors.

Elena Mesropyan

MEDICIGlobal Head of Content

Global Head of Content, MEDICI

Elena is a research professional with a background in social sciences and extensive experience in consumer behavior studies and marketing analytics. She is passionate about technologies enabling financial inclusion for underprivileged and vulnerable groups of the population around the world.