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Overview of the Payments Industry

The Ecosystem, Consumer & Wholesale Payments, and the Application of New Technologies

The Evolution of Channels and Means

Money and the idea of its exchange through payments have evolved a lot from the time of its inception. From goods to grain, from metal coins to paper, from bank accounts to e-wallets, money has taken various shapes, sizes, and forms. Payments evolved from a barter system (exchange of goods for grains) to the token system (exchange of coins and cash on paper) to cash pooling (bank accounts and deposits) to cashless payments (credit cards, checks, e-wallets). Over the last decade or so, payment technologies have grown at a dizzying pace.

Payments are now evolving at a rapid pace with new providers, new platforms, and new payment tools launching on a near daily basis. As consumer behavior evolves, an expectation of omnicommerce emerges – that is the ability to pay with the same method whether buying in-store, online or via a mobile device. This shift precipitates a need for retailers to adapt toward fast, simple and secure mobile payments.

The payments industry would be in a transformational state in 2017. The ongoing war with alternative payment channels will intensify and challenges in emerging markets would force the incumbents to take drastic measures. Some key drivers would be:

1. Real-Time Payments: RTP represents a new phase of evolution within the payments industry, with several key features that differentiate them from current payment methods, specifically speed, value-added messaging capabilities and immediate availability of transaction status. RTP will provide FIs with the functionality/features to innovate and meet customer demand.

2. Distributed Ledger Technology (DLT)/Blockchain: Blockchain has the potential to completely change the financial transaction processing cost model amongst its various applications. It also enables all processing to be done over a distributed system network or in the cloud, avoiding the usage of costly data centers or mainframes.

3. Expansion of Payments to Non-Physical Interfaces: Traditional interfaces are challenged by external stakeholders (Amazon, Google, Facebook, and Apple) in two ways – voice assistants and VR. Connected assistants become smarter and add functionality with the enhancement of NLP and image recognition. Betting on physical interfaces, and mobile, in particular, can no longer ensure long-term relevance as voice-first solutions evolve. WithFacebook obsessed on killing the smartphone to own a virtual space, classic interfaces and solutions developed for them will gradually fall out of grace.

4. Unified Platforms: The first Visa/Mastercard/SWIFT-free payments system – the Unified Payments Interface (UPI) by NPCI was launched in 2016. UPI is an open-source 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. UPI offers a whole new model of the financial services industry ecosystem. UPI became a starting point of what SWIFT called a journey to a single payments platform. UPI is a benchmark to what the payments landscape should be moving towards given that oversaturated payments ecosystem, where too many ‘pay’s’ won’t let anyone win. Disjoint experiences across businesses create customer confusion, and, at the end, with a limited customer base, limit opportunities for every payment service provider – existing and new. Professionals from SWIFT emphasize that the payments industry must migrate from a plethora of aging and expensive systems and schemes to a single platform to process all payments. However, a single payment experience for customers (based on seamless system interoperability, comparable to mobile telephony) is a more probable future than a single payments platform.

Participants

Source: Overview of the Payments Ecosystem – Electronic Transactions Association

Channels

Here are three main payment channels based on market participants and underlying funding mechanisms:

  • B2C

  • C2C

  • B2B

Regulation, demographics, and technology are affecting B2C and B2B in various ways. Technology is most actively shaping C2C payments while B2C and C2B have not been left behind with technology partnerships mushrooming across banks, enterprises, and startups. C2C payments have the highest potential to evolve as a result of several factors:

  • Convenience and ease of use

  • Lack of entrenched counterparties such as businesses, which are typically much slower to adopt new business processes

  • Lack of stickiness for incumbent service providers such as offers and rewards

Processors for the payment systems can use different channels to make a payment and each has different operating characteristics, rules and settlement mechanisms. All payment systems can be broadly placed into one of the following four payment channels:

  • Paper-Based systems such as checks or drafts. Payments are initiated when one party writes an instruction on paper to pay another. These systems are one of the oldest forms of non-cash payment systems. Checks are a common paper-based channel and are still widely used in the United States and a few other countries.

    • RTGS (Real Time Gross Settlement) or High-Value Payments, commonly called wire transfers. Wires came into being in the late 1800s with the invention of the telegraph but did not become widely used until the early 1900s.

    • RTNS, or Real Time Net Settlement systems or Automated Clearing House (ACH) batch payments were introduced in the early 1970s and were designed to replace checks with electronic payments. Unlike wires, which are processed individually, ACH payments are processed in batches and were originally intended for small payments under $100,000 such as payroll and consumer transactions.

    • Cards are a payment channel that includes credit, debit and stored value cards. They are a fast growing segment of the methods for making and receiving payments.

    • Mobile payment is defined as the use of mobile phone to pay for the purchase of goods and services at a retail POS terminal or on the Internet. Payment may be initiated via SMS text message, mobile browser, downloadable app, contactless near-field communication (NFC), or quick response (QR) code. As more and more smartphone owners use their devices to pay for products online, mobile payment services are predicted to grow rapidly. At the same time, the emergence of one-touch checkout buttons, P2P payments and the rise of sharing economies have created new opportunities for remote mobile payments.

    • Real-Time Low-value payments provide consumers and businesses with the ability to conveniently send and receive immediate fund transfers directly from their accounts at FIs, anytime 24/7/365. Financial institutions can leverage a variety of features – enhanced speed, security, and messaging capabilities – to create unique offerings for their retail and corporate customers. RTP also provides a backbone on which new business models can be redefined.

Payments Schemes

Source: What does the payment ecosystem look like?, Ecommerce Foundation

OBeP Scheme

The Online Banking ePayments (OBeP) scheme is a type of payments network, developed by the local or international banking industry – in conjunction with technology providers – designed to facilitate online bank transfers or direct debits.

In an OBeP scheme, the consumer is authenticated in real-time by the consumer’s financial institution’s online banking infrastructure. The availability of funds is validated in real-time and the consumer’s financial institution provides a guarantee of the payment to the merchant in case the payment is made as a credit transfer (push payment): the consumer/buyer initiates the payment. In case the merchant initiates the payment – a debit transfer (pull payment) – the consumer is protected from wrong debits and has the right to reverse the payment depending on scheme regulation and market legislation.

OBeP schemes often allow for direct merchant integration and do guarantee the payment to merchants. Other benefits are the relatively low transaction cost compared to card, wallet or other alternative payments.

OBeP Types

Across markets, there are several OBeP scheme types to distinguish:

  • Mono-Bank OBeP Scheme: Entails that a seller or Payment Service Provider has a separate connection to each participating financial institution.

  • Multi-Bank OBeP Scheme: Entails that a seller or Payment Service Provider has one single connection to the OBeP network in order to accept payment from any participating financial institution (Ex.: the iDEAL scheme in the Netherlands and BankAxess in Norway)

  • Overlay OBeP Scheme: Similar to the Multi-Bank or Mono-Bank scheme, however, there is a third party (the overlay provider) who sits between the payment network and the consumer. The overlay provider requires the consumer to share their online banking credentials with them in order to have access to the consumer’s bank account and to initiate the credit transfer to the merchant. (e.g. SOFORT banking, or SOFORT Überweisung)

Three-Party Model

A three-party scheme consists of three main parties whereby the issuer – who has the relationship with the cardholder – and the acquirer – who has the relationship with the merchant – is the same entity. The three parties consist of the consumer, the merchant and the scheme.

Often the three-party model is a franchise set-up, whereby there is only one franchisee in the market. There is no competition within the brand; however, there is competition with other card brands and other alternative payment methods. Some examples of three-party card schemes: Diners Club International, Discover, and American Express.

In the last few years, these schemes have also partnered with other issuers and acquirers to ensure issuance and acceptance of their card brand. These schemes could be seen as ‘premium’ card schemes as they tend to have strong cardholder focus and to provide additional privileges for cardholders. Merchants are often charged a relatively high merchant commission rate.

Four-Party Model

In a four-party scheme, the issuer – who has the relationship with the cardholder – and the acquirer, who has the relationship with the merchant, are different entities. The four parties consist of the consumer, the merchant, the issuer and the acquirer. These four-party schemes are referred to as ‘open schemes’ as they allow banks and financial institutions to join, to start issuing their cards and/or to acquire merchants for card acceptance. In principle, there is no limitation to who may join the scheme, as long as the scheme requirements are met. Some examples of a three-party card scheme: Mastercard, Visa, Maestro, UnionPay, JCB and RuPay (India).

The four-party model is known for its interchange fee revenue model. The interchange fee is a fee – fixed or a percentage of the transaction – that is paid by the acquirer to the applicable issuer. The interchange fee represents a major share in the total commission charged to merchants.

SEPA Payments Scheme

The single euro payments area (SEPA) harmonizes the way cashless euro payments are made across Europe. It allows European consumers, businesses, and public administrations to make and receive the following types of transactions under the same basic conditions (credit transfers, direct debit payments, card payments). This makes all cross-border electronic payments in euro as easy as domestic payments. SEPA covers the whole of the EU. It also applies to payments in euros in other European countries: Iceland, Norway, Switzerland, Liechtenstein, Monaco and San Marino.

The advantages of the SEPA Scheme include:

  • A single system for both domestic and cross-border bank transfers

  • Allowing cross-border transactions by direct debit, that is to charge directly an account in one country for services provided in another country

  • Allowing people working or studying in another SEPA country to use an existing account in their home country to receive their salary or pay bills in the new country

  • Ensuring cheaper, safer and faster cross-border payments and more transparent pricing thanks to the single set of payment schemes and standards

SEPA is a collaborative process. The SEPA project was launched by the European banking and payment industry represented by the European Payments Council (EPC). The EPC has designed the SEPA schemes for credit transfers and direct debits, and is developing a scheme for payment cards. It is also currently working on a new framework for mobile payments. The principle of equal charges both for national and cross-border payments applies to all electronically processed payments in euros – including credit transfers, direct debits, withdrawals at cash dispensers (ATMs), payments by debit and credit cards, and money remittance.

Countries outside the euro area may also extend the application of this regulation to their national currency. The SEPA vision is one of a harmonized European-wide standard payments environment using mandatory and consistent ISO 20022 XML messaging. Eventually, it will bring significant savings to companies by driving down transaction costs and cross-border charging practices.

Further benefits include:

  • A reduction in the number of bank accounts needed to do business across Europe

  • Faster settlements and simplified processing

  • Increased transparency of pricing and fees

  • Potential for the centralization of accounts and payment flows

Processes – How Transactions Work

Payments transactions are processed through a variety of platforms, including brick-and-mortar stores, e-commerce stores, wireless terminals, and phone or mobile devices. The entire cycle usually takes place within two to three seconds.

We will use a credit card payment as a model to demonstrate each step in the transaction process, which includes the following participants:\

  • Cardholder: There are two types of cardholders: a transactor who repays the credit card balance in full and a revolver who repays only a portion of the balance while the rest accrues interest.

  • Merchant: This is the store or vendor who sells goods or services to the cardholder. The merchant accepts credit card payments. It also sends card information to and requests payment authorization from the cardholder’s issuing bank.

  • Acquiring Bank/Merchant’s Bank: The acquiring bank is responsible for receiving payment authorization requests from the merchant and sending them to the issuing bank through the appropriate channels. It then relays the issuing bank’s response to the merchant.

  • Acquiring Processor/Service Provider: This third-party entity is sometimes an arm of the acquiring bank. A processor provides a service or device that allows merchants to accept credit cards as well as send credit card payment details to the credit card network. It then forwards the payment authorization back to the acquiring bank.

  • Credit card Network/Association Member: These entities operate the networks that process credit card payments worldwide and govern interchange fees. Examples of credit card networks are Visa, Mastercard, Discover and American Express. In the transaction process, a credit card network receives the credit card payment details from the acquiring processor. It forwards the payment authorization request to the issuing bank and sends the issuing bank’s response to the acquiring processor.

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