PAYMENTS ARE CHANGING, BUT HOW PREPARED ARE RETAIL ...
Transcript of PAYMENTS ARE CHANGING, BUT HOW PREPARED ARE RETAIL ...
Financial Services
PAYMENTS ARE CHANGING, BUT HOW PREPARED ARE RETAIL BANKS?
POINT OF VIEW
AUTHORS
Sean Cory, Partner
Pontus Mannberg, Principal
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INTRODUCTION
The Nordic retail banking sector is as healthy as ever. The large financial institutions show a return of around 15%
(after tax) on equity for their retail business. All have managed to increase capital ratios, tackle (at least part of) the
cost base, and started their journey towards becoming more customer-centric. Compared to their south European
counterparts, there are limited amounts of non-performing loans to work out, as the overall economy grows stronger
across all markets. At first glance there seems to be no major threats on the horizon, but what if this is mainly due to
a previous lack of serious competition and infrastructure advancement.
An example of this situation is highlighted by incumbents losing significant share in the use of credit to facilitate
commerce and transact payments online. We believe Nordic retail banks run the risk of being sidelined, being only
the providers of banking infrastructure to pay utility bills, as consumers will use other forms of payments to transact
and finance the bigger tickets. There have also been some high profile projects failing to deliver on their promise like
Swedbank’s Bart venture and the difficulty to commercialize Swish1.
European retail banks are beginning to take payments more seriously. During the last three years we have seen
budgets for payments projects increasing from about 1% of development spend to above 5%. We believe many
Nordic banks have underinvested in this space, and have highlighted three key reasons for change.
1 Swish is a peer-to-peer mobile payments solution jointly owned by Danske Bank, Handelsbanken, Länsförsäkringar, Nordea, SEB, Skandia, Swedbank and Sparbankerna
Exhibit 1: Share of development spend being allocated to alternative payments
50
100
% OF BUDGET PLANNED
<1
1–5
5–10
>10
2011 2012 2013
0
Source Joint Oliver Wyman and EFMA report - Advanced and mobile payments: What’s stopping you? (December 2012)
Note Q3.2. What percentage of development spend does alternative payments represent? (N = 158)
1. THE DISRUPTORS GAINING SHARE
We believe one of the most important trends, in terms of impact
on overall profitability, is the growth in online retail and the use of
various consumer finance products in this market. The “disruptors”
are taking share of traditional retail banking profits by launching
invoice payments, installment loans and other types of personal
loans. Considering how revenues are split in the payments value
chain, new entrants’ growth and ability to enter the market, and the
specific customer preferences in the Nordics, we see the disruptors
as a threat in the short- to medium-term.
2. REGULATORY CAPS ON CARDS
In addition, the regulatory agenda comes into play with Single
European Payment Area, Payment Services Directive 2 and EU
regulation of interchange fees for card payment transactions
currently being planned (20 bps on debit card and 30 bps on credit
card). The effects of these regulations are yet to be fully understood,
however, we can expect them to impact not just retail banks but
everyone in the ecosystem, with lower margins as an outcome.
3. APPLE ENTERING THE WORLD OF PAYMENT SOLUTIONS
On the 9th of September 2014, Apple entered the world of payments. Having already agreed deals with MasterCard,
Visa and American Express (in addition to a number of US retail chains), we believe Apple Pay has the potential to
radically restructure the payments value chain. Although currently only launching in the US, considering the high
volumes of iPhones in the Nordic countries, a Nordic expansion does seems likely and so we believe banks should
watch this space closely.
Exhibit 2: Apple Pay
• Apple Pay is a check-out solution, based on NFC technology, enabling o�ine and online commerce via your Iphone
• This app keeps hold of your credit and debit card information and is currently supported by three major networks (American Express, MasterCard, and Visa), issued by most of the larger US banks (Bank of America, Capital One Bank, Chase, Citi, and Wells Fargo)*1. Apple Pay will automatically launch your preferred card in-store and in-app
• The app (expected to be launched in October 2014) is also supported by some of the major retailers in the US (Bloomingdale’s, Disney Store, Duane Reade, Macy’s, McDonald’s, Sephora, Staples, Subway, Walgreens, and Whole Foods Market)
• Apple might have succeeded where others have failed, by bringing together a coalition of stakeholders spanning issuers, merchants and networks (previous/current e�orts, such as MCX, Softcard/Isis, and Google have been blocked by their apparent support for one set of interest groups at the expense of other parties)
• There are still a lot of unknowns in terms of how the economics will work out, but according to the industry news site Bank Innovation, Apple will receive 15–25 bps of payments volume that goes through its system, paid for by card issuers
• Key features include− Consumer friendly check-out for both o�ine and online commerce via one touch payments and
finger ID recognition− Improved security (compared to cards without Chip and Pin)
*1 Representing 83% of the credit card purchase volume in the US
Source Apple press info: Apple announces Apple Pay (September 2014)
This report looks at some of the trends in the current payments landscape, both for cards and alternative methods
(offline and online), and how these may impact the Nordic banks.
PAYMENTS REGULATION
SINGLE EUROPEAN PAYMENT AREA (SEPA) PAYMENT SERVICES DIRECTIVE 2 (PSD)EU REGULATION OF INTERCHANGE FEES FOR CARD PAYMENT TRANSACTIONS
• Regulation of euro retail cash flows, affecting both retail banks and payment institutions
• Technical and business requirements cover standards for euro credit transfers, direct debits, payment schemes and frameworks for electronic payments
• Support the digital agenda across EU
• Cover EU, Iceland, Liechtenstein, Norway, Switzerland, and Monaco
• Regulation of payment initiation services that operate between the merchant and the purchaser’s bank, affecting all retail banks and payment institutions, as well as, card issuers
• Contains guidelines on interchange fees for card-based payment transactions
• Regulation to be transposed into Nordic law
• Interchange fees cap on domestic and cross-border transactions
− Credit cards: 30 bps of the transaction value
− Debit cards: 20 bps of the transaction value
• Price honesty regulation
− Discrimination based on issuing retail bank is not allowed
− Merchants are prohibited from steering customers to more efficient payment instruments
− Acquiring PSPs must provide at least monthly statements of fees to merchants
− Merchants must reveal to their customers, fees they pay to payment services acquirers
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OFFLINE COMMERCE
The Nordics are among the most advanced markets in the world in terms of penetration of card and electronic
payments. According to a recent report from the Swedish Bank Association (Svenska Bankföreningen), only 22% of
the Swedes normally carry cash with them. In addition to that, Swedes make on average 240 card transactions per
annum with similar figures for the other Nordic countries, compared to an average of 65 in the rest of Europe.
Source Swedish Bank Association: Kortbetalningarnas betydelse i samhället (March 2014)
Exhibit 3: Number of card transactions and point of sale (POS) terminals per head
200
100
300
NUMBER OF POS TERMINALS PER 1000 PEOPLE
0
400
NUMBER OF CARD TRANSACTIONS PER HEAD
50400
Nordics
2012 SELECTED COUNTRIES
Iceland
ItalySpain
Finland
Norway
Denmark
US
Sweden
Ireland
Cyprus
UK
FrancePortugalBelgium
NetherlandsEstonia
Luxembourg
302010Non Nordics
Source Norges Bank: Annual report on payment systems 2012 (June 2013) and ECB Note POS terminals estimates for US and Iceland from 2011
1. CARDS
Growth in the number of cards issued and POS terminals installed has been solid over the last 10 years and although
it appears to be slowing, just looking at the sheer number of card transactions and POS terminals used, we do not
foresee cards being replaced in the near future. In the medium-term there could be possibilities for new entrants to
install invoice payment solutions as an alternative option to the POS terminals, such that they compete directly with
credit cards in that market. Considering upcoming caps on card fees, this could of course become a reality sooner
rather than later.
The key issue is whether or not to stay in the merchant acquiring space. For many retail banks, consumer facing
payments businesses might become less attractive as regulatory caps on card transactions will pressure acquiring
margins. As a consequence, we believe banks should either substantially grow or exit the merchant acquiring
space in the medium- to long-term. We have recently seen SEB selling their merchant acquiring business Euroline
to private equity investor’s Nordic capital, and foresee more M&A activity, also cross-border mergers, as a
probable scenario.
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Exhibit 4: Growth in number of cards issued and number of POS terminals
40
50
30
60
20
10
70
‘01 ‘02 ‘03 ‘04 ‘06 ‘07 ‘08 ‘10 ‘11 ‘12‘05 ‘09
NUMBER OF CARDS OUTSTANDING (MM)
Sweden
Denmark
Finland
Norway
0
400
600
500
300
200
100
700
‘01 ‘10 ‘11 ‘12
0
‘02 ‘03 ‘04 ‘06 ‘07 ‘08‘05 ‘09
NUMBER OF POS TERMINALS (K)
YEARSYEARS CAGR %
6
6
9
1
8
CAGR %
8
7
9
8
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2. ALTERNATIVE PAYMENTS
Prior to Apple Pay, we believed current mobile payment and the various closed loop solutions were failing to provide
any real value to the end customer. Independently of the numerous brands reportedly making an effort in the
payments space, having a separate card and/or application per store or type of transaction is not convenient.
There has also been a question around what technology to use, with NFC struggling to take off. The result has been
low penetration and high profile solutions like Swedbank’s Bart venture (based on NFC) have recently been closed
down due to low consumer uptake.
We believe that Apple Pay could well become the catalyst of change within this space. We expect them to compete
by offering merchants lower transaction fees and, even though it requires an initial investment in the NFC
technology, things could move very quickly. For the consumers in the Nordics (where all cards have Chip and Pin),
the preliminary benefit would be marginal to using a credit card both from a convenience and fraud perspective. But,
if Apple uses the data available to help consumers gather loyalty points for all their purchases, as well as, keeping all
their receipts in their phone, that would be a game changer. From the banks perspective, Apple Pay will put pressure
on margins. Even if the banks were still required to do the merchant acquiring (i.e. the main part of the revenue
pool), the concern has to be that Apple could launch a closed loop solution, with every consumer sending money
to an Apple Pay Wallet, cutting out the bank’s interface with the end customer. For the banks in the Nordics, which
could well be a likely expansion market, our recommendation is: do not let Apple (or any other solutions provider)
control the customer interface. Even if Apple Pay has been marketed as a “bank friendly solution”, we struggle to see
the long-term benefit for the banks.
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If the Nordic retail banks are going to keep pace with these recent developments we would recommend they join
forces and develop their own infrastructure. Nordic retail banks have industry leading mobile banking solutions,
with a high and growing user-base. Ensuring that these are loaded with value added services, such as payments,
spend analytics and loyalty schemes, would be a more customer-centric solution. As a consequence,
a key area to focus on would be how to commercialise Swish (or similar solutions) to be an option for on and offline.
These sorts of applications can, to some extent, also be used as a CRM channel. The question is how to make money
out of it. Banks could charge for it (at least for certain segments), meaning that they should model pricing, value
proposition and segmentation to optimise profitability.
Exhibit 5: Emerging payments topics
Mobile payments Apple Pay, Google Wallet, SEQR, WyWallet
PayPal and digital wallets PayPal, V.me
GPR prepaid NetSpend, Walmart MoneyCard
Mobile acquiring Square, iZettle, Bart
EMV*¹ EMVCo
P2P payments Swish, SEQR, WyWallet
Merchant-issued payment cards TARGET 2, REDcard
Virtual currencies Bitcoin, Amazon coin
Mobile billing BilltoMobile
Closed loop stored value Starbucks Coffee
*1 Europay, MasterCard and Visa
CONCLUSIONS
Disruptive technologies at POS (such as invoice solutions) could become a problem at some point, but we do
not foresee cards being replaced at POS in the near future. The important question is whether to grow or exit the
merchant acquiring business.
Apple Pay’s eventual market entry will not only put pressure on margins, but also threaten to take over the customer
interface. Banks should focus their efforts on developing and commercialising consumer-friendly mobile solutions,
that connect mobile payments with mobile banking.
Relative importance
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ONLINE COMMERCE
Compared to other European markets, Nordic countries have one of the highest percentages of online shoppers
and number of online purchases. In 2012, €11 BN was spent online in the Nordic markets, with around 80% of the
population being online shoppers. These numbers have – as in the rest of Europe – grown substantially and more
and more Nordic consumers are shopping online, each of them spending on average €683 over the year. The main
reasons cited by most consumers for shopping online was the convenience and potential time saving. Sweden is
the largest market in the region, driven by strong retail brands and increasing investments from retailers into online
sales capabilities.
Exhibit 6: Total online purchases across Nordic markets
1 25
2 50
3 75
0 0
4 100
Sweden Norway Denmark Finland
€ BN %
Online purchases 2012
Online shoppers 2013 in %
Source PostNord: Ecommerce 2014 and Makesyoulocal
1. CARDS
Looking at the online value chain for a credit card transaction, banks are currently controlling the most revenue
generating steps (acquirer and issuer) and as a consequence recoup about 90% of the total profits generated.
This position is being threatened by a number of alternative business models. As previously mentioned, considering
what upcoming EU regulation of interchange fees for card payment transactions might mean for banks’ (and card
schemes) profitability, placing a bet on an alternative payment method is advisable. This will of course also impact
the disruptors as well, since the benchmark cost to the merchant will go down after the caps are in place, making
relatively more expensive solutions like Klarna and PayPal look even more expensive.
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In the online world Gateway/PSP represents the starting point, and thus customer-facing (in a B2B and B2C
scenario) position in the value chain, with Apple Pay looking to compete in this space. We believe ownership of the
customer interface is very important and think retail banks should consider what impact this could have on them.
The question is whether to enter directly into the PSP space or how (and with whom) to form strategic alliances. The
new competition is targeting this area and as a consequence we see developments in a number of ways. Gateways/
PSPs are aggregating merchants to drive fee reduction for acquiring services. This would mean that Gateway/PSP
providers acts as an intermediate, owning both the acquirer and the merchant relationships. The benefit of this
structure is a close relationship with merchants which allows for driving discounts on acquirer fees by aggregating
volumes across merchants. Another similar example, is offering an extended gateway (the so called “checkout
solution”), which is an alternative way to provide acquiring services. Checkout products offer settlement through
“virtual acquiring” and we believe this is what Apple Pay will do. The way it works, is that the PSP or payments
company does not acquire itself but has an acquiring partner (i.e. no agreement between merchant and acquirer),
once again aggregating volumes and taking share of the traditional acquiring profit pool.
For companies applying for a credit market institute license, further expansion within the value chain is a possibility.
This includes products like instalment loans, financial guarantees, factoring services, as well as, taking up retail
deposits (to be gathered either directly or indirectly through a third-party).
Exhibit 7: Earnings generated by online card transactions within the payments value chain
MerchantGateway/payment
service provider (PSP)
Clearing organisa-tion (e.g. Visa and
MasterCard)Acquirer
Acquiring processor if outsourced
ACQUIRING SERVICES
Issuing bank
ISSUING SERVICES
Issuing processor if outsourced
Description • Provide merchant software for transaction capture and routing
• Transmit transaction data to the acquirer
• Requires a payment institute license
• Hold deposit accounts for merchants
• Authorisation
• Responsible for collection of transaction information and settlement
• Processors connect the merchant to payment networks by providing systems and operations
• Provide network for transaction routing
• Connects and switches transactions between merchants and card processors
• Promote brand acceptance
• Holds contractual agreement with cardholder
• Bear credit risk
• Everything but balance sheet activities can be outsourced
Revenue split*¹, ² ~5% ~45% ~7% ~43%
Revenue sources • Transaction fee
• Software fee
• Transaction fee
• Merchant servicing fees (e.g. terminal management)
• Scheme fee • Interest revenue on revolving balances
• Other fees and commissions
• Interchange fee
• Scheme incentives and fee rebates
*1 Nordic merchant service fees (MSC) are the same for credit and debit card transactions, but the interchange fees set by clearing organisations differ between the two payment methods
*2 Based on a 1000 SEK online card transaction for a SME merchant. Total revenue divided across players is approximately 2% of the transaction volume
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Exhibit 8: The Nordic Gateway/PSP market
PayByBill, Bill Me Later, ViaBill
Digital River, epay, Paynova, QuickPay, Cyberbit, Pensio,
CyberSource, Wiredge, Samport, Payer, Dibs, CertiTrade
Euroline*1, Handelsbanken, Nordea, Teller*2 , Valitor Evry
ONLINE INVOICE AND FACTORING SERVICES
GATEWAYS/PSPS ACQUIRERS (WITH ONLINE CARD PAYMENT OFFER)
ACQUIRER PROCESSORS
Swedbank
Klarna, PayEx, Svea
Nets
*1 Recently acquired from SEB by Nordic capital
*2 Owned by Nets
2. ALTERNATIVE PAYMENTS
Compared to the rest of Europe, the Nordic markets (at least the Swedish and Finnish ones) differ in terms of
preferred payment methods when shopping online. Based on a survey conducted by TNS SIFO, invoice is the
preferred method for online purchases in Sweden and Finland, whereas card payment is the most popular in Norway
and Denmark. Interestingly Sweden and Finland also show similar characteristics in terms of having a higher online
banking penetration.
Exhibit 9: Share of consumers per preferred payment method
50
0
100
Debit/credit card
Invoice
Online banking
PayPal and similar
Others
Sweden Norway DenmarkFinland
IN %
Source PostNord: Ecommerce 2014
Note Based on survey conducted by TNS SIFO on consumers in Nordic markets, only one answer was possible
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We believe that the Nordic retail banks should start paying more attention to the growing online retail channel,
as well as, the invoice and installment loan products, which are very popular online. This is the area where new
competitors like Klarna and PayPal have been hugely successful. These business models are largely based on
creating a separate online value chain that closes out the traditional participants (i.e. banks and card schemes).
Most of these new competitors are offering various “buy now, pay later” consumer credit products, which takes a
share of the banks’ profits and new loan originations. The pitch to the merchant is about improving conversions,
not just because of the “pay later” option, but because they optimise the whole buying experience, making it easier
for the consumer to perform a payment. For some of the bigger ticket items a personal loan or mortgage top-up
would traditionally have been used as a means to raise credit for consumption. We see more and more types of
goods moving to the online channel and as a consequence the corresponding payment transaction.
The new competition will continue to provide user-friendly invoice and installment products, as well as, various
consumer credit solutions, which will have an even greater impact on the profitability of banks, as online retail grows
in importance. As new payment providers become profitable, they will grow and most likely increase their scope of
services, moving into traditional personal loans, deposits etc.
CONCLUSIONS
The online value chain for card transactions is under threat. Banks should consider how this will impact their
revenues and where to play, since although profits might currently sit in the acquiring and issuing space,
this will change and staying close to the customer will be crucial going forward.
The arena where consumers are making their payments is changing. Online retail is gaining share and how
consumers prefer to pay online differs from offline. Banks should consider how to challenge the new competitors.
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SUMMARY OF CONCLUSIONS
The payments arena is changing. Online retail is gaining share and how consumers prefer to pay online differs
from offline. Apple Pay’s eventual market entry will not only put pressure on margins, but also threaten to take over
the customer interface. Retail banks should consider how this will impact their revenues and where to play, since
although profits might currently sit in the acquiring and issuing space, this will change and staying close to the
customer will be crucial going forward. Retail banks should also consider how to challenge the new competitors:
disruptive technologies like invoice and various mobile payments solutions will become a problem at some point.
Retail banks should focus their efforts on commercialising consumer friendly mobile solutions that connect mobile
payments with mobile banking. Because even though we do not foresee cards being replaced in the near future, new
market entrants and upcoming regulations will fundamentally alter the economics of the cards value chain (online
and offline).
Recommended next steps:
1. Analyse how new regulation will impact the financials of the cards value chain (online and offline) and where areas of relative competitive advantage might occur
2. Develop the strategy for what role to play, and whether to maintain or exit the merchant acquiring side
3. Define the scope of ambitions and design a consumer friendly mobile solution that enables the retail bank’s mobile banking app to process mobile payments and provide credit online
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