Treasury Today Country Profiles in association with Citi

Creativity in challenging times: innovation in payments

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The payments world is vast and expanding rapidly. While much of the visible progress can only be found in the retail space, corporates should be aware of the quiet revolution taking place. From corporate payment processes to bank best practice, and non-bank market participants through to new technology, innovation is driving growth and efficiency. But challenges remain, particularly in the face of new regulations.

These are uncertain times for the financial services industry. Bank lending has not recovered to the levels it reached before the 2008 credit crisis, while sovereign debt levels in many countries around the world are making markets unpredictable.

Against this backdrop, corporates are looking to explore both new sources of funding and reduce their reliance on bank credit. One of the ways that treasurers are leading this process is by looking closely at their payment processes to drive efficiencies and value across their organisation.

A method that many are using to achieve this is by centralising their payment processes through the use of a holistic payments hub. This is a comprehensive approach, integrating accounts receivable (AR) and accounts payable (AP) to streamline operations and create a greater visibility into cash. At the end of last year, Logica surveyed 157 corporates from across North America and Europe on this topic. Almost two-thirds of the companies that responded are at one stage or another in the process of implementing a payments hub, consolidating their AR and AP.

“We’re finding that many corporates are in some stage of implementing a payments hub,” says Nasreen Quibria, Payments Expert at Logica. “Whether it is already live, under consideration in the implementation stage, or the treasurer is developing the business case. Alternatively, they are in the selection process with individual solution providers,” Quibria explains.

In the geographical spread of these results, there is slightly more of a trend towards payments hubs in North America than in Europe. “40% of corporates in North America are already live with their payments hub, compared to 29% of corporates in Europe. But on the other hand, in the supplementary steps towards going live with a payments hub, the numbers are similar,” Quibria says. “But if you also look at the opposite side of the coin, those who have no plans to implement a payments hub or those who considered it and then rejected the idea, the numbers are considerably higher in Europe. 45% of respondents to the survey based in Europe have no plans to implement a payments hub, compared to 32% in the US.”

While corporates may be looking more closely at their AP and AR, some are only focused on examining their receivables. Corporates are looking to enhance their receivables processing by implementing solutions that will help them integrate all of their receivables information.

Ways in which they are doing this include working to improve collections procedures and introducing techniques such as differentiating between creditors according to their risk profiles. This latter example can create significant improvements in the days sales outstanding (DSO) of a corporate. There are a range of receivables financing techniques that are available to corporates who are looking to improve their working capital and monetise their receivables, such as factoring for example.

One new trend is that non-bank supply chain finance players are emerging. An example of this type of provider is The Receivables Exchange, which has been dubbed the ‘eBay of receivables’. This is because it is an online platform for receivables, providing an electronic marketplace for corporates to initiate supply chain finance and offer it to suppliers. And when suppliers use the website, it can be with or without the knowledge of their corporate customers. This type of solution is typically suited to the small or mid-size corporation.

Regulatory pressures stifling payments innovation

While new entrants to the payments industry are increasing, the environment can be challenging. The recent wave of regulations in the financial services industry has been detrimental to innovation in payments – both in the corporate and retail spaces. A good example of this, looking at the US, is the Dodd-Frank Act, in particular the Durbin Amendment price controls for debit card fees. This has had unintended price consequences, which have had the effect of stifling innovation.

Consider Isis, for instance – a joint venture bringing together the ‘big three’ US wireless companies (AT&T, T-Mobile and Verizon) with the payments giants of MasterCard, Visa, American Express and Discover Financial Services. The purpose of Isis was to create and operate a new nationwide mobile payments system utilising the mobile wallet concept and near field communication (NFC) technology.

One benefit of Isis is that it would have enabled unbanked customers to make payments. Unfortunately, the Durbin Amendment eliminated Isis’s opportunity to enter as a low cost provider of payment services, because the Federal Reserve slashed the fees that banks are able to charge on debit transactions, from 44 cents per transaction to 21 cents per transaction.

The consequence of this is that it has promoted reliance on inferior substitute payment types – paper-based legacy payment instruments such as cash or cheques. The Durbin Amendment has made the use of payment cards, specifically debit cards, more expensive for the consumer, while credit cards are not always an optimal payment instrument, for budgeting and other reasons.

The big payment card providers and the networks have been lobbying against initiatives such as the Durbin Amendment. “The amendment only went into effect very recently and there has been considerable backlash, so there is no doubt that something has to happen to bring the two sides closer together,” explains Quibria. In the meantime, banks that are losing revenue on their interchange fees will have to develop new business models while at the same time remaining sensitive to how these are implemented.

When Bank of America announced in September last year that it would introduce a\monthly charge for customers with debit cards, it faced a widespread backlash from its customer base, and saw its shares drop 2% the day following the announcement. Little over a month later, the bank was forced to shelve the plan. Banks will continue to look for ways to recoup costs that result from the regulatory squeeze, but will perhaps introduce new initiatives in a more palatable way in the future.

Smartphones driving mobile payments forward

In mobile payments, there are a lot of exciting developments occurring since the market is currently overcrowded, and participants are jostling for position. ‘Mobile payments’ used to refer to money transfers that you could authorise through a text message (SMS), and were particularly popular in remote areas and emerging countries with a large unbanked population. But the advent of the smartphone has revolutionised the concept of mobile payments, and has implications for everyone.

Point of sale (POS) devices, such as Jack Dorsey’s Square and Intuit’s GoPayment, can allow the smartphone holder to use their device as a card reader, or use apps on the device to ‘check in’ with local merchants when they arrive in the store, and have their order put on their online tab. Then there’s the ‘mobile wallet’, the ability to carry all of your payments cards in one app on your mobile. Players here include Google Wallet and – interestingly – Isis, while the traditional payments cards companies are also getting in on the act, with examples such the Visa Wallet and Serve from American Express. The addition of NFC technology to mobile wallet applications will be the next driver of innovation in this field.

The main question in the mobile payments space right now is who is going to be the end game player – will it be Google, Apple, Isis, or someone completely different? At the start of the year, PayPal announced that it is developing its own mobile wallet. 2012 will be a defining year for mobile payments, specifically for alternative payment providers rather than financial institutions.

There are analogies to be drawn here with the previous decade – PayPal really took off as an alternative payments platform, while the financial institutions were slow to adopt and innovate in this space. As a result, banks have not really been able to recover from this slow start. Fast forward ten years and we are seeing a similar trend today in mobile – it is the non-financial service providers that are really breaking ground in the mobile payments space.

In this busy market, it is too early to tell who is truly leading the way though. Google Wallet has been the first market participant to pilot its services in some shops in New York and various other locations. Looking historically at Google’s presence in the payments space, it tried to enter into the alternative payments space with Google Checkout, but found that this innovation was not successful. Similarly, given that consumers are not accustomed to using Google for their transactions, it faces a battle to become the front-runner in this market.

One company that does have the potential to take the lead is Apple. There was a lot of rumour around the time when the iPhone 4S came out that there would be an NFC chip built into it, but to the surprise of many commentators this was not the case. However, the possibility is still there to add the chip to iPhone 5 or a later model.

The potential that Apple has over some of its smartphone rivals is based on a mix of their existing infrastructure and customer base. Last year the company announced that it had hit 200m Apple ID accounts through iTunes.

Each one of these accounts links a credit or debit card to the ability to make one-click purchases, so Apple now has over 200m payments cards on its books. The company also already has mobile payments apps built into its operating system, it has been innovating in the micro payments space and driving the adoption of consumers paying for various applications and games and download apps through the iPhone.

Given its considerable customer base, Apple is going to be able to push mobile payments once the NFC chip is integrated into the iPhone. The company can then also enhance any mobile wallet offering with various other value propositions, through deals, rewards or promotions, for example.

Mobile is a corporate phenomenon too

One group of corporates that mobile payments will have a significant effect on are those in retail. But retailers will have to use a combination of value propositions before there can be real traction in the market. This can create a chicken and egg situation – the retailer wants to see the consumer using the payment method before they adopt it, but at the same time consumers are not likely to use it unless it has an additional value proposition for them.

Consumers have a selection of payment instruments that are already in their wallet, from existing debit and credit cards through to cash and cheques, so why would they go ahead and adopt a new payment method? They need to be provided with additional incentives, whether in the form of promotions or rewards.

Mobile also has a role to play in corporate banking. Financial services provided to corporate customers through the mobile channel have traditionally been about giving treasurers the ability to view their accounts. However, new innovations have allowed corporates far more functionality, to review invoices or authorise payments, for example. Once again, the speed of smartphone development means that there will be more activity and adoption in this area for corporates.

A new world: social payments

With the rise of smartphones, app stores and the mobile web, social media is primed to drive innovation in payments. Users of social networking sites are making purchases based on recommendations from their connections, and are also transacting within the social media environment themselves, be it in online stores or through social gaming.

Virtual currencies are one segment of social media payments to look out for. Anyone who experienced the Innotribe stream at Sibos 2011 in Toronto will know that it created a brand new currency especially for the conference – the Reputone – that could be spent on a variety of products and services or gifted to a friend.

An area that is more or less single-handedly driving the growth and adoption of virtual currencies is social gaming, which is based on interactive social networks and platforms. This type of network requires a different payment instrument, a virtual or digital currency. The emerging virtual economy is estimated to be in the trillions of dollars, based on a virtual market for micropayments, but it is not as new as you may suspect.

One of the first examples of the virtual economy was seen in the online virtual world ‘Second Life’, which was launched in June 2003. Almost a decade old already, the growth of the virtual economy from non-bank sources has similar implications for financial institutions as those in the mobile payments space mentioned earlier. Banks may be left behind here, as dynamic non-bank organisations such as Facebook and Google are looking to carve out a piece of this lucrative market.

Take Facebook as an example. One estimate last year predicted that the company would make \m in revenue in 2011 from its Facebook Credits – from users purchasing services and ‘in game’ benefits via the virtual currency. This highlights a considerable revenue opportunity for any company looking to enter the market. One of the reasons that Google and Facebook have been so successful is because they focus on various types of initiatives, and if one fails they quickly move on to the next one. For the financial institutions looking to compete, they really need to come up with some sort of strategy to enter this market, or they might soon find that it is ‘game over’.

Some banks are taking a more proactive approach to social media this year though. In the corporate space, certain banks have been rolling out social media to their corporate advisory groups, allowing the treasurers of some of their key clients to keep connected once a face-to-face or telephone discussion has taken place.

In the retail banking space, banks are also creatively thinking about how they can use social media to engage with their clients. An example of such an innovation comes from Citi, who at the start of the year announced the launch of a Facebook app for members of its ThankYou rewards scheme. By using the app, Citi customers that are members of the loyalty scheme can start a pool of points for a chosen goal – be it a charitable cause, a weekend break with friends, etc – and then invite any number of their Facebook friends that also use the loyalty scheme.

Members can select the specific amount of points that they wish to add to the pool, and can also track the pool’s progress towards the goal. To incentivise its customers to use the new app, Citi gave away 10m ThankYou points, 2,500 to each of the first 4,000 customers to register the app with their personal Facebook page.

For banks to stay ahead of the curve in this new world, they will need to use social media to improve their decision making, which will in turn drive their financial results.

Beating the fraudsters

As payment channels and methods multiply, so too do the potential fraud threats. The security of a payment can very often depend on the payment type. The traditional paper-based payments are more susceptible to fraud, and organisations are less likely to be subjected to fraud when using other types of payments instruments, such as ACH credit, for example.

However, particularly with the pressures of the current economic environment, the threat of fraud is as tangible as ever. These threats are interesting when you look at how they have evolved, morphing from simple viruses and phishing websites through to hijacking a company’s browser and siphoning off funds from bank accounts.

Banks provide a number of traditional financial fraud control services, such as ACH debit blocks and filters. Unfortunately, many companies do not necessarily use these, leaving themselves vulnerable to the increase in electronic payment fraud. In the past year in the US, the National Automated Clearing House Association (NACHA) had to write to companies to warn them of threats to ACH, as in some cases fraudsters were using the NACHA name to elicit funds from corporates.

In addition, the Federal Financial Institutions Examination Council (FFIEC) issued supplemental guidance on internet banking authentication and new rules on anti-money laundering (AML) under the Dodd-Frank Act.

Companies need to take a proactive approach to being vigilant around variations of emerging payments fraud techniques. However, there is no one specific vendor out there that is able to keep track of all cyber crimes that are evolving, as these fraudsters are very sophisticated and are constantly changing, finding new ways to attack.

For security of digital identity in banking relationships and payments, SWIFT launched the 3SKey solution in 2010. Aimed at both banks and corporates, the token is designed to be a single solution for multi-bank, multi-network personal digital identity. The benefits for corporates include ease of use – one token replacing myriad tokens and passwords that can be necessary to manage numerous banking relationships today.

It is also accepted by all banks, and can help increase efficiencies and security for corporates in their banking relationships. For banks, the additional information that 3SKey provides them with can remove a lot of rejections of payment information from their processing, which in turn cuts the amount of manual checking that the bank has to carry out. Innovations such as 3SKey demonstrate that fraud prevention measures can also bring other benefits.

Flawed innovation

In spite of all the dynamic innovation that is currently occurring in the payments space, not all of it will be adopted and not every company will last the journey. A cautionary tale comes from the US. A company there called Tempo Payments produced a decoupled debit payment instrument, and it received a lot of media attention when it was first introduced in 2003.

But last year, the CEO Mike Grossman announced that the company was going to have to shut down, saying “We are a casualty of the Durbin Amendment.” The cuts to the debit fee charges on transaction costs meant that it was no longer viable for the company to remain in business. For the smaller players in the market, this story may become a familiar one as a result of new regulation.

“In spite of all the dynamic innovation that is currently occurring in the payments space, not all of it will be adopted and not every company will last the journey.”

It might not just be the smaller companies that suffer. Look at Isis: while on the one hand it has the backing of the ‘big three’ US mobile network operators, as mentioned earlier, it also faces the challenges of Dodd-Frank’s Durbin Amendment. An additional challenge for the participants in Isis is that, while working together on this project, some are also developing their own mobile wallet solutions.

So, a lot of these companies are taking dual strategies and, by doing so, could be actually seen to be hindering the opportunities that Isis could provide. With a number of Isis participants hedging their bets, the challenge of the solution taking off becomes greater.

There is no doubt that some of the innovation currently happening across the payments industry will bring efficiencies to all market participants, whether you are a corporate, a bank, a vendor or a consumer. But the next challenge will be to understand which of the market participants, particularly in the crowded mobile space, are in it for the long haul.