The payments industry has long been working on solving customers’ pain points and making transactions simpler, quicker and cheaper. One of the problems was that men were wearing ill-fitting suits because their wallets were stuffed with cash, jokes Lee Britton, Director of the Money Service Lab. Such problems have been fixed with the drive towards a cashless society, where digital payments have become the norm. Britton has worked in payments innovation for decades, bringing cashless solutions to transport networks, football stadiums, government benefits programmes, and more – as well as removing the need for a physical wallet.
Through those years Britton has seen many cycles of boom and bust – and hubris and humility. And now, after a golden period for fintech start-ups, where there was much buzz about the firms that were changing the way we pay, the industry is undergoing a correction. Many start-ups are now struggling to find funding, which is impacting the kind of innovation that will be pursued, and ultimately feed into the way that corporates manage their payments.
Venture capital (VC) funding has dropped off in recent months, and KPMG noted in its Pulse of Fintech survey how 2023 was a difficult year for all financial technology companies, not just those in payments. KPMG noted that Asia Pacific experienced the largest drop in investment from 2022’s figure of US$51.3bn to US$10.8bn in 2023. Meanwhile Europe, the Middle East and Africa had a drop in investment from US$49.6bn to US$24.5bn for the same period. Although the fintech sector has been struggling, payments are still gaining a lot of attention, and attracting the lion’s share of investment. Despite this, however, the payments sector still had a drop from US$57.9bn to US$20.7bn between 2022 and 2023.
The KPMG report highlights a number of difficulties last year: high interest rates, high inflation, geopolitical uncertainties with the conflict in Ukraine, and also concerns with company valuations. With these factors at play, a number of trends are emerging: investors are focusing on profitability rather than pursuing growth, and deals will be subject to greater scrutiny. Also, there is now a greater interest in business-to-business solutions rather than those that focus on consumers.
The gloomy environment has been having an impact on the state of innovation in the payments sector, and this is a topic the Payments Innovation Jury 2024 looked at in detail, the findings of which were published in a report entitled, ‘Market Meltdown: Impacts on infrastructure, regulation and innovation’. The report notes that tumultuous changes in the payments sector began in 2022 and continued into 2023, which has been accompanied by a downward correction in the valuation of payments companies.
Although many start-ups previously raised funds in a low-interest rate environment where money was cheap, the Payments Innovation Jury found that the over-valuations of companies was driven more by investors bidding up deal prices and paying insufficient attention to profitability.
Those boom times are over, and the dearth of funding in recent years has been dubbed the ‘fintech winter’, or more broadly the ‘VC winter’. John Chaplin, the Chairman of the Payments Innovation Jury, tells Treasury Today that the problems that payments companies are currently facing did not start with investment being restricted. “It’s a bit like house prices,” explains Chaplin. “Prices have started to move down and so the supply side has changed.”
For a while in the industry, comments Chaplin, there was the belief that if start-ups kept growing it didn’t matter if they weren’t profitable; they believed if they kept spending money and growing fast they would eventually get profitable. That didn’t prove to be the case. Faced with difficult times, many realised they were actually going out of business. Even if they cut costs, it meant they would go bankrupt at a slower pace, says Chaplin.
Commenting on the current state of the fintech industry, Anton Ruddenklau, Global Head of Fintech and Innovation at KPMG International, who authored the report stated: “Looking to 2024, it’s going to be a buyer’s market. There’s going to be a fire sale. There has to be a fire sale because a lot of the incumbents can’t afford to keep running anymore. They’ve run out of funding pathway and their investors have no stomach given how the environment has shifted. Fintechs that have been disrupted somewhat by new technologies – particularly generative AI [artificial intelligence] – are definitely struggling.”
The Innovation Jury notes that investment levels in payments have now tumbled and there has been a diversion of investment into other sectors, such as AI. This ultimately will impact the kind of innovation that is likely to come in the future for the payments industry. Patricia Hines, Head of Banking, Wealth and Risk at Celent, comments, “In addition to a lack of early-stage funding, payment start-ups face rising concerns over perceived and real fraud.”
Hines explains that because companies are being required to shift focus, and resources, to developing robust fraud mitigation strategies, this exacerbates the already-limited budgets of start-ups. “At the same time, regulatory and compliance oversight is tightening, potentially stifling innovation efforts as a result of decreased focus. Although not necessarily a direct result of increased oversight, the rise of regulatory fines and actions makes start-ups less attractive to risk-averse financial professionals.”
For entrepreneurs building their payments companies, there are many costs that come with getting their idea to market – such as fraud mitigation and regulatory compliance. Chaplin comments that many companies were playing a scale game. They built platforms and assumed their costs would be fixed and would have to add payments volume to make their venture worthwhile. However, “fraud losses are real costs” Chaplin says. Also, these companies made the assumption that they would only need to invest once in the platform, and didn’t account for the fact they would have to keep investing to adapt to changing regulations, and also keep their position in the market.
Britton also comments on the fast-evolving nature of the technology: “Previously people would tell you that the technology was disposable, and you could write it off over ten or 20 years. Now it is becoming obsolete in three to five years. The return on investment has to be real,” he tells Treasury Today.
In the current environment, start-ups are being hit the hardest. Does the early focus on returns and profitability mean that the most innovative ideas may never see the light of day? Quite possibly. Britton comments that start-ups are “now not letting their minds wander and have to execute on a very specific business plan,” especially in an environment where the cost of capital is much higher because of higher interest rates. This specific plan, for example, may mean that a company “won’t be doing anything funky” and will delay its expansion to other regions, such as North America or Asia, until after the company is profitable.
Given the lack of funding available for start-ups, and the increasing burden of regulation, much payments innovation is occurring within financial institutions. There was a cycle of banks not building themselves – because of the rise of the likes of ApplePay, for example – but now things have gone full circle to banks building their own solutions, comments Britton. This is in line with what Hines at Celent is seeing: “In a bold move to stay competitive, many banks are rolling out their own cutting-edge payment solutions. They’re either fully harnessing their internal capabilities or forming strategic partnerships to introduce services like BNPL [Buy Now, Pay Later], pay-by-bank, instant payments, QR [quick response] code payments, digital wallets and marketplace payments.”
Much of these trends are relevant to corporate treasurers, because – as Hines explains – they are impacted directly by what happens in this space. “Many treasurers are in the thick of payment innovation, especially those in direct-to-consumer industries such as retail, hospitality, healthcare and insurance. In these industries, treasury and finance teams must handle increasing high-volume, low-value transactions, making reconciliation across the enterprise even more challenging,” Hines says. “Treasurers also understand the imperative to improve the shopping, patient or consumer experience. This starts with flexible payment options and payment choice, accessible through intuitive digital channels,” she adds.
How closely should treasurers follow the developments in payment innovation; do they need to, or could they let their banks do it for them? “Regarding whether treasurers should leave payments innovation up to their banking partners, the short answer is ‘yes’. Banks, especially the largest ones, have substantial technology budgets, risk frameworks, contract attorneys, product managers, and integration teams. Although leveraging bank payment solutions may offer less flexibility, the corporate avoids upfront licensing fees, implementation costs, and system integration challenges,” says Hines.
There are a number of innovation trends that are likely to impact corporate treasury. A report released by HSBC in January 2024 entitled ‘Global payments trends: Considerations for corporate treasurers’ noted how there is a broader shift to global cashless payments, with digital payment volumes projected to increase by more than 80% from 2020 to 2025 from one trillion transactions to 1.9 million. The HSBC report notes a number of future payments trends that are relevant to treasurers, including distributed ledger technology, generative AI, Web3 and the metaverse, embedded payments, cross-border instant payments and central bank digital currencies.
Hines comments on how treasurers need to keep an eye on how consumers are changing the way they pay at the point of sale, as well as the wholesale infrastructure that makes their liquidity and cash management more efficient. Hines says: “The shift to digital payments and payment choice, along with other impacts such as the ISO 20022 migration and payments fraud, necessitates improvements to the point-of-sale as well as payments back office infrastructure, both for banks and their corporate clients. These changes reflect a broader evolution in the payments industry driven by technological advancements, changing consumer preferences, and the need for more efficient and secure payment methods.”
Chaplin comments there is much interest in real-time payments as well as account to account payments, but he expects to see a difference in uptake according to the region. For example, in developing markets where payment cards did not gain a foothold, account to account and mobile money will build a major market position. Meanwhile, cards will be hard to dislodge from their incumbent position in developed markets. Chaplin points out that even where smartphones and digital solutions are used in developed markets by consumers, even though the physical card is no longer necessary, the payments are still being run along the traditional banking and payment network infrastructure.
For now, although payments start-ups are struggling, there is still a wider drive to digital payments and new ways to pay – and also a world where wallets aren’t stuffed with cash.
