This issue we talk to Linda McLaughlin-Moore about the core principles for growth in the payments industry going forward. We discuss the ways in which the financial crisis has changed the payments landscape and look at the impact that the economic turmoil has had on corporate demands in this area. We also explore the ways in which banks are responding to these new customer requirements.

How has the financial crisis affected the payments industry?

The market turmoil has eroded basic levels of trust in those at the heart of the payments industry, ie financial services institutions and, essentially, the banking system as a whole. This loss of faith has however prompted those within the financial services industry to revisit their existing procedures and identify areas in which they can improve their business practices.

Let us take the manufacturing industry by way of an example. From the sudden onset of the crisis, manufacturers have quickly had to review their inefficient processes and find ways to unlock trapped cash from within the company. That is to say, they have been forced to come out of their comfort zones, improve their inventory management and face the reality that for some time to come, levels of demand may be significantly lower than before. Although this may seem in part to be a negative step, it is in fact a positive opportunity to transform the company’s processes.

As banks, we need to look at our industry this way as well. For those bankers who are in emerging payments markets, like China, such an event can fuel a significant amount of growth and investment in core banking technology, which can catapult their organisations into the competitive field. These types of shifts and investments are more difficult in countries where there is a significant amount of legacy structures.

The crisis should be seen as a call to action for the payments industry – growth in payments should not be seen as less of a priority because of the crisis. Industry players should seek to align their value proposition with the new client requirements and demands that have come out of the crisis. As a starting point, we – and by this I mean the industry players – need to build on and renew our existing capabilities and strengths.

The industry needs to adopt a ‘back-to-basics’ approach and focus on the core values and principles that we offer to our corporate clients. It is a question of building on those foundations to make a stable, reliable and, of course, trustworthy basis on which to deal with our customers. In order to get back to the root of the business, we – like the manufacturers I mentioned – need to thoroughly review our basic processes. We need to understand what it is that clients want and determine how best to deliver the value that they expect. The first thing to do here is to understand how clients’ needs have changed with the market disruption.

Can we start by looking at how clients’ requirements had evolved pre-crisis?

Some of the pre-crisis drivers are of course still present, but understanding the emerging trends in the payments industry before the financial crisis is a useful step in adopting a back-to-basics approach. Pre-crisis, there was very much a trend towards solutions that were ‘faster, better, cheaper,’ especially with the evolving role of technology in the industry. But what is really meant by this?

• Faster. Before the crisis, corporates saw the bounds of treasury technology being pushed further and further. They began to require their banks to offer real-time processing and wireless communication to enable ‘anytime, anywhere’ banking.
• Better. As clients’ activities became increasingly global, their processes had a tendency to become more complicated, with variations in regional formats and legacy practices. As such, clients turned to bank solutions – and again, technology – to provide a flexible and agile treasury structure where straight through processing (STP) was a must. Achieving centralised visibility and control was a top priority, regardless of treasury structure.
• Cheaper. If processes are STP, this means they are more efficient – therefore, pre-crisis, clients began to expect costs to be integrated, and scaled down appropriately. In addition, clients looked increasingly for value added services to distinguish between their banking partners and to achieve more value at less cost.

And how has the financial crisis impacted on these requirements?

I believe it is true to say that clients have also been adopting a back-to-basics approach, meaning that their priorities have changed. Core activities have become ‘interesting’ again as that is where the lifeblood of the business is – ie the cash. There are four main trends to discuss here:

• Treasury under the spotlight. The financial crisis has put corporate treasury at centre stage, underscoring the importance of liquidity and risk management – core elements of treasury’s mandate to safeguard financial assets.
• Working capital optimisation. Freeing up trapped cash internally has become a first line of defence against reduced bank lending and lower consumer demand. Treasury has positioned itself as a strategic business partner through driving working capital efficiency.
• Transparency. Achieving a holistic overview of the physical and financial supply chains is a growing priority for treasurers with the aim of achieving greater transparency of cash flows in order to optimise working capital. In addition, transparency has also become key in banking relationships as counterparty risk has become an increased threat.
• Paying for value. In a turnaround from the pre-crisis situation, corporates have shown increased interest in paid-for bank services, particularly those that offer optimisation of liquidity and working capital within a transparent and risk-managed environment.

In what ways can banks respond to these new demands?

Sticking with the approach of revisiting fundamentals, the primary move is for banks to redefine what actually constitutes a payment. By this I mean that we need to forget the bank jargon and adopt a client-centric view of the payments process and industry as a whole. Placing payments into the two bank categories of ‘treasury’ and ‘commercial’ can be counterproductive, limiting the scope of what payments include.

After all, payments have always been, and will continue to be, a commodity. For clients, payments are not standalone, as they are to a bank – they are an integral part of the business and its wider commercial processes. It is important that banks begin to appreciate the broader payments context.

There are a number of client ‘layers’ to a payment that banks have not necessarily paid sufficient attention to as yet. These include remittance detail, the cash conversion cycle and value added information. Increasingly, banks need to think outside of the box, and recognise that clients do in fact use more than one bank. This means building in multi-bank functionality where appropriate and offering format conversion services.

Banks also need to consider taking a much more active role in their client’s business – taking on the processes surrounding the payment, for example. Such processes may include intelligent routing (selecting the appropriate channel for the payment) and fraud detection. The integration of payments more fully into the cash conversion cycle is also something that banks need to look at more closely with their customers as this would increase STP rates, thereby boosting efficiency and improving control for both parties.

A final point to add is that the information that a bank holds can be crucial to a corporate. Why not provide bank analysis of payment information, for example? This would allow corporates to move towards achieving their aims of working capital optimisation (by identifying trends) and of improving transparency (by supplying an overview of goods, money and information).

To what extent is this achievable?

As a single bank player in the market, it is difficult to say; but as a combined force, it is definitely possible. Banks should be looking to leverage shared-industry utilities to solve collective industry challenges and address client priorities.

For instance, individual institutions of course have their role to play in payments fraud, and must ensure that they are vigilant, running employee training schemes and communicating internally, for example. However, the true fight against fraud should take place at a more macro level – the industry must build new anti-fraud capabilities with cross-jurisdictional functionality. It truly is a collaborative approach that is required.

So do you think banks will be forming more partnerships going forward?

We will probably see less of the traditional correspondent networks going forward as these are usually based on historical relationships that are not necessarily as strategically advantageous as they have the potential to be. They will be replaced by collaborative networks – or strategic partnerships – whereby there will be fewer actual relationships as such, but they will run deeper and will have a more strategic focus towards meeting clients’ needs.

In China, we believe that it is very important for foreign banks to have strong partnerships with local banks. While foreign banks can leverage their customer relationships and robust global systems, no foreign bank will ever have the local coverage that a Chinese bank has. We think that it is critical to have broad and deep relationships with other banks.

As we are expanding our footprint in China and our in-country capabilities, we will continue to work closely with Chinese banks to meet all of our clients’ needs.

Could you provide an example of this type of collaboration?

In order to make their payment processes more efficient, companies in the Asia-Pacific region have begun looking to new technologies to reduce paper in the payments workflow. Such companies have found that a convenient alternative to foreign currency and travellers’ cheques for employees is prepaid cards. These cards, which only allow employees to access pre-loaded funds and do not offer a credit line, provide additional efficiencies by automating the reimbursement process for travel and entertainment expenses, for example.

In response, J.P. Morgan deployed a prepaid travel card programme last year to several of our Financial Institution clients in South Asia. This solution assists these Financial Institution clients to deploy our capability and offer pre-paid card programmes to their customers. This programme enables clients to migrate from paper to electronics, as well as enhancing their operating environment through automated reporting and reconciliation tools. Both banks and their clients benefit from this type of solution as they can both save on processing costs and boost their respective efficiencies.

Banks are leveraging each others’ capabilities more and more these days. In a co-operative manner, it enables each of the banking partners to expand their capabilities while focusing their investment dollars on where they have strength.

What do you predict for the payments industry over the next 12 months?

Given all that we have discussed, I would hope to see the global payments market becoming more integrated and moving closer to addressing the needs of clients, be this in terms of risk management, transparency, efficiency or liquidity.

While I believe this evolution can be pushed forward by industry participants, the regulators will also have their role to play. The development of standards, such as ISO 20022 for example, will serve to enhance this integration and interoperability within the payments arena. The key message for banks is to revisit their clients’ priorities and to respond to these with a value proposition. The key for corporates is to communicate openly with their banking partners.

This interview is based on a whitepaper by Linda McLaughlin-Moore, entitled ‘Back to Basics: Core Principles for Payments Industry Growth’, which is available at www.jpmorgan.com.