Riding the payments roller-coaster

The payments infrastructure is a "competitive edge for banks".

UK banks are still in “a difficult place” as they face economic uncertainty, increased cost and competitive pressures, complex regulations and rapid technological changes – but the changes that are happening in the payments industry offer scope for them to reclaim the initiative and deploy innovative solutions.

That was the message from a panel of experts convened by Oracle at the British Bankers’ Association in London last week.

The stage was set by Eric Leenders, retail banking executive at the British Bankers’ Association, who said that the banking industry is still “in a difficult place”, having fallen from grace in the financial crisis, and still suffers from a lack of trust. Underneath that, however, retail banking is still a simple business: taking deposits making loans, and handling payments.

Leenders pointed on that all of these are changing in subtle ways – looking at the UK loan market, he pointed out that if current trends continue, the largest category of unsecured loans will be student loans within three to four years. More generally, he said that banks are also affected by the wider economy, where the trend seems to still be that people are “saving not spending”.

On top of this, the spectre of payment protection insurance mis-selling continues to haunt the industry, while the “Twin Peaks” of new regulatory bodies replacing the former Financial Services Authority will usher in a new regulatory approach. [The Financial Prudence Authority will be responsible for the financial stability of the industry and the Financial Conduct Authority will be responsible for, among other things, the way the industry interacts with its customers, including payments services.]

“There will be a whole new approach to supervision, more akin to the US or Japanese approach,” said Leenders. This move away from ‘light-touch’ supervision is also likely to result in further attempts to have the industry compensate for past products. “PPI is only an example of the retrospective application of legislation,” he said.

One potential area of trouble on the horizon concerns endowment or interest-only mortgages, which were heavily marketed in the 1980s and are now coming to maturity: with an endowment mortgage, the consumer repaid only the interest on the loan, not the loan itself, plus a proportion into an investment that would pay the loan on maturity. A combination of falling interest rates and rampant house price inflation means that many home-owners now face the possibility of begin unable to repay the principle.

In the face of these market conditions, banks are looking at simplification of their business models and product offerings, and increasingly looking to migrate their customer base upwards to the more profitable mass affluent sector, while continually working to contain costs.

While technological changes are affecting all areas of banking, payments services is undergoing a more dramatic shift than most. The combination of mobile developments and a move to real-time systems, together with government-led modernisation initiatives and wider changes in the regulatory framework, such as the Single Euro Payments Area, have created a rapidly changing and confusing environment.

In many ways, the UK is ahead environment of the curve in adopting new payment technologies. David Gradwell, head of consulting at payment infrastructure provider VocaLink told the audience that the Faster Payments System has been rapidly taken up, as demonstrated by the fact that almost all standing order payments have migrated from the BACS scheme to FPS.

VocaLink has been commissioned by the UK Payments Council to manage the proxy database that will be used for the mobile person-to-person money transfer scheme that is scheduled to come into operation in the first quarter of 2014.

The database maps account details to a proxy, simplifying the process of transferring money. Typically, this proxy will be a mobile phone number, but it could actually be pretty much anything, said Gradwell. One option might be for a proxy to be a National Insurance or Social Security number, for instance.

VocaLink will be managing the service, proving it via Faster Payments or the Link scheme used for ATMs, which has a wider membership. It is developing interfaces for banks that already have mobile service offerings and also a version for banks that haven’t yet developed their own, providing a managed service, including the registration process. “It’s not a zero cost, but as IT projects in banks go, this is as easy as it gets,” he said.

Rob Kotlarz, business development director at Sterci, which provides payment systems to Lloyds and HSBC, said that this sort of innovation, far from disintermediating the banking industry, plays to its strengths: “When people say that banks are going to be redundant going forward it amuses me, because banks are the market infrastructure, and that is the competitive advantage the have in payments – PayPal wouldn’t work without Bank of New York Mellon’s connectivity to that market infrastructure.”

Rik de Deyn, senior director, banking, at Oracle agreed, pointing out that a common infrastructure across payment channels has other benefits too. Addressing Leenders’ point about cost containment, he said that taking “payments as a business” and modernising payments systems has significant impact on running costs – in some examples he gave this amounted to a 66% reduction in total cost of ownership over five years.

“Some things are non-negotiable, like business continuity, but that saving moves from the maintenance budget to innovation,” he said.