No Match Found
In this section, we identify unique barriers to banks such as tighter regulation and the drawbacks of legacy infrastructure and systems. We highlight how these are restricting banks' ability to rapidly provide the more agile and custom-tailored solutions that are typical of Baas/PaaS solutions offered by fintech and big tech. They are also leading to an imbalance in the competitive landscape as banks' more digitally native and less restricted PI counterparts leverage these gaps to attract more customers - challenging their monopoly within the payments system and bringing their current and future customer retention potential into question.
As the payments revolution picks up momentum, banks continue to face a number of structural hurdles that have to be managed in order to compete effectively in the emerging payments landscape, enhance customer retention and maintain their profitability. Of these, regulation perhaps stands as the most significant. Regulation in itself has largely underpinned the digital transformation of payments observed in the payments ecosystem. The PSD2 directive, for instance, has played a significant role in promoting innovative competition and enhancing inclusion through standardisation. This regulation compels banks to allow third party providers access clients' bank accounts through APIs, underscoring the expansion of fintech and bigtech in driving financial management, payments speed and ease.
At the same time, banks, by reason of their operations and their impacts on overall financial stability, are subject to heavier and tighter scrutiny and regulatory oversight than their fintech and big tech competitors.Thus, we see that further regulation, if not equally implemented across all financial and NBFIs, could further widen the regulatory gap between banks and their competitors by subjecting them to higher compliance costs.
The impact of the aforementioned regulatory gap is that banks find themselves operating in an uneven playing field where non-bank payments players tend to have more flexibility for faster technological adoption and innovation and thus more market appeal. Consequently, these players are not only able to take on more risk but also intensify competitive pressures on their more traditional and long-established bank peers. Moreover, with digital transformation underpinning their core business model, these firms are able to secure vast investment allocations towards advanced digital innovations. In fact, as of end-2020, the top 50 European fintech companies had raised more than EUR 14.3bn in funding and were collectively valued at over EUR 78bn. It is no wonder then that they are increasingly attracting a greater proportion of retail and corporate customers, and consolidating their position as market challengers in this sector - with the potential to impact banks' future profitability should this trend persist and accelerate.
While it can be agreed that further innovation inevitably holds massive benefits for banks, it also imposes upon banks the task of repurposing and upgrading their aged technology and infrastructure in order to keep up with the surge in transaction volumes and customers’ demand for faster payments processing and other advanced functionalities. This has become particularly imperative as digital innovations like Artificial Intelligence (AI) and big data are rapidly transforming the payments landscape, evidenced by the emergence of a plethora of digital payments channels. Currently, not all banks have access to the agile infrastructure required to execute rapid and real-time iterations or facilitate the rapid embedding of modern technologies within their systems. A Reuters study supports this, showing that 43% of banking infrastructure is still based on the Common Business Oriented Language (COBOL), a programming language devised in 1959.
In the coming years, navigating this complex terrain would be inherent to banks' ability to move at a similar pace as their non-bank counterparts. Indeed, it would be necessary to their very survival, with 80% of banks that still use legacy systems forecasted to be extinct by 2030 unless they amplify and accelerate their digitalisation efforts. This need to upgrade banks' infrastructure is reinforced when one considers that not doing so could raise compatibility issues when attempting to implement new standards and payment channels on the outdated systems currently operated by banks. The global ISO 20022 financial messaging standard set to be adopted from November 2022 (Exhibit 10) is an example of such new standards. It was developed in response to the inconsistencies and lack of customisation associated with existing financial messaging standards such as SWIFT. Further, the ratification and implementation of CBDCs, which are being considered increasingly by several central banks, could also result in new payment channels with impacts on reducing the need for banks' intermediation between central banks and customers/businesses.
That being said, embarking on this infrastructure upgrade is far from easy. Banks have to contend with hefty financial costs, complex organisational bureaucracies, and stringent and sluggish regulatory frameworks. They also have to unravel several ambiguities surrounding integration with layered and intertwined existing systems, data migration challenges, technical standards for data management and sharing, as well as the choice of payment channels to adopt.
The payments evolution and revolution have sparked innovative disruption at multiple levels, with impacts on customers’ experience, limiting intermediation in the payments process, and improving profits for PSPs. The main catalysts of this are shifting socio-economic factors, regulation, and technology - all of which are underpinning various demand and supply factors that are accelerating the rate of disruption within the payments landscape (Exhibit 11).
The changing socio-economic landscape is increasingly shaping customers’ behaviours. Preference for a more seamless payments experience is almost considered non-negotiable, especially by younger, more tech-savvy generations who expect to be able to carry out all activities conveniently from their mobile devices - including payments- and are more willing to share personal data to facilitate this process. Meanwhile, the surge in transaction volumes and demand for instant and direct payments is placing pressure on banks’ legacy systems and amplifying costs (operational headwinds).
Regulation is also being seen to have a double-sided impact on the payments ecosystem. On one hand, it is driving innovation, fostering competition and the entrance of new players, and incentivising banks to pursue greater digitalisation. At the same time, its increased focus on investor and customer protection and the resilience of emerging payments systems through strict compliance requirements is resulting in tighter regulation of banks - not only in terms of capital ratios, amount of guaranteed deposits, and leverage ratios but also in restricting banks’ ability to explore certain forms of crypto-assets for example.
Technology represents the third dimension, underpinning the digitalisation of the payments ecosystem in response to market changes and leveraging regulation to open up the ecosystem for further innovation by new players, who are quicker to provide more tailored and customer-centric payments solutions. This is not only spurring changes in demand and supply dynamics but is also redefining the scope of customer engagement in the process, with banks’ laggard reactions to the latter proving to be a big test of their customer retention abilities. Demand side changes such as the growing need for instant payments and data sharing have seen companies in the B2B segment in search of more efficient and suitable cross-border payments systems - necessary to make better treasury decisions and obtain greater business visibility. This is anticipated to continue, with 42% of respondents in a PwC survey expecting an acceleration of cross-border, cross-currency instant, and B2B payments. The continuous shift toward e-commerce and e-payments - expected by 89% of respondents in the same survey - is also expected to yield further B2B demand for digital payment solutions.
Another dimension of technology-driven pressures within the cross-border payments sphere can be seen in the impacts of the former on disrupting existing business models, particularly when it comes to client relationship management (CRM). From this perspective, we are seeing an evolution of client engagement mechanisms, moving from the era of the telephone to current substantial business model adjustments with the use of online direct relationship tools, and more broadly digitally enhanced relationship management. While proximity to the client remains central to these adjustments, the disruption of payments and the perceived disconnect with banks from clients’ perspectives may be an additional challenge for banks, regardless of their level of engagement in the payments sphere.
On the supply side, banks and traditional PSPs are encountering pressures to accelerate their digital transformation and alleviate processing strains on existing infrastructure. These pressures are bolstered significantly by the influx of more digitally native players who are increasingly challenging their business models with quicker and more tailored customer-centric payment solutions. Not only that, but with a greater ability to fully explore the use of mobile payments and other disruptive technologies, these new entrants within the payments realm are clearly pointing out that much progress remains to be made by banks in this respect.
Audit Partner, Banking, People Leader, PwC Luxembourg
Tel: +352 49 48 48 2451
Deputy Managing Partner, Technology & Transformation Leader, PwC Luxembourg
Tel: +352 49 48 48 4174
Advisory Partner, Banking, PwC Luxembourg
Tel: +352 49 48 48 4131
Assurance Partner, E-Money & Payments Institutions Leader, PwC Luxembourg
Tel: +352 49 49 48 2065