Payment Systems
Overview
One Minute Read
The Payment Systems segment is the core infrastructure that supports the transfer of funds between banks, individuals and businesses. Technological innovation, regulatory reforms and the increasing digitalisation of people’s daily lives have reshaped the payments landscape and are set to continue to do so. The COVID-19 pandemic has only accelerated this with a cross-generational shift to digital. Payments are shifting from cash and physical cards transactions to digital payments & mobile wallets. Digital currencies are likely to go mainstream, helping to replace physical cash. In response, the sector is transforming towards to a digital financial ecosystem, driven by five challenges and the widespread adoption of digital technology.
Segment Description
Payments Systems is core infrastrucutre segment that supports the $6.6 trillion Payments sector of the $25.6 trillion global financial services industry [1].
Payment Systems are a set of common rules and procedures that support the transfer of funds between people, businesses and financial institutions. Most payment systems are managed by operators, and supported by one or more infrastructure providers of hardware, software, and communication networks. These operators are sometimes know as Payment Networks or Payment Rails. Some financial institutions have direct access to each payment system and provide payment services to their customers.
There a wide variety of national and international payments systems dependent on the payment type, these include:
- Card Payments. They run on an independent network operated by companies that provide the technology to power their transactions. These card networks charge merchants fees to process payments using their payment infrastructures. The Payment Networks include Mastercard, Visa, American Express and JCB.
- Interbank Payments is a payment processing network used to transfer money electronically between banks. Most of these tend to be national, or regional in the case of the EU. Pay.UK is the recognised operator and standards body for the UK’s retail interbank payment systems and operates the three national retail payment schemes – the Bacs Payment System, the Faster Payment System and the Cheque and Credit Clearing Company (now the Image Clearing System). The single euro payments area (SEPA) is a framework of transactions that harmonizes the way cashless payments are transacted between euro countries. It’s a popular payment rail across Europe, facilitating over 43 billion transactions per year in 36 member countries. For international transactions, The Society for Worldwide Interbank Financial Telecommunication (SWIFT) is a cooperative society providing services related to executing financial transactions and payments between banks worldwide. In 2021, more than 11,000 global SWIFT member institutions sent an average of 42 million messages per day across the network.
- Blockchain is a distributed leger technology that creates a peer-to-peer network. A number of decentralised payment (and other user cases) systems are built on this technology including Bitcoin and Ethereum. These may disrupt traditional centralised payment systems.
Payment networks are moving towards Real-time payments to enable instantaneous digital payments. Examples of real-time payment rails include the RTP Network from The Clearing House and Mastercard’s multi-rail strategy that uses RTP Network, ACH, SEPA Instant Payment, and Mastercard’s acquired infrastructure from VocalLink and Nets.
Drivers
Shaped by the global megatrends, the financial crisis in 2008, the pandemic, rising interest rates and a declining economy, the segment is being transformed by the five major drivers that are shaping the wider Payments sector.
However, two particular drivers are key in Payment Systems:
Trust & Compliance - Digital payments and digital/crypto currency are also evolving fast. Regulation will continue to play a core part of driving the payments market. Many Payment Systems are national today, but geopolitics may disrupt the global systems.
Innovation – Innovation such as Apple Pay, Wechat Pay, Bitcoin and M-Pesa have transformed payments. Blockchain, digital currency and mobile payments are just some of the technologies which are disrupting the market. The challenge is how do the players harness these technologies and how does regulation keep up.
Trust & Compliance
Regulation is a core part of the payments market and is key to maintaining trust. There are three
Traditonal Payments systems are underpinned by national regulations and systems, for example SEPA in the EU. Geopolitics are challenging the global Payment Systems such as Visa/Mastercard and SWIFT. The EU is already seeking more autonomy from the US dominated Card Payment Systems and China’s financial markets will become more important and evolve around their own Payment Systems. A by-product of the focus on regional and national payments infrastructures will be the increased complexity of regulations across markets.
Crypto currency has evolved fast, but high profile failures and frauds mean that the market is attracting government scrutiny and be brough more formally into the regulatory structure.
With the decline of cash governments are also looking at Central Bank Digital Currencies (CBDC) as an evolution. These will create the need for new Payment Systems, and regulations, both nationally and internationally.
Compliance with a focus on the usage and security of customer data (e.g. GDPR) and anti-money laundering (AML) will remain high for Payment Systems.
Innovation
COVID-19 has accelerated the shift to digital payments away from cash and digital currencies (CBDC) are being developed. There are four major innovation areas:
Mobile & Contactless - Mobile is now the gateway for identity and through digital wallets and NFC the tokem for payment that should replace physical cards. Mobile payments are expected to almost double to $4.6 trillion by 2025 [1]. Payment Systems like M-Pesa provide an alternative Payment System using the mobile network.
Real-time Payments - Payment Systems have introduced real-time payments across Account to Account (A2A) networks, e.g. Faster Payments in the UK.
Open Banking - Allows payments to be embedded within real-life transactions e.g. e-commerce.
Crytocurrencies and Decentralised Finance (DeFi) are using technologies such as Distributed Leger Technology (DLT)/Blockchain to decentralise finance and create peer-to-peer transactions. Blockchain technology enables “instant” real-time settlement, offering the ability to eliminate settlement waiting times. In many traditional forms, settlement can take up to three days despite the actual clearing transaction only taking a few seconds.
Traditional payments firms need to innovate fast otherwise they may be disintermediated. Innovation will drive acquisition for example Visa has acquired Open Banking platform Tink. The challenge is how do the players harness these technologies and how does regulation keep up.
Transformation
The industry is transforming towards to a digital financial ecosystem where the payments market is shifting from cash and physical payments towards the speed and convenience of mobile wallets and digital payments. The decline of cash accelerated by COVID-19 and the rise of cryptocurrencies is accelerating a move towards digital cash. Ultimately payments will become invisible as they are embedded into real-life transaction within an open finance ecosystem.
Payment Networks understand that the new normal is digital and will build on the wider Payments transformations:
Mobile Wallets
Digital Payments
Digital Currency
and Open Finance Ecosystems
However in Payment Networks there are two specific transformatiom:
- Digital Currency Systems - The shift to digitial currencies will challenge Payment Systems but it can also open new use caseds and increase the efficiency of the transactions.
- Fraud & Security Compliance - In the wake of the pandemic the important of security and fraud prevention has become more critical and central to consumer confidence in the system.
Digital Currency
Digital currencies hold the promise of programmability, enriched data, lower costs, and faster payments. They have the potential to affect 5% to 10%—or more - of the global payments market by 2030, Bain & Company estimates [1].
There are currently four types of digital currency: central bank digital currency (CBDC), with more than 100 countries exploring the merits of a centrally issued currency; tokenized bank deposits representing a claim on a bank; stablecoins pegged to external source of value, such as a US Dollar Coin (USDC); and cryptocurrencies like Bitcoin, not pegged to an underlying asset.
Digital currencies have several potential benefits:
- Real-time, anytime settlement. Round-the-clock certainty of settlement with a counterparty would allow the payer and the payment processing firm to free up trapped pools of liquidity, optimizing working capital and collateral.
- Programmability. Digital currencies could enable conditional, event-driven, and automated initiation and settlement of payments through the use of smart contracts tied to the currency.
- Cost efficiency. Using blockchain technology may eliminate or reduce backoffice processes such as manual repairs due to failure, sanctions screening, and compliance reporting.
- Enriched data sets. The data from payments would provide information required to understand the nature of the payment and reconcile it with transactions.
The most immediate payment opportunities for digital currencies are web3 native applications, then traditional cross-border applications.
Central banks, global banks, BigTechs and digital native fintechs are vying to establish their solutions as the standard for this evolution of the payments system. For instance, Visa and Mastercard are exploring the use of digital currencies to make everyday payments on their networks. Between them, the companies have announced partnerships with Coinbase, Bakkt, BitPay, and others to support emerging payment forms. The maturity of digital currencies, including regulaiton, varies by country.
Digital currencies will require considerable Cloud capability with Data & Automation. Security is a key consideration.
Fraud & Security Compliance
In the wake of the pandemic the important of security and fraud prevention has become more critical. Banks have seen a 35% increase in fraud attempts through digital channels during the crisis [4]. 25% of Europeans exposed to any fraud suffered financial damage, causing a total loss of around €24bn in 2 years [5]. Regulatory fines are growing as a consequence. AML and data privacy fines totalled $5.4 billion in 2021 [1].
Payment Systems and the participants are investing in digital identity, automation, advanced analytics and AI to detect fraud and security risks in order to protect the network and maintain consumer confidence. Regulators are increasing security regulations and data protection frameworks.
Distributed Leger Technology has the potential to increase security but still suffers from risks such as fraud, misappropriation and money laundering. Smart contracts, which are self-executing and developed manually, are susceptible to coding errors that have a potential for misuse by users on an open-source network.
Digital Technology
Fundamentally Payment Systems will need to adopt three key technology approaches:
Cloud-first for operational efficiency and time-to-market gains.
API-first for effective ecosystems collaboration.
AI-first to combat fraud.
Security, Compliance & Data Privacy is a priority as customers, and regulators, expect payments to operate at a very high levels to protect customer confidential information and money.