McKinsey projects that the 2020 global payments revenue will be 7% lower than in 2019. But the crisis resulted in much more than a $140 billion decline. The pandemic-induced disruption compressed five years’ worth of change into less than a year, accelerating transformation in customer behavior and payments operating models.
The decline in revenue and new entrants successfully leveraging market changes has banks and long-time players rethinking their approach. Companies are urgently looking for ways to come off the sidelines as modern digital platforms enable newcomers to capture spaces dominated by established financial institutions.
Consulting firm McKinsey & Company recently published its 2020 Global Payments report. This year, McKinsey explored how companies can position themselves to capture pockets of growth stemming from the accelerating winds of change in global payments.
As a banking and payment software provider, we devote a lot of time and resources to researching how global changes impact our clients and the industry. At SDK.finance, we believe that understanding how disruptive trends affect the payments ecosystem is key to developing modern banking platforms and future-proofing our payments products.
Here are the three key takeaways we got from reading the new report.
Decline in cash usage
Physical distancing measures, limits on business activity, and shifts in commercial behavior have resulted in a sharp reduction of in-person purchases and cash transactions. The fear of contracting the virus through cash and high-traffic ATMs resulted in customers and merchants shifting towards electronic and contactless payment options to complete transactions.
Source: McKinsey Global Payments Map
In the UK, ATM usage declined by 46% per month on average from March to July 2020. McKinsey’s analysis suggests that evolving consumer behavior in both mature and emerging markets will reduce the share of global payment transactions in cash by four to five percent. For comparison, such a decline would take four to five years before the pandemic. In response to a reduction in cash use and in-person services, banks have accelerated the move to online banking by closing branches and ATMs. Since June, the top four banks In Australia have removed over 2000 ATMs and closed 175 physical branches.
The physical shift was complemented by a welcome and fundamental shift in the adoption of technologies. Investments into instant payments and account-to-account transfers infrastructure have begun to reap significant benefits as digital payment volumes soar, driven by consumer migration to digital channels.
Traditional operating models are not delivering
Although banks are the primary providers of payments services, most of them do not benefit from digital payment volumes soaring. Traditionally, banks rely on revenue sources other than payments – interest margins on accounts, credit lines, interchange revenues, and cross-border fees. In the current environment, most of those are not delivering and are not expected to rebound soon.
Payments also take up a significant part of banks’ operating cost base, representing up to 40% in some cases. Maintaining outdated infrastructure, managing upgrades, and rationalizing legacy technologies is expensive, and many banks face a significant challenge in the near to midterm if they do not optimize costs.
Source: S&P Capital IQ; McKinsey analysis
Given that payments represent the most frequent interaction between banks and customers, financial institutions need to invest and improve digital infrastructure to remain competitive. Instead of maintaining high outdated payments services and their high ownership costs, banks need to invest in modern platforms to free up capacity to develop new products and enable new customer experiences.
In the face of market upheaval, banks need to reevaluate their operating models and determine what role payments play in their unique product offering. The only truly negative option is to do nothing.
Options for change
Incremental efficiency improvements to outdated payment systems are no longer enough to maintain the structural advantages banks have in the market. McKinsey believes that banks can reach an acceptable profitability level if they achieve cost improvements upwards of 30%. Different operational models can help banks leverage technology to enable new services such as instant payments and open banking.
Payments as a service
A new generation of payments-as-a-service (PaaS) players allows banks to quickly expand and modernize their existing services using cloud-based platforms. Without high upfront costs, banks can link specialized payments services via APIs to their core banking platforms. They can then seamlessly offer services such as cross-border payments, currency exchange, and payments clearing to their customers.
This model significantly expedites time to market for new payments products from years to months. PaaS providers continuously work on their services, meaning that banks receive frequent product updates and upgrades without disproportionate maintenance investment.
Banks that don’t have the capacity to invest in a full payments technology stack developed in-house can still offer top-of-the-line services to their customers by outsourcing select services. This approach enables banks to rapidly expand their capabilities and maximize functionality without incurring high in-house development costs.
Changing the operating business model is difficult but necessary to enable future growth. Given the high opportunity cost of maintaining legacy technology in the current economic climate, banks need to thoroughly evaluate their payment capabilities and how they can improve them.
SDK.finance provides core payment software for banks and financial institutions that allow to build next-generation payment products.
Contact the SDK.finance team directly to learn more about what type of banking software will be perfect for your business needs.