Payments: Traditional vs. Emerging Solutions
For decades, all of us have relied on traditional banking solutions to make payments and cover transactions for goods and services as well as investments. Both business and personal banking has been strictly focused on a centralized system led by financial institutions like banks and credit unions as well as wealth management and investment houses that oversee our investment portfolios.
Traditional Payments & Pain Points
While the payments system in the U.S. has been evolving for some time, migrating from checks to a greater use of credit and debit cards, other types of payments, such as prepaid cards are being used. Although cash is still in use along with personal and business bank accounts, digital wallets are gaining more attention as a commonplace way to store and send money.
This traditional system has worked fairly well although weaknesses have appeared where hackers have been able to access personal data to commit fraud and identity theft. Still others have been able to manipulate the financial and investment system that has essentially been left unchecked, potentially causing catastrophic events like the 2008 financial crisis and global credit meltdown (a.k.a., “The Big Short“).
Additionally, a new global business environment has developed due, in large part, to the Internet’s reach, the evolution of e-commerce businesses, and social media platforms that have stimulated an interest in working and sharing goods and services from around the world. With this international business environment has come challenges in regards to payments, including a wide range of currencies that need to be exchanged as well as disparate financial systems, tax laws, and security measures.
Innovative Payment Solutions Emerge
In response, emerging payment solutions have taken center stage in recent years, including those solutions that use cryptocurrencies and a decentralized transaction and financial system. Still other options have not been widely adopted but have the potential to address the weaknesses found in the traditional payment systems. A 2013 report from the American Bankers Association on the changing face of payment systems noted the dynamic nature that is now taking over due to the wealth of new technology and a willingness to develop something new.
A 2015 World Economic Forum report, entitled, “The Future of Financial Services” has identified a wide range of disruptive financial technologies that are set to forever change how we see payments. The two key disruptive trends involve a cashless world and payment rails that is now being propelled by various types of financial technology innovations.
The cashless world is characterized by features that include mobile payments, streamlined payments, integrated billing and next generation security. These solutions provide a way for customers to enjoy more convenience and higher security while those receiving payment from them can better understand spending patterns and behaviors through the transaction data.
Behind the cashless world is the adoption of smartphones that consumers and businesses are using to take care of many aspects of their lives, including payments due to the development of commonly used platforms like PayPal. Accenture listed other key trends that are driving the push toward these emerging payment technologies, including contactless adoption, cloud-based payment systems, mobile point-of-sale, retailer apps and micropayments.
The emerging payment rails focus on the potential of cryptocurrencies and their ability to transfer value rather than to just store value like traditional payment solutions did. Through cryptographic protocols, P2P transfers, and mobile money, there may be a significant decrease in the use of the traditional intermediary that comes with a centralized system. However, there are still many standards and regulations to set with this emerging payment solution before it can be expanded and adopted on a wider scale. Yet, investment and wealth management companies also see the value of what certain types of emerging payment solutions can bring to them and their clients.
While virtual currencies like Bitcoin and Litecoin are being used for various applications like online gaming and social networking, the technology behind known as blockchain is being studied for all types of uses, including smart contracts and for investment portfolios. Larger retailers like Overstock and Amazon are already accepting it as payment on products. However, many are still unsure due to risks like high volatility, potential misuse for criminal activity, information security, consumer protection, how to convert it into legal tender and the absence of standardization and regulations.
What Will Happen to Traditional Banks and Financial Institutions?
While this presents opportunities for enhanced personal and business payment experiences for all involved, banks and other financial institutions have mixed feelings about these emerging payment solutions. In some respect, they feel threatened, especially as more researchers ponder if this means the end of the line for a centralized financial system. As a 2013 NACHA Global Payments Forum white paper noted:
“If banks are not flexible enough to provide the innovative services that future generations require, bank accounts could lose their relevancy to consumers and businesses. Banks need to understand the impact that payments convergence, alternative accounts, mobile payments, automated account switching, and real-time payments have on consumer and corporate expectations, and they will need to leverage these trends to keep the bank account at the heart of the payments industry.”
Involved in these emerging payment solutions are numerous nonbank players, such as large telecommunications and technology startups. As a McKinsey & Company article concluded, “They have blurred the lines between media content, product merchandising, order, and payment, all while tailoring cross-functional offers to individual, real-time needs. In addition, nonbank digital players enjoy some important advantages, including fewer regulatory constraints, a higher risk appetite, and greater leeway from customers. For now, the payments business remains squarely within the core bank franchise, but attackers such as Google, Apple, and PayPal threaten critical sources of revenue.”
However, some banks have looked to these emerging solutions as an opportunity to radically change their business model and create a better payments experience for their customers. As the aforementioned NACHA white paper explained, banks can focus on nurturing relationships with younger generations of customers and capitalize on the long-standing ability to provide security and trust through their bank account model. The white paper also suggested, “Rather than seek to fend off the nonbanks that threaten their stake in the payments industry, banks should join them and use their own unique advantages to sway the evolution of the payments industry in their favor.
Additionally, other financial services companies like Morgan Stanley have released white papers on mobile payments to illustrate their acceptance and belief in such an emerging payment platform. In noting its ability to really become the primary payments area of the future, Morgan Stanley noted some things that had to change before a traditional payments system was really replaced:
“The mobile payments arena remains fragmented and wide open. Success will largely depend on consumers and merchants, whose adoption of mobile payments will hinge on whether the system is widely accepted, makes transactions easier, has robust consumer protections and security, can target and drive sales, and has low costs for merchants.”
Many predict that banks and financial institutions will come out the other end of this period where payments are rapidly evolving into other forms and processes because their framework and structure will still be of benefit. Even now, many of the emerging payment solutions are being built on or use an aspect of a traditional payments platform. It would seem that, if banks and traditional investment companies want to stay relevant, it might be good to strategically partner with those firms developing these emerging payment solutions to create something that could take the best of both platforms to generate the quality and secure customer service experience that today’s consumer and business want.