For decades, all of us have relied on traditional banking solutions to make payments. A centralized system has been the focus of business and personal banking. The system is led by financial institutions like banks, credit unions, and wealth management and investment houses.
Traditional Payments & Pain Points
The payments system in the U.S. has been evolving for some time. It’s migrated from checks to a greater use of credit and debit cards and other types of payments. Although cash is still in use, digital wallets are gaining more attention 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 to many factors. These include the Internet’s reach, the evolution of e-commerce businesses, and social media platforms. With this international business environment has come challenges in regards to payments. It includes disparate financial systems, tax laws, and security measures.
Innovative Payment Solutions Emerge
In response, emerging solutions have taken center stage in recent years. This includes those solutions that use cryptocurrencies and a decentralized transaction and financial system. However, they have the potential to address the weaknesses found in the traditional 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.
The Cashless world
The cashless world is characterized by features that include mobile invoicing, integrated billing and next generation security. These solutions provide a way for customers to enjoy more convenience and higher security. Those receiving cash from them can better understand spending patterns and behaviors through the transaction data.
Behind the cashless world is the adoption of smartphones that consumers are using to take care of themselves. 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, there may be a decrease in the use of the traditional intermediary in a centralized system. Yet, investment companies see the value of what 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, information security, and consumer protection.
What Will Happen to Traditional Banks and Financial Institutions?
This presents opportunities for enhanced personal and business payment experiences for all involved. Additionally, 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. It includes 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.”
What does this mean?
However, some banks have looked to these emerging solutions as an opportunity. They can radically change their business model and create a better payments experience for their customers. As the NACHA explained, banks can focus on nurturing relationships with younger generations of customers. They also can 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 non-banks 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. Traditional payment systems do need to change, as noted by Morgan Stanley:
“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. People are building on emerging payment solutions. Others use an aspect of a traditional payments platform. Banks and investment companies want to stay relevant.
It might be good to strategically partner with those firms developing these emerging payment solutions. Together, they can create something that could take the best of both platforms. This will in turn generate the quality and secure customer service experience that today’s consumer and business want.