Where is the action in retail payments?

 In the beginning there was gold  followed by cash. Then came the check. And then came technology where we are now.

The best analogy to understand  the action in retail payments is that of a kitchen table where the transaction occurs. The table has 4 legs and the table top. 

The four legs together with the table top  in our kitchen table example are the basic requirements of creating a transaction.

Customer:

The  first leg is a card holder who wants to purchase goods or services for which the payment card is used. Many flavors of cards exist- credit card, debit card, prepaid card and virtual cards. With the rise of smart phones a new breed of payment vehicles called digital wallets has emerged. Here you load funds from your bank account. Open Banking allows you to choose from the smart phone which bank you want to use to load funds.

The action is in offering the customer  multiple choices in making payments--cards, wallets, QR codes, Buy now pay later(BNPL), Request to pay(RTP), EMT or email money transfer, account to account to split a restaurant bill to name a few. 

Merchant:

This second leg is the entity that sells you the goods or services. This can take place in a physical store or online in a website or app. The payment is accepted in a Point of sale terminal or  in a secure area of their website called Payment Gateway where you enter the card details. In facilitating a payment, they accept any of the payment vehicles  the customer chooses to pay. Once received, they send the transaction over to the third leg called processor.

The action is in enabling Merchants accept the various payment vehicles. This is driven by the need to offer convenience and personalization to the customer which ultimately drives revenue.

Processor:

The third leg goes by various names --acquirer, payment processor, PSP, merchant aggregator. Sometimes a bank can offer the processing. With the rise in transaction types the action for the processors is making sure the transaction goes through and also to route the transaction at the least cost  for themselves and the Merchant. 

Issuer:

The fourth and final leg of our kitchen table analogy  is a bank or fintech who has issued the card or payment vehicle to the customer. These entities are responsible for funding the transaction by taking money from the customer bank account  and sending it on to the Merchant's bank account. 

The action here is that the Issuer has to provide these new payment vehicles to the customer . The success lies in how well they market the vehicle leading to more acceptance in the market.

Networks:

Finally the table top or the network that connects all the parties . They are the trusted brands we know so well like Visa, Mastercard, Amex. New payment networks based on current technologies are disrupting the legacy Networks business models. This is where the action lies.

 These new  networks are domestic networks in nature ,usually driven by the government and are provided to increase the availability of new payment vehicles . The goal of these governments is to enable transition from cash and financial inclusion. Absent legacy costs, these networks offer speed , convenience and lower costs to all the legs of the kitchen table top in the payment ecosystem. Examples of these networks are Interac in Canada, UPI in India, M-pesa in Kenya, SEPA in EU.

The legacy networks are not resting . They are also building these new networks in addition to their legacy infrastructure.

Some of the technology building blocks that enable this action in the retail payments area include ISO20022 payment messaging, tokenization, digital identity. They all take advantage of rich data now available about customer behavior to reduce operational risk elements like failing transactions in straight through processing, fraud mitigation, cloud infrastructure to cut costs and digital trends to attract new customers.

All in all a great time to be in this space.

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Embedded Finance and Payments

 We have seen a lot of exciting developments in the consumer space introducing payments as a way to enhance revenue and customer interaction. Starting with major tech players like Apple and Google offering wallets for paying merchants, Square added debit cards to its Cash App P2P platform, Uber used the Visa  rails to provide instant payments to its drivers to Shopify adding Stripe's payment processing capability for its merchants.

These initiatives have led to revenue gains for all parties but more importantly taken away customers which would have belonged to banks. JP Morgan's CEO was moved to announce that some of these fintechs are a threat to their business. Couple with the valuations these tech companies are getting in the tens of billion in many cases , you can understand the impact embedded finance is having on the traditional banking industry.

How are these results possible? Its possible by embedding the payment APIs into the company's business process such that the consumer can take advantage of the rich UXs the fintech offers and it gives benefits in terms of data about the customer behavior. 

With ISO20022 payment message standard gain traction, the benefit of embedding payment flows and interactions with the data generated will be an opportunity for serving the B2B sector as well with products such as virtual card for vendor payments.

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The business of banking and payments

 What does a bank do? From the perspective of a consumer of business here are the core functions:

-Offers consumers banking services around their day to day needs of payroll, paying bills, cash requirements, mortgages, deposits and managing wealth.

-Offers businesses a way to receive money from customers and pay their suppliers, loans to fund their business, handle domestic and international  payments 

Between themselves, they offer loan syndication, securitization, investments , stocks and bonds.

A common theme is the use of information technology to support their transactions and service their constituents with information about their money.

Since thousands of years this has been the function of banks. A trusted repository of your money and a facilitators of transactions for business benefit from financing wars to paying for your coffee. 

What has changed in the last two decades? The rise of internet as a set of technologies to enable banking. The unintended consequence is that Internet has enabled banks to take advantage of scale and hide bad behavior such as creating complex derivate trades without responsibility  for the underlying asset. 

But what about payments? The Internet has been of net benefit to the payments segment by enabling tracking of the legal beneficiaries and cost transparency for the end user of banking services. Trends like modernization of payment rails, APIs, Open Banking, ISO20022 messaging are facilitating deep integration across the payments value chain. This is a clean , fee based business with few places to hide for bad actors.

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Barriers to Open Banking

 As the banking industry is wrestles with  the twin challenges of  new customer acquisition and operational costs they are aligning some of their spend on digital transformation to Open Banking driven by the requirement of giving TPP or third party providers access to customer payments data.

This has created some additional barriers around competition and innovation. Lets consider these in more detail:

Competition:

-All jurisdictions with PSD2 have rules around which accounts should be accessible by TPPs. Many banks have even published APIs of their own, however there lack of standardization of these APIs. If banks build "premium" APIs the TPPs will be charged for this access.

-In market driven jurisdictions like USA and Canada they are talking of consumer rights but legislation is absent . In this case bank have partnered with TPPs like Plaid under a screen scraping contract to display account information . But these carry contractual risks as the recent litigation by TD bank has shown.

Innovation:

-A bank may hope to provide access to data residing in legacy mainframe systems, but will face manual work arounds when encountering the new authentication and authorization requirements for services offered by third parties.

-When a TPP wants access to data in absence of detailed rules around ownership of customer data banks may comply by providing the bare bones payment information. In such cases the 360 degree view of the customer is unavailable for TPPs to offer personalized service.

The solution is to think of Open Banking as market infrastructure and enable each other. The regulators also need to play an enabling role to ensure fair rules and partnership. This will take time to evolve.

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What is a Data Fabric?

 We are all aware that banks today are dealing with multiple data sources. Each of these data sources or end points  have to be brought into a central warehouse to run analytics on.  All this data movement requires integration capabilities and further the need to manage for security , the information about the data or metadata.

Data fabric is a middle layer that sits on top these end points and the connections architecture . You can think of this as a logical or virtual layer. You then build services to connect to the data fabric.  It has the contextual capability which describes the lineage of the data and the business logic.

This infrastructure allows the consumer of this data a convenient data set for analysis regardless if the user is from a bank or the customer. This data set is always current and fast  because we are not copying the stored data and its rich because it comes from any number of data sources.

The benefit is for the bank that you don't have to make copies of the data , the fabric abstracts the data into a dataset  for analysis and for the end customer they can interact with their own data . Due to zero replication, it is easier to administer and manage the data thus providing them control over the data they shared with the bank.

The overall benefit for the bank is this type of infrastructure allows them to think of new ways to create products and provide insights to their customers. 

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Business in the instant payment world

 Many jurisdictions are working on implementing a low value system on real time rails. Built on ISO20022 payment messaging standards, these promise the availability of instant and irrevocable settlement as well as rich data about the transaction such as invoice details.

Some well established business use cases that will benefit from these new capabilities  where payments are available 24x7  as opposed to time delay for ACH and checks are:

-Ecommerce vendors buying and selling online

-Gig economy payroll for workers for payment of hourly wages

-Emergency relief payments that we have become familiar during this pandemic

The benefit to the receiver are obvious-- money in hand instantly. But the business are also needs to step up in managing this sea change such as :

-How will information on the remittance be stored and reconciled

-If you are receiving funds after hours how will this be managed in an automated manner in your AR.

-What approvals will be in place to release the payment noting these are irrevocable and instant.

Think of the improvement in cash flow with these new tools. Also the reduction in time spent reconciling payments. Paying by installment may lead to new and more revenue.

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What is LEI?

 LEI stands for Legal Entity Identifier . This is a 20 character alpha numeric code based on ISO 17442 standard. This code helps in identifying the legal entities in a payment transaction. 

For example in Canada all counterparties to the derivatives transactions need to have an LEI. As faster payments and pay mod initiatives kick  in, more market participants including legal companies, their subsidiaries, government departments, charities will be expected to have this code.

The LEI Common Data File Format v.2.1 is expected to record previous legal names, "operating under", "brand name", "trading as". This clarity is expected to reduce operating cost and false positives.

In future once LEIs are incorporated into the business processes substantial cost savings accrue  in verifying entity during loan origination, KYC refresh, credit worthiness monitoring , compliance reporting etc.

Banks can consider using LEI as a business case to step up the ISO20022 modernization effort.

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The Age of Open Banking

 Let us pivot for a moment from the back office of ISO20022 payment messages to the front office where the customer meets the bank.  Imagine your legacy bank has worked hard to modernize its payment systems and now carries rich data about a transaction end to end.

What challenges do banks face? Several in fact. 

Sharing Customer Data: Who do I share this data with?  What is the risk to the bank, the customer? How is my API strategy shaping up?  Regulations are spotty at best and cant be depended to course correct us.

Partner: As a bank, I don't know the use cases of the rich data I am bringing, so let me partner with a third party. While I do benefit with customer acquisition is it damaging  my brand? Do I promote my APIs to anybody or restrict it and if so what do I restrict ? Case in point--TD Bank sued Plaid recently. 

Plus and minus points to consider such as how will the data be used by the third party and what risks arise to me as a custodian of this data. Key benefits of my product are a convenient way to compare accounts, some financial services and loans. Will price comparison benefit me or not? Upside is my sales channels and distribution increase. What are the downsides?

Distributor: In addition to my own products as a bank I can resell third party products like mortgage calculators, education and tools around budgeting for example. This leads to better customer journey. But what if the third party leaves and goes to another bank? Case in point--Mogo bank account origination was with one bank and they flipped to another--in this case Mogo is reselling the partner banks' balance sheet leading to some basis points yield but customer information is with Mogo so who has more value?

No easy answers here. Lot depends on the assessment of your capability as a bank to go to the market, what are your strategic goals near term and whether a Partner or Distributor model has buy in of the executives.

 

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How to use data from ISO20022?

 

 

The attraction of ISO20022 messaging data is:

-It is unambiguous: the meaning of each data element is known

-It is credible: the origin point of the data is known.

-It is consistent: all ISO messages follow a standard that is universally understood.

 

These factors lend itself to data analytics at scale. Many banks have data lakes and initiatives to use AI/ML to develop insights. The building blocks are in place.

What is payments data?

Data generated by providing payment services such as card payments, mobile payments, debit and credit transfers, ATM transactions etc. The type of information about the persons doing the transactions collected are PII data, sort and account codes, payment date and time as examples. Enriched data that is not necessary for payment processing such as location, mobile device id, cookie for online store, channel, frequency of use are other features that can be incorporated while developing insight from the payment data.

Use case for these analytics

-Internal

Operational efficiency such as cash loading cycle for ATMs, designing reward programs for encouraging a specific banking channel, loan underwriting feeds, better AML/KYC to start with and these can go deeper as the bank becomes familiar with exploiting the use cases and repurpose for other areas

-External

Developing premium products such as integration to corporate ERP systems for real time cash flow analysis, treasury collateral forecasting, sharing purchasing behaviour with customers is helpful for predicting seasonality in purchase, value or impact of a promotion or sale offers. These offerings build deeper touch points with customer and ring fence the customer from competition by fintechs.

 

 

 

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Case for ISO20022 migration

 

Its not about a technical specification and the fact that a lot of data travels with the payment in ISO20022.In making a business case for migrating to ISO20022, its very hard to sell to executives why a change of this magnitude is desirable. I collected a couple of data points both for the bank and its customer to showcase why this migration is desirable.

 

For Bank:

Banks have a very complex legacy architecture that has served them well for most part. However, the cost of servicing failed STP payment transactions is becoming prohibitive.

In Singapore for example a 60% STP rate is the norm. What is the norm for your bank? Is it acceptable? Factor in costs for false positives in sanctions screening. The business case can be built around these two cost factors as a starting point.

 

For Customer:

An Insurance company for example can expect 400 invoices to be paid in 10 payments. If the bank can provide enriched data about these invoices and payments the reconciliation effort is substantially reduced. The reporting around this information can be built into the value proposition.

 

What if the bank does nothing?

Over time the legacy infrastructure burden will render the bank unable to compete even if there is time available to migrate to ISO20022. The bank may have to start somewhere, perhaps look at message translation options as a starting point.

 

The way to build the business case will be in terms of operational costs, customer servicing and mandate timelines coming from bodies like SWIFT and country specific modernization deadlines.

 

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Compliance a Concern for Banks migrating to ISO20022

As ISO 20022 becomes more prevalent as a message standard of choice, banks are wrestling with the compliance risks that come with implementing this standard.

 

For the last 40 years a name and address in Swift MT consisted of 4 lines of 35 characters each. MT focused on concise information as opposed to clarity since it was developed in the days of low bandwidth and leased data lines were every expensive. In addition, over the last few years there has been the requirement of AML screening against sanctions lists and enhanced KYC including more information about LEI, names and addresses of beneficiaries. Further, the MT formats only support a Latin syntax whereas the rise of Asian character sets like Chinese are required nowadays.

 The ISO 20022 message definitions specified by payment providers include more data than the corresponding MTs used in cross-border business. If an ISO 20022 instruction is converted to MT for a cross-border leg, there is a risk of data being dropped or truncated. This creates compliance concerns because dropping data in end-to-end payment processing is unacceptable. Incomplete data, truncated data, false positives around sanctions lists all lead to increased regulatory burden for banks. The cost of investigation of errors and customer service grows proportionally. 

Banks must consider several thousand man-days of effort to ensure the data flows seamlessly. Some areas they will need to look at:

 -Legal Entity Identifier reference look up database 

-Source data for KYC with more accurate data capture at payment origination point. 

-High value system gateway updates 

-Updates from clearing system need to have a process to manage and apply the changes periodically

-Support of ISO20022 data, XML middleware, storage, and security

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 Welcome to my blog.

Here I will endeavor to post in brief some of the key issues facing the payments industry as banks modernize their financial messaging infrastructure. These are the common themes: ISO20022, APIs, Open Banking. In future posts you can see updates on current thinking on how to approach the major aspects and some more detail of what needs to happen at the frontlines.

I hope my content helps executives at banks and product managers who are not payment experts to get a birds eye view of the effort and opportunities in this journey.

Stay tuned!

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