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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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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How will payments be regulated?

 With the success of Chinese and UK based fintech and the changes in the USA allowing the likes of Amazon to offer lending to small business, fintechs are a well established member of the market infrastructure. As the volumes they handle rises the questions is what will regulators do?

On the one hand they want to encourage competition, enable the underserved and have worked to ensure data collections and sharing is regulated. Now that these goals have been met, the challenge is what to do with the new monopolies being created in fintech.

Witness the ANT group IPO shut down. Regulators will now want to ensure that no body is too big to regulate. The sheer scale of data about customer behaviour an Alibaba or Amazon can gather gives them an unbeatable advantage versus banks. These companies will also lock out new fintech competition by buying  them out or restricting access to data, the same problem that banks have.

One way is to ensure as in US that the parent company has liquid assets corralled off to cover the activities of their payments and microlending activities. The capital needed will satisfy regulators but want about innovation?

Would blockchain DLTs be the answer? By providing access to payment processors via DLT  they allow more entrants to what is essentially an old boys club and protect innovation perhaps.

It will be interesting to note the developments in regulations.

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What is a Data Repository

 In order to provide true value to the customer, banks need to understand them first. To understand customer behaviour with the goal of offering products/services relevant to them, the bank collects all details of the customer transactions. Then they study the data to see if any deeper understanding can be gleaned.

To facilitate the process of getting insights banks use a collection of data bases called Data Repository   (aka data lake, data mart, data library, data archive). This repository stores the data sets on which analytics are run to gain insights and predictions around customer behaviour. The business then takes a call on what insights to offer the customer . 

To get to the data sets however is a major task. The different sources from which data will be gathered need to identified. The data from each of these databases will be placed in a data warehouse . To get data into the warehouse requires ETL tools that will extract data from each of the databases, transform the data format of this data  into a format the data warehouse will understand and load the data to create the data set for analytics.

In fast moving real time businesses like banks, the data needs to be current, accurate and changes need to be captured . The processes and technical architecture of the data repository needs to accommodate these requests. Many ways to create these technical infrastructures exist and new ones such as cloud based ,open source, hybrid and connections with social and data feeds add more complexity.

Start small or repurpose an existing data set and scale up as you build consensus and maturity to deliver these data sets.

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The need for data integration

 In modern banking technology environment , the quest to get hold of data is a very complex exercise. First the data about the transaction has to be collected and there are rules on what to collect , how to collect and from where you are receiving this data. Then the need to transform the data into a form that can be ingested ,indexed and visualized by the product developers. After this, the data has to be moved to analytical platforms to slice and dice the data in a way that will make sense to the business teams. Finally the data has to be stored for a period of time . While doing all this the data has to be secure and protected  from hacking or loss.

Data Integration is the discipline of IT that comprises of the practices. architecture and tools that allows the bank to manage their disparate data sets in a coherent manner. This discipline covers all flavors and  types- data ingestion, data transformations, data processing, data pipelines, data synchronization, data virtualization, data fabrics, data engineering, data staging, streams data and data services to name a few.

In absence or lack of process around your data it can quickly overwhelm banking operations and lead to deterioration of services and impact the bottom-line.

Luckily this is a well known problem for which many approaches  and technical solutions are available. The challenge is all these solutions cover some parts of the puzzle and the bank has to figure out what works best for them. Understanding your data lifecycle, who needs access to what data are the key aspects to figure--how to do once a path has been decided is the easier part.

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Customer minutes and friction as a metric for Banks

 Everywhere we see especially in ecommerce what used to be complicated method of paying for goods and if required getting refunds used to be fraught process. Nowadays Amazon has shown the way with One click ordering and refunds.

This consumer focus to help make their lives easier while interacting with a machine has been rewarded both by customers and the stock markets . What are some examples where banks have made the difference?

- Transaction alerts on the mobile app 

-Customer authentication on the phone if calling from a registered number

-Servicing via chat if customer is on the online banking portal.

These use cases showcase how to reduce friction by reducing "Customer minutes" i.e. time spent by customers to address their issues. Think of how the internal business processes have been rejigged to permit these outcomes.

ISO20022 rich payment messaging data is a building block for enabling these types of friction reductions in business and the real benefit is in terms of better cash flow and the opportunity to innovate on top of the payment message data set.

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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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Value of digital transformation

 

Customer onboarding at Visa

Customer onboarding at Plaid

Visa paid $5.3 billion for Plaid. What does this tell us about the potential for digital transformation and embedded finance with ISO20022?

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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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