Should banks be increasing their investments in payments technologies? In particular should they be aggressively pursuing opportunities for the developments of new payments instruments, e.g. in mobile payments or e-invoicing to name two much discussed examples?
The response from most senior bank managers will be a cautious one, most likely an outright no. Payments technologies and other equipment expenditures are already a major expenditure item. A typical mid-sized bank with balance sheet assets of say 250bn might be spending already 200mn a year on investment in information technology and other equipment, perhaps a sixth of net income.
It is a substantial operational challenge just to ensure reliable provision of standard card and money transmission services – including debit and credit card usage both online and at point of sale and the reliable execution of customer payments including salaries and household bills. It is a big ask to spend more on projects with an uncertain outcome.
Upgrade or changes are especially difficult investment decisions. All the more difficult to approve today because of pressures on banks post-crisis, with many institutions struggling to achieve the double digit returns on equity that shareholders would like to see.
Reluctance to do more than the minimum investment in new payments technologies is understandable. One paper I published on the economics of payments a few years back was called “What’s in it for us?” I pointed out that bank payments innovation is rather different from innovation in other industries, say mobile phones, because typically bank payment arrangements are co-ordinated across the industry. As a result the first mover advantage, the increase in sales and margins for the firms that are first to market with the latest innovation, has not been an important incentive for investment in new payments technologies.
All this is understandable. But failure by banks today to actively pursue payments innovation could turn out to be a major strategic error. Here are some hard headed reasons why the banking industry should be fully exploiting the possibilities for technological advance in retail payments.
First development of payments technologies is intimately tied up with the growth of incomes and economic activity. The poster child for this link is the massive boost to the economies of many poor countries from mobile phone payments technologies such as m-pesa in Kenya. But this link is not just relevant to rural Africa. There is increasing evidence that payments technologies can make a substantial contribution to growth even in the developed world. Without growth bank returns will continue to disappoint.
Second the key to achieving satisfactory returns for bank shareholders, post-crisis, will be customer satisfaction. The banks that managed best through the crisis were those that focused on meeting customer needs, and there are some customers, notably some smaller and mid-sized businesses, for whom payment and associated cash flow management services are critical. Integration of these services with inter-net transactions, supply chain and trade finance will be crucial.
Finally, the clinching argument: if you don’t do it someone else will. To date the banking industry has not experienced the disruptive impact of technological change that has so altered other industries (two that jump immediately to my mind are music & book retailing and air travel). But it would be complacent in the extreme to assume that the progress of digital technology will never reach the point at which new entrants cannot offer new, low cost and convenient payment and banking services. If they do there could be rapid and large scale customer attrition from our familiar incumbent institutions. If that is avoided it will be because today’s banks recognise the threat and ensure that they do fully exploit the new technological opportunities for payments innovation.