What the heck is PayTech (Part 2)

In the first part of our analysis of PayTech we looked at the transformation that has already taken place. We examined at the different areas and using examples have shown how FinTech innovation has changed existing models. In the second part we will now address the developments that have become evident and how they will shape the industry

 

The Enabling Role of Regulation

One of the key elements of the new wave of innovation is based on the effective use of the vast amounts of data that is amassed by financial institutions. Without the enabling effect of new regulation like the EU’s second Payment Services Directive (PSD2) that gives third parties access to clients’ data of banks, new technologies could not be as efficient though.

On the other side of the pond the CFPB pushes for open data, too, to foster innovation in the payments sector and encourage more collaboration between providers.

As a result of PSD2 we already see a move towards account aggregation and personal financial management that is offered by both traditional banks and FinTechs alike. On the back of that retailers will also be able to foster better data about their clients. Payments made through wearables will also benefit from the new rules and could provide a bump for the struggling smart electronic devices. PSD2 will also open the door for mobile wallets from China that are already accepted by many retailers in Europe for Chinese nationals, to introduce services that target other nationalities, too.

Regulation will also play a pivotal role in the adoption of biometrics as an authentication tool. Since the technology has made significant improvements, it is now suitable instrument to secure customer accounts and adoption by FinTechs and banks will increase if the regulations and standards put the right framework in place.

Real-time payments

So far the adoption of real-time payments has been slow, but this is likely to change given the investments in the respective infrastructure though not in the short run and especially not for consumers. However, the value of services and products based on real-time payments is significant and will spur the development as it reduces settlement time, which in turn means better and more efficient control over cash. The added certainty of funds results in a real-time view of funds and simplifies reporting as well as financial planning.

Virtual Currencies

For most, the response of banks to the rise of Bitcoin and other virtual currencies has been something between reservation, denial and outright confrontation. While many have been more interested in the underlying technology, virtual currencies itself represent opportunities for financial institutions in terms of corporate treasury. Cross-border payments as seen with Ripple will further move into the limelight and with every bank joining the network, transactions volumes increase, which again contributes to the standing and the proliferation of virtual currencies as payment instruments. Central banks continue to examine the opportunities brought by virtual currencies and while many still seem reluctant of the idea to issue their fiat currencies on distributed ledger technology, a few are already working on concrete ways of using them.

Networks and ecosystems

The times of customers that have their account with the same bank for their whole life are long gone. The ease with which financial service providers can be switched and the willingness of customers to do so has increased the need for firms to provide better customer experiences and rewards. Payment service providers are in a unique position to deliver such rewards in line with a customer’s preferences and purchase history in a seamless and prompt fashion. Like many financial institutions the key lies in building networks and/or become a platform upon which supplemental services are integrated and offered to customers to create additional value and increase the likelihood of customer satisfaction and loyalty. No small feat but arguably the only way to survive in the long run. Ecosystems are the answer to the challenge as financial institutions have access to customer data that if used properly reveals insights in a client’s life no other service provider has.

FinTechs and Banks: competition, mergers, partnerships

The transformation of the payments industry is more likely to gather speed than slowing down, as future generations will be even more accustomed with technologies that older clients still might find difficult to adjust to. The adoption of challenger banks is also powered by better customer experiences and offerings that address clients’ needs. But it is not all competition as partnerships between incumbents and newcomers have shown. While FinTechs are more agile and flexible in particular with regard to the use of new technologies, traditional institutions often have knowledge, experience and resources the former lack.

As many FinTechs might find it difficult to be profitable or scale to an extent where they would be, the solution is often to seek forms of collaboration with banks and traditional financial institutions. The latter on the other side struggle to respond to the technological challenges and despite having significant IT resources at their disposal see the integration of external services as the way forward.

It will also be interesting see how the tech giants will enter the ring. It no longer is a question of whether Google, Facebook and Apple will try to get a piece of the banks’ cake as ApplePay shows, but more so where they identify opportunities for themselves or whether certain aspects should be left to their financial counterparts.

The Protection Role of Regulation: Data Security, Cybercrime and Fraud Innovation

Data security is one of the top challenges in payments. Experts predict that cybercrime will cost the world $6 trillion annually by 2021, doubling from $3 trillion in 2015. It is a constant game of cat-and-mouse with criminals finding new ways to defraud financial institutions and individuals alike. A report by Capgemini projected $31.3 billion in global card losses in 2018.

New regulations like the EU’s General Data Protection Regulation (GDPR) or the New York Department of Financial Services (NYDFS) Cyber Security Regulation have increased the obligations on financial institutions. Both introduce severe penalties for non-compliance, but the actual damage for an institution can go much further as recent examples like the hacks of the SWIFT network have shown. The industry has responded primarily by increasing their insurance coverage against liabilities stemming from cyber security laws. The respective part of the insurance industry has grown by more than a third in 2016 alone to $1.35 billion in terms of direct written premium. This is due to the current patchwork of laws, which makes it particularly challenging for firms that operate in various jurisdictions. So far the response by banks has often been to increase the head count, which has reached critical limits though in terms of cost of business. An alternative is the use of technology, which takes us to our final point:

The Impact of RegTech

The cost of compliance for financial institutions in terms of cyber security has risen sharply as we have just seen. But it is not the only aspect that will increase compliance spending if no alternative and more cost-effective solutions are introduced. In this context the conversation often turns to regulatory technology (RegTech) and how innovative technologies like artificial intelligence or biometrics can solve the problem.

RegTech solutions based on machine learning for instance potential payment fraud can be discovered more efficiently and faster by analysing a customer’s purchase history and looking for patterns or anomalies. This reduces the cost due to the damage of fraudulent behaviour but also frees up compliance resources. Annual RegTech spending is predicted to exceed $76 billion per year by 2022 because of new regulations like PSD2 or the Chinese cyber security law large chunks of this will come from the payment industry.

 


This article is part of our FinTech series on the disruption of Financial Services that looks at the different areas, how they have been changed and what the future may hold in store. The first article was about WealthTech and if you want to know more about FinTech and how is transform financial services, check out our dedicated area here.