“Payments is now a new battleground,” says John Hutton, director of payments at Nationwide, “particularly with Open Banking and the adoption of Third Party Providers (TPPs) and Payment Initiation Service Providers (PISPs). Through that ecosystem a TPP can start to manage on behalf of a customer.”
If the convergence of technology and financial services has sparked innovation, then the innovation seen in the payments sector has been explosive. The rise of paytechs and challenger banks has seen a renewed interest in the payments space, particularly their cross-border capabilities, and challenging the traditional in-house payment system build by banks.
Historically, innovation of the UK’s banking payment systems was only as quick as the innovation of the batched based Bacs (1968) - responsible for the schemes behind the clearing and settlement of UK automated payment method - and Chaps (1984) -which offers same-day sterling fund transfers - with access limited to a handful of incumbent banks who could afford the cost to build the internal hook up and employ an IT department to maintain it.
In this way, internal banking payment systems only innovated at the pace of industry wide schemes and only by a select few players.
But the formation of Faster Payments in 2008 – a nationwide cross-industry payments infrastructure initiative - reduced the previous norm of a three day clearing period to the current two hours, kindling the start of the payments revolution.
“It wasn’t until Faster Payments that consumers began to notice the near real-time capabilities,” says Michael James, head of technical architecture at Altus Consulting, “that faster payment has really generated the demand to push for innovation across the board.”
Payments used to be considered a function of no return, but banks have shifted their strategy, approach, and culture.
“Payments underpin what a bank does,” Nationwide’s Hutton says, “It’s a utility function where customers generally aren’t interested in your underlying infrastructure, platform or partnership, they just want it to work in the background. That was an old world view of five to 10 years ago.”
The UK’s Faster Payments certainly fits the bill as background payments infrastructure for the market. A spokesperson for Pay.UK, the organisation which runs the country’s retail payments operations including Faster Payments, Bacs and Cheques, says there are similarities between the telecom and banking industries in terms of how the market is moving forward.
“At the start, the mobile telephone operators were very much in control,” he says “and what happened over time was an disaggregation of the market; for example a Tesco front on O2 plumbing.”
“We’re beginning to see it in banking, where more customer facing brands are looking for new opportunities using payments infrastructure enabled by initiatives like Faster Payments New Access Model, Open Banking and what we’re doing with the New Payments Architecture,” says the spokesperson, referring to the project lead by Pay.UK to develop the next iteration of the UK’s payments infrastructure.
But that is not to say that access to the Faster Payments programme has not been subject to criticism, even if the underlying architecture is due for innovation. Access to the programme has been stilted and direct participation has only doubled from 10 to 20 since 2014. The historic barriers to entry may be down to the access requirements that include mandatory access to the Bank of England settlement account, direct technical connection to the FPS Central Infrastructure, mandatory 24/7 reception of payments, and specific liquidity and risk management tools.
“Faster Payments was started 10 years ago by 10 members - RBS Group, Barclays, Santander, Nationwide to name a few - who kept it very closed,” says Julian Sawyer, chief commercial officer of challenger bank and paytech, Starling, which recently joined the Faster Payments scheme as a direct participant. Without direct participation in the scheme, companies and banks must come to a commercial arrangement to be sponsored in by proxy connection to a direct participant which Sawyer believes is only as good as your sponsor: “If you’re not a direct participant then you still have to be sponsored into the scheme which has traditionally been RBS and Barclays who have offered batch-based access that’s expensive and a long, slow onboarding process. Not a great answer.”
Batch payment processing has historically been the method for processing credit and debit payments by Chaps and Bacs, relying on processing a number of transactions in bulk at a single time throughout the day. It is also the preferred processing method of the large incumbent institutions as it is more cost effective, says Sawyer.
“Faster Payments is a real-time system not batch based, it is the inefficiency of the banks who are sponsoring that is creating friction that is not there in the scheme. That friction from the big traditional sponsors is created by their own legacy technological incapability of offering real time,” says Sawyer.
But recently, new access models have opened Faster Payments access up to new challengers with the first non-bank direct participant, TransferWise, joining in 2018.
“We’re a gatekeeper with a guardianship role,” says the Pay.UK spokesperson, “we need to ensure the security and sustainability of payments infrastructure, but we have an interest in opening that gate to new types of company when it can benefit users.”
“Previously the only people able to directly access payments infrastructure would be your big financial institutions, with the clout to build their own system, but with new options to access Faster Payments’ and in future the NPA there are new opportunities to connect directly and to develop overlay services.
“We’re seeing some different models coming through,” he adds “Just a few years ago if a non-traditional bank wanted to make Faster Payments it would have had to go through an aggregator. Now challenger banks and other types of company like Transferwise and ipagoo are connected directly.
“It’s allowing a growing and vibrant market to thrive.” says the Pay.UK spokesperson.
But for Starling’s Sawyer, the first digital only bank to join as a direct participant in 2017, it is the challenger’s job to widen the gateposts further by offering sponsorship.
“We now have 18 to 19 banks onboard, so it’s hardly a runaway success,” says Sawyer. “People like Starling and Clearbank come along that do things fundamentally differently; we’re both sponsors of corporates, government, e-money institutions and banks into the Faster Payments scheme,” says Sawyer.
A number of challengers and fintechs have stepped in to meet demand for real-time payments, according to Capgemini’s payments and card solutions leader, Christoph Vergne.
“The market is very active,” he says. “Growth rate in the volumes of transactions are higher than ever at 12% globally, upwards on the prediction last year of 10.1% ,” quoting the World Payments report 2018.
For Vergne, a key factor lies in the proactivity of the European Banking Authority (EBA) and Financial Conduct Authority (FCA) bringing in competition initiatives in the UK (Open Banking, the Competition & Market Authority rankings), European based technical standards (PSD2) as well as security standards (ISO 20022). This all leads to greater collaboration between fintech vendors and banks, says Vergne.
But Jan Dirk van Beusekom, head of strategic marketing for cash management & trade finance at BNP Paribas, suggests that the collaboration required to drive the growth of these ecosystems was not without its challenges for the incumbent institutions.
“PSD2 more or less forced banks to open up user data of the corporates to other parties that wished to enrich the platform,” he says. “Even though we were forced initially, we also think it is the way forward and we are happily creating open channels with suppliers and customers.
“Data is the new driver and the new gold and protecting it becomes a primary concern for banks. Banks are definitely more than data vaults, there are a lot of other services that banks still need to provide, such as the trust and human factor as well as implementation,” says Beusekom.
Beusekom goes a step beyond the role of the EBA and FCA, suggesting that the ecosystem is market driven.
“The real push behind the formation of these ecosystems is customer expectation and how it has affected pricing,” he says. “Obviously, the fintechs have had a disruptive effect on the incumbent banks, initially we needed to shift our mindset and that’s still ongoing.”
Ultimately, the fledgling payment ecosystems requires a reorientation of the buy versus build dilemma. For Altus’ James, building payments infrastructure is not conducive to the pace of innovation banks are facing nor, for that matter, are organisational structures helping, with the incumbent and challenger structures directly affecting their internal build ability.
“Why aren’t banks building? Because they’ve got a whole heap of other stuff to do. The cost of change in a financial institution is vast.
“Take the size of IT teams between incumbents and challengers as an example, they vary significantly. You might have 20-30 architects in Lloyd’s and two in Starling because functions are compartmentalised,” says James.
For the incumbents, who’ve had to learn the hard way to collaborate with fintechs rather than buy and integrate, the market is blurring the lines between build and buy to a mixture of both, believes BNP Paribas’ Beusekom.
“I don’t think either buy or build is able to currently deliver what is expected by the customer by themselves,” says Beusekom.
“Better to say orchestrate,” adds Capgemini’s Vergne, “instead of build or buy. If banks can sit at the centre of the ecosystem they will be in a winning position.”
And the payments space spearheads this type of behaviour more than in other areas of financial services, particularly with the ultra competitive nature of current account banking in recent years, says Nationwide’s Hutton.
Starling is one market participant attempting to take full advantage of Open Banking, by building their model on the API culture that is emerging in financial services.
“I’d describe Starling as first and foremost a technology company doing payments,” says Sawyer, chief commercial officer at Starling bank. “I think our approach, the API economy and platformication is changing the way that technology in financial services is being used, applied and consumed.
Historically, payment service providers and general fintechs have delivered solutions in a bespoke and customised manner, often with long review processes at larger institutions; a standard, pay per use solution drastically cuts down on time to market.
“We have a 12 month contract, that means we have to be nice and sharp in 12 months time for people to renew. Traditionally it’s been a five year contract with terms that were very expensive. We’re mimicking the way we consume technology, like Salesforce or Spotify.”
But Nationwide’s Hutton questions the claim that offering a Faster Payments package is a differentiator. One of the original founders of Faster Payments and its associated underlying payments infrastructure, the building society has a long history with Faster Payments.
Hutton sits as a director on the board of Faster Payments, while his predecessor Paul Horlock is now the chief executive officer of the UK's new payment system operator (NPSO).
“I’m not sure I agree with the fact that because we’re a larger player that our infrastructure, both old and new, doesn’t mean we can’t process a Faster Payment in the same way as a new bank,” says Hutton, “we all have to abide by the same rules, so there’s no real competitive advantage a challenger bank would have.
“I’ve seen the direct access model being built and sponsored,” adds Hutton “so I’ve watched the Monzos and Starlings come on directly, Metro being the first main one, so I understand that model.”
The challengers have embraced Open Banking and an open collaboration with other fintech players to compete with larger financial institutions in the UK – the connection between the banks and fintechs is Open APIs and, specifically around the buy versus build debate, Nationwide’s Hutton was coy on the full impact the emergent API culture would bring.
“We’re continuing to invest in our payment infrastructure like a lot of other banks, who are looking to replatform because of legacy infrastructure,” says Hutton.
With internal IT systems that may be decades old in some cases, it is little wonder that incumbents face a monumental task to renovate to new platforms while keeping business as usual fully operational, with the TSB migration crisis a warning.
“We’ll have to have a hybrid model running heritage systems which hold real value with historical data and interactions which is something challenger banks simply do not have access to,” Hutton says.
Altus Consulting’s Michael James, formerly of Nationwide, believes the building society’s model lends itself comfortably to the role of orchestrator.
“[Nationwide] put in vast amounts of money into SAP for banking,” says James, “it cost them huge amounts of money - but it gave them the agility it needs in the current market to innovate and change and their client share has increased, I would say, as a result. Investment in the backend is important and it will give you ultimate freedom.”
For Hutton and Nationwide, Open Banking and the emerging orchestrator role of banks is about how to deliver value to the building society’s end member is key.
“We have a good mobile banking app and the payment service that we offer is a 24/7 resilient offering for those that don’t require main cut off times like Chaps, SWIFT etc. By evolving a fully resilient payments platform that can cater to the needs of our members, from a future proofing perspective, we can adapt our payments offering so that it is congruent with industry changes, such as the changes ISO 20022 will bring.
“For the core services, we’re interested in the membership having access to the right services not necessarily being the most glitzy and up to date platform,” says Hutton.
But that strategy has always been focused on the building society’s holistic view of its offering to its membership.
“Our strategy is based on our propositional value,” says Nationwide’s Hutton, “other than just a product by product function which is the way a lot of third party providers and larger banks will look at it.
“I can definitely see the possibility of Nationwide using third party providers with Open Banking,” says Hutton, “but I think it’s important that we take our time to figure out our Open Banking strategy because the proposition - the membership experience - is the most important thing. Finding the right partners is key for our members.”
While Nationwide is taking its time to deliberate its Open Banking strategy, it bears reason to question the exact differentiator that early and agile to market has.
“I see someone like Monzo or Starling with a brilliant proposition,” says Hutton, “with really good fun money management tools where they can analyse your spending patterns. The rest of the market is developing those as well. There’ll come a time when it becomes, what next? What’s next is the fact that people still want to trust a brand.”
But Starling’s Sawyer believes the orchestration role in the UK payments market is time sensitive.
“You look at incumbent banks in three pots,” he says. “You have 10 or 12 banks that are directly connected in Faster Payments and, for their customers, they’re doing real time payment processing, you have others that are doing it through us, and then you have the other 380-400 odd banks that are not connected, and are using existing batch based access to Faster Payments.
“The question is, will those 380 non-connected banks move to us or will retail and business customers talk with their feet to Starling? I expect a mixture of both.”