A closer look at innovation in retail payments
"One cannot be forever innovating. I want to create classics." (Coco Chanel)
Innovation is currently one of the most discussed topics in the payments industry. Some believe that the current systems are 'dinosaurs', deeply rooted in the last century and due to die off in the near future. Some compare innovation with 'okapis', a very shy and hidden animal which does not prosper in an environment of obsessive supervision and uncompromising regulation1. Some might even think of innovation as a chameleon - rarely seen, and even if present, difficult to spot.
For sure, central bankers have no vested interest in zoology. But they have a vested interest in the safety and efficiency of payment systems. Since innovation is essential for economic development, and consequently for the vitality of the payments industry, the Committee on Payment and Settlement Systems (CPSS)2 decided to shed some light on this dazzling matter. The CPSS set up a working group to conduct a survey on innovation in retail payments among central banks. As a result, a comprehensive fact-finding mission on innovation in retail payments was triggered, which provides an empirical basis for an analysis on the current status and trends. Payment experts within central banks were asked to name innovations in retail payments in their national environment. More than 120 innovations were identified throughout G20 countries. The working group gave a more comprehensive picture by presenting these alongside selected developments in other countries. Single innovations (i.e. concrete products) were included as well as stylised groups of innovations (e.g. pre-paid cards). It is obvious however, that such a fact-finding mission cannot claim to produce an exhaustive list of all existing innovations, even in the participating countries.
One of the main challenges presented by this initiative is how to define innovation in respect of different developments. The working group concluded that there are no universal criteria. The specific domestic situation has to be considered when assessing whether a development constitutes a new or significantly improved product or process. Consequently, the broad range of innovations that were reported identified innovation with regards to the respective economy. The fact-finding mission focused mainly on developments in the last decade.
Innovations - not (yet) leading the market
Innovation should, by nature, enable significant gains in market share. It is not surprising however, that new developments in payments are not quickly accepted; indeed full market penetration is required for an innovation to develop into an established means of payment. As a result, the current payment landscape is mainly based on traditional payment instruments. This is illustrated in a survey among working group members which aimed to identify the most and second-best popular payment instruments used in certain situations. According to the survey, cash is still king at the point-of-sale (PoS) as well as for person-to-person ( ) payments. Unsurprisingly, credit transfers and direct debits are most relevant for pre-arranged payments, but are also significant in other situations. Credit cards dominate e-commerce, while debit cards which can be considered an innovation of the past, have gained popularity at the PoS. Only a few central banks reported innovative products being relevant in this context (e.g. Octopus Card in Hong Kong, BPAY in Australia, SADAD in Saudia Arabia).
See figure 1: Use of payment instruments depending on the payment situation
(click to enlarge)
New technologies pave the way - but not exclusively
Very often, new technologies are deemed to be the main driver for innovation. This is also true in the payments market. It is often not solely the availability of new technologies however, which gives birth to an innovation. In some cases, innovation may be based on established technologies combined with new business models. Important drivers of innovation in the recent past could be described as follows.
- High internet usage and strong growth in e-commerce.
- Increasing penetration of mobile phones and the appearance of advanced technology (e.g. smartphones).
- Development of near field communication (NFC) and the increasing use of cards in public transport (e.g. in Japan).
- Efforts of governments in several countries to include the un(der)banked population (e.g. by establishing bank agents in rural areas or introducing pre-paid cards for recipients of social welfare [e.g. USA, Brazil, Mexico, Russia]).
- Trend towards the real-time processing of payments (e.g. in the UK, South Africa and India).
At present, it is difficult to assess the impact that social networks may have on future payment methods and processing.
One way of grouping innovations could be to follow the traditional payment process model, comprising the four cornerstones: payer and payee as well as their respective payment service providers. Based on the results of the working group's research, innovation is in many cases related to the process of initiating a payment (e.g. using a mobile phone to initiate a traditional payment). Just as frequently however, the innovation does not simply modify the access channel but creates a completely new scheme (e-money) or considerably improves an existing one. In some cases innovation refers to infrastructural enhancements of payment service providers' internal processing systems or the interbank clearing systems.
See figure 2: Extended model of the payment process
(click to enlarge)
It is worth mentioning that the categorisation of innovative products in retail payments constitutes an important challenge. A mobile phone can, for example, serve several purposes. It can grant access to a traditional bank account, it can be used as a substitute for a physical card (credit or debit) or for accessing e-money schemes. Some providers might decide to offer their service via the internet (e.g. by using email addresses as an identifier) while offering specific applications on a mobile phone (e.g. using mobile phone numbers). Owing to the rapid development of communication technologies it is likely that different categories in payments will become increasingly blurred.
Nevertheless it is helpful to view innovation in payments from a product-related perspective. In this respect, most of the reported innovations were referring to card payments (often pre-paid with NFC technology), followed by mobile payments and e-payments (i.e. payments via the internet). The remaining innovations could be grouped into electronic bill payment and presentment (EBPP) and improvements in infrastructure.
'Ain't no mountain high enough' - network effects and two-sided markets
The nature of the retail payments market as a network and two-sided market presents a challenge for the implementation of new technologies. Why? Firstly, usage of a new payment instrument will only be attractive if there is a sufficient number of active users (network effect). Secondly, since making a payment requires adoption on two sides, i.e. payers (consumers) and payees (merchants), a 'critical mass' is needed on each side in order to make the innovation a success. There are many cases which show that these factors are key to understanding why many innovative products did not go beyond a pilot phase or only had very low acceptance rates. For example, standalone electronic purses were launched in a number of countries throughout the nineties, but failed to meet high expectations. Many merchants did not support the new schemes since they were not convinced of the advantages or the technical solution. The low degree of acceptance made the use of those cards rather unattractive for consumers who also observed some disadvantages (no interest, risk of loss). In contrast, mobile-based payment solutions in Africa were more successful since they could draw upon an existing customer base. The initial offer of services enabled the 'two-sided market' problem to be avoided and the service was extended to include person-to-business payments only at a later stage.
Payment innovations in mature markets might face more challenges as they have to compete with legacy services (e.g. debit cards). On one hand, it might be difficult to convince the users of such new solutions; on the other hand, payment service providers might fear that a new offering could negatively impact their existing business. Special attention also needs to be paid to the growing security concerns of end users with regard to new technologies.
Although it is not contested that innovation develops best in a competitive environment, the question remains as to what extent cooperative efforts are needed in order to make an innovation successful. The definition of common (technical) standards allowing, at least, for interoperability between different schemes may be needed to overcome the obstacles inherent to the economics of the payment industry. There is some experience showing that it is more efficient to compete on the basis of common standards than to compete for standards.
It is not surprising that most of the innovations reported in the working group are owned by financial institutions with a focus on card payments. Non-financial institutions however are not far behind and are now playing an even more prominent role in internet and mobile payments. In a few cases, central banks own innovations, particularly those associated with improvements in the clearing and settlement infrastructure. A slightly different perspective is that the vast majority of innovations are triggered by established players; most of the non-financial institutions are considered newcomers.
Need to dig deeper
The current article gives some insight into the topic of innovation, but the work is far from complete. Various aspects need further and thorough investigation, inter alia the role of standardisation, the importance of consumer habits, security aspects and the role of regulation. Another important issue which the working group will address is whether the progress of innovation within the market is still incremental or whether bigger leaps can be expected. Regardless, the pace of launching new and innovative payment products has definitely increased within recent years. New players have started to enter the market and could pose a new challenge to incumbent players if they are able to bring in a large existing customer base. There is a tendency to implement innovations on a global basis (e.g. the NFC-products offered by global card schemes). To a certain extent, that is in contrast to the fact that until now the process of innovation has very often been driven at a domestic level. The working group intends to finalise its work by the beginning of next year. From a European perspective, innovation in payments is considered a key issue within the Single Euro Payments Area ( ) context. The integration of the European payments landscape will offer a unique window of opportunity to establish new innovative payments solutions in the areas of card, internet and mobile payments. In that respect, it is time to pay more attention to innovation instead of focussing too much on the classics.
Dirk Schrade is Deputy Head of the Department Payment and Settlements Systems at the Deutsche Bundesbank (German national central bank) and chairs the CPSS Working Group on Innovation in Retail Payments. The views in this article are those of the author and not necessarily those of the Deutsche Bundesbank.
Related articles in this issue:
Related articles in previous issues:
Innovacompegration (This is Not a Typo). Reflections on the best approach to innovation, integration and competition in payments ( Newsletter, Issue 10, April 2011)
1Javier Santamaria: Innovacompegration (This is not a Typo), Newsletter, April 2011.
2The CPSS serves as a forum for central banks to monitor and analyse developments in domestic payment, settlement and clearing systems as well as in cross-border and multicurrency systems. The CPSS Committee also focuses on standard-setting activities. The CPSS consists of the Reserve Bank of Australia, National Bank of Belgium, Central Bank of Brazil, Bank of Canada, The People's Bank of China, European Central Bank, Bank of France, Deutsche Bundesbank, Hong Kong Monetary Authority, Reserve Bank of India, Bank of Italy, Bank of Japan, Bank of Korea, Bank of Mexico, Netherlands Bank, Monetary Authority of Singapore, Sveriges Riksbank, Swiss National Bank, Central Bank of the Russian Federation, Saudi Arabian Monetary Agency, South African Reserve Bank, Central Bank of the Republic of Turkey, Bank of England, Board of Governors of the Federal Reserve System, Federal Reserve Bank of New York.
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