Banking on the Future

SEPA (single European payments area) regulation will form a single payments format and system for all European community countries by 2010. Industry estimates are that banks will spend billions in order to comply with the regulation, but result in a net drop in payments revenue to the banking industry of around 50%.

Since businesses do not survive by making large investments to reduce revenues and profits, SEPA implementation necessarily means that this regulation will change the competitive landscape of the financial industry in Europe. The scope of the SEPA impact will truly provide a once-in-a-lifetime opportunity for banks to redefine their competitive differentiation based on payment processing. NelsonHall has been monitoring the European banking industry to identify:

• what options are available to banks to address this challenge
• how banks are responding to this competitive challenge
• how bank customers are responding to this opportunity

Because of limited resources in the face of multiple challenges, banks are carefully choosing which processes they want to deliver themselves, and what is the most cost efficient way to run processes they want to keep. Outsourcing is a top choice as demonstrated by cases, all signed in the past 12 months, like:

• ABN AMRO signing a contract with Equens to provide SEPA card processing services
• Atos Origin acquiring Banksys and BCC from a consortium of Belgian banks for electronic payment processing services
• TSYS being awarded card processing contracts with platform migration as a key component by banks such as Rabobank
• Getronics partnering with ING bank to create a biller service provider

CHALLENGES IN BANKING ARE BIGGER THAN SEPA

Globally, the banking industry is facing great changes in regulatory oversight. Basel 2, Check 21, SAS 70, to name a few of the key regulatory changes mandated, will necessitate that each bank re-architect its core systems and operational delivery capabilities. Reconfiguring systems will not be possible, system conversion will be necessary. Global banks are consolidating their operational platforms to two or three global delivery centres.

Banks need to form a point of view on what the new operational bases of competition will be. Our conversations with banks show that banks understand that this is not a 'best of breed' selection process, and that new platforms have to be developed to meet this challenge.

Should the organisation make a mistake, it is likely to be a very expensive one to rectify.

Unfortunately years of cost competition and outsourcing have hollowed out banks' abilities to internally develop, maintain and operate custom systems. Outsourcing is a logical choice, but is risky considering that many outsourcing deals have not delivered the anticipated results. Outsourcing, as part of a system conversion, is an even riskier proposition and therefore needs to be subject to very intense business review prior to undertaking.

CHANGING THE PAYMENT PROCESS

SEPA will reduce the pricing of payments processing, driving many banks from the market. The remaining players are trying to adapt to changed market conditions and will need to build transaction scale to survive. Banks are looking to outsource to payment process providers that help them to meet the challenges of today's marketplace.

Our interviews with banks show they are looking for five key benefits from payment processors:

1. Conversion of fixed cost to variable cost: by having the payment processor make the investment in platform modernisation and charging for service on a transaction fee basis
2. Platform flexibility, compatibility, and improvements: the ability to integrate to legacy platforms, while adding functionality over time and an ability to scale rapidly
3. Cost reduction: cost reductions of at least 20%, with continuing cost reductions over the next five years
4. Increased speed of execution: as bankers compete for a shrinking pool of business and enter new country markets, swift execution is a key competitive advantage
5. Re-engineered processes: to enhance straight-though processing and improve data access to drive new business development

To achieve these benefits, payment processors are developing and delivering new bundling of processes, as well as new features and functionality. Instead of segmenting service by country, vendors are creating offerings segmented by process type. For example: debit card, prepaid card, credit card, or internet initiated.

GLOBAL VENDORS

Not only are vendor offerings changing, but vendors themselves are also changing. Instead of remaining highly localised geographically, they are buying regional vendors and product-type specialists to incorporate them into a globally delivered 'industrially hardened' set of service offerings to create the necessary enablers and benefits.

In fact, in the past 12 months, M&A activity among third-party payments processors has spiked, as evidenced by the merger of Interpay and Transaktionsinstitut to create Equens.

At the same time, divestitures of payment processing operations by firms has also spiked upward, examples include the sale by a consortium of Swedish banks of card processor Cekab to EDB and First Data's announced shuttering of its check and money order business.

These activities will ensure both consolidation and globalisation for the industry over the next five years.

Despite high interest in offshoring, today the offshore delivery market for European payments processing remains very small (less than 1% of total payment service delivery). The shift to image-based checks and electronic transfers coupled with low telecommunication costs will drive the move to offshore delivery, primarily in Eastern Europe. For the moment the least pressure to offshore processing comes in physical check processing, despite its high cost.

ADAPTING TO CHANGE

In banking, success depends on the ability to adapt to a changing environment. The European payments market is changing and so must the processes that service that market change. Cost pressures and access to talent have made it imperative for mid-tier and small banks to engage with third party processors to deliver payment processes in a flexible and dependable manner, while reducing a bank's time to market.

This type of process change necessitates increased due diligence. After all, if you are going to bet the bank on new processes and partners, you had better be right.