The rapid transformation of the payments industry over the past decade has brought banks worldwide to a crossroads. Balancing growing consumer demand for instant payments and emerging digital services against the spiraling complexity of maintaining efficient retail payment infrastructure places significant pressure on banks, particularly smaller ones, to keep up. The proliferation of real-time payments systems and new service layer innovations, such as Request to Pay and payments tracking, put the capabilities (and limitations) of legacy payments infrastructure under the spotlight.
Payments modernisation is no longer optional, it’s imperative for survival. Despite this commercial imperative, very few payments innovations occur without the right infrastructure environment in place. Regulators in the payments industry do increasingly view innovation as a crucial pillar of activity and advance considered regulations to drive innovation, at least in part, by creating the right conditions. At the same time, competition in the retail payments market is front and center of regulators’ minds as they grapple with new players in the ecosystem and the mushrooming of new licensed entities
So, given the very real pressures and complexities of an increasingly diverse payments ecosystem, how should banks future-proof their payments infrastructure to remain profitable and relevant long term?
It might seem counterintuitive, but for some banks the best way to futureproof payments infrastructure is to offload the service entirely—to other banks. Let me explain.
In the industry, there’s a phrase that describes the constant tension between innovation and regulation: To comply with regulations, fintechs need to act like banks. To fend off encroaching competitors, banks need to act like fintechs. As new digital payment instruments, including central bank digital currencies (CBDCs) and cryptocurrencies, emerge and open banking and application programming interfaces (APIs) unlock access and connectivity options, banks must invest in technology that provides infrastructure to meet rapidly changing requirements and on-demand scalability. These are not small upgrades.
While bigger banks have the resources to modernise infrastructure and invest in payments technology, smaller banks often don’t have the deep pockets needed to keep pace with technological shifts. Try as they might, they will never be able to truly compete with nimble, unregulated fintechs or with larger Tier 1 banks that can throw large amounts of cash at the problem.
Instead, smaller banks must think strategically about which parts of their value chain they should keep in-house and which non-competitive services they can outsource to a partner to free up resources for true innovation. Fintechs may seem like an appealing choice, but since they’re not regulated, they can’t handle the full range of services that small banks need to offload to stay agile. At the end of the day, customers want to know their money is safe.
Take Single Euro Payments Area (SEPA) payments for example. Small UK banks that offer SEPA payment services cannot be competitive from a cost perspective but offloading the responsibility to a fintech will not change the volume or regulatory responsibilities, so a stand-alone business case is very difficult to make. However, if you add indirect access to faster payments and correspondent banking to the equation and realise that there are banking partners offering this today (and decades before today), interesting options emerge.
The onus is on the Tier 1 banks to be able to offer that one-stop shop experience for any payment type (plus value added services like FX and liquidity) from an organisational as well as a technological angle; this does not work if the payments processing ecosystem is old, costly, and dispersed across the organization. Most Tier 1 banks are in transformation cycles, so this offering should be front and center to their thinking.
By allowing the small banks to free up resources where it matters to compete (front end) and adding volume to the commodity processing of the large banks (back end), effectively lowering the cost per transaction, the ecosystem as a whole will become more efficient.
A truly vibrant payments ecosystem—that benefits both consumers and the financial services sector—depends on building a flexible real-time payments infrastructure that promotes access, competition, co-operation, and innovation. When small banks partner with bigger banks that have already upgraded their technology platforms, they can offer, via third party, tech-based services like payments that still comply with regulations and don’t require costly capital outlays for infrastructure modernisation. By sidelining themselves in some capacities, they set themselves up to go the distance in their areas of strength.
Banks that are serious about creating a future-proof payments strategy (both big and small) must evaluate their current offerings, their long-term goals, and their legacy infrastructure with a critical eye. Only then can they determine if the best way to compete is by withdrawing from the infrastructure modernisation race altogether, protecting their ability to innovate in other ways—and their bottom line.
