The emerging challenge for European retail banks
Since the financial crisis, European banks have not made returns in excess of their cost of equity, and they are not expected to do so for several years to come. The forces assailing bank profitability are arguably playing out with the greatest intensity in the area of payments.
- Status quo under threat
- Key Challenges
- Increasing non-bank competition
- The emerging payments landscape
- Responding to the challenge
Payments are a key revenue stream for European banks. Deloitte estimates that retail payments will account for €128 billion in revenues in 2015, or around a quarter of total European retail banking revenues.
Moreover, payments are of strategic importance both as the anchor for client relationships and as a platform for selling a range of other products, such as loans, credit cards, savings accounts and mortgages.
Payments are now the subject of intense regulatory scrutiny, both at EU level and in individual countries, with price caps and structural measures being introduced to promote competition and innovation.
The status quo under threat
Banks have historically been the dominant players in payments systems in Europe and around the world. This is true both in the so‑called ‘front‑end’ where customer payments are initiated, (for example by writing a cheque, initiating a credit transfer, or paying by card) and the ‘back‑end’ where payments are processed.
Deloitte estimates that retail payments will generate around €128 billion in revenues for banks in 2015, or around a quarter of total European retail banking revenues3. These revenues derive from three different sources: product fees, transaction fees, and interest.
Regulators have identified the dominance of banks in payments as a problem. The European Commission, for example, sees high costs of payments as a tax on trade. It estimated that payments in 2005, including cash, cost two to three per cent of EU gross domestic product. EU payments regulation aims to reduce this by half.
While Deloitte estimates that the IFR will have only a modest effect on banks, Deloitte believes that the impact of opening up the payments market under PSD2 (and by the PSR in the UK), coupled with technological change, could be large.
Changing consumer preferences
In the past, underlying service levels for payments were broadly similar. The emergence of new services, such as the UK’s Faster Payments, and new methods of payments, such as contactless cards and mobile payments, has enabled consumers to experiment.
Increasing non-bank competition
Many of the experts Deloitte interviewed were not particularly worried about increasing non‑bank involvement in payments. Their view was that the revenues, profits and overall liquidity for banks are not significantly threatened by the competition.
About half of respondents expect that the impact on retail bank payments profits of opening up payments initiation will be ‘low’ or ‘very low’ for both card and non‑card payments (see Figure 14). They took this view, mainly because the initial effect of the new payments services will be to displace cash payments.
The emerging payments landscape
Banks have strategic choices to make. How much should they invest to defend their position in payments, and how should they invest? Should they ‘go it alone’ or should they collaborate? Should they focus on providing the ‘rails’ for payments, and leave the innovation to fintech? Should they take a different approach for card and non‑card payments?
These choices will to some extent depend on how the payment landscape evolves. In turn, this will depend on the success of regulators in opening up payments systems to alternative payments services providers, and on consumers’ appetite for adopting alternative models.
Responding to the challenge
The purely financial case for responding to non‑bank payment services providers may be difficult to prove at this stage of market development. However, the downside risk from allowing non‑bank competitors to establish an unimpeded strong foothold is too great to do nothing in response, even if the probability of significant disruption may seem small at the moment.
By not responding to innovations in payments, or by relying on fintech, banks risk becoming utilities earning low margins. In such a scenario, they will need to build scale to make sufficient returns on investment. Becoming a utility can be a viable strategic option for banks that are able to operate efficiently and at scale. But it must be a conscious choice. There is a defensive imperative to act.