Volume 8, Number 21 May 2015 McKinsey on Payments

Foreword 1

Gauging the disruptive potential of digital wallets 3 While they have established a solid foundation for growth, digital wallets are by no means a guaranteed success. They must continue to evolve if they are to have a truly disruptive impact on the payments landscape. Providers can improve their chances by focusing on six “markers” for success in payments innovation.

New partnership models in transaction banking 11 A number of trends are leading to a fundamental rethinking of the traditional model by which offer transaction banking services to clients outside their established markets. Four distinct partnership models offer the best opportunities for banks seeking to succeed in an evolving landscape.

Toward an Internet of Value: An interview with Chris Larsen, 19 CEO of Ripple Labs McKinsey on Payments sits down with the co-founder of Ripple Labs to discuss the nuts and bolts of the Ripple protocol, the implications for the correspondent banking model, and the emergence of an “Internet of Value.”

Faster payments: Building a business, not just an infrastructure 23 A faster payments infrastructure is not an end in itself, it is an opportunity for banks to deliver innovative products and services in both consumer and corporate payments. To monetize this opportunity, financial institutions should focus relentlessly on design, customer experience, accessibility and convenience. Faster payments: Building a business, not just an infrastructure 23

Faster payments: Building a business, not just an infrastructure

To date, most discussions about building a “faster payments” system have focused primarily on speed and “plumbing.” Even more important, however, are the innovative products and services that an enhanced infrastructure will allow financial institutions to bring to market. These new products and services—in both consumer and corporate payments—can create new revenue streams and help banks and other players realize a return on their investment in a modernized payments system.

Rob Hayden It’s about more than speed time clearing system. Banks must thus in- vest years and significant resources in up- Grace Hou In a recent article (“Transforming national payment systems,” McKinsey on Payments, grading their platforms and integrating September 2014) we discussed the impor- with the modernized system. The UK Faster tance of upgrading payments infrastructure to Payments, for example, cost between £150 make it both faster and more effective, safer million and £200 million to build and op- and secure, with designs based on specific use erate for the initial contract period of seven cases. Since then, the United Kingdom and years (2008-2015), plus up to £50 million Singapore have continued to lead the way; the for banks to connect to the central infra- UK with further growth in its Faster Pay- structure. Because of these costs, improve- ments system (see sidebar, page 27), and Sin- ments to payments systems must facilitate gapore with its G3 Immediate Payments. innovation and generate revenue streams Denmark launched a real-time payments so- for financial institutions. lution in December 2014, Australia and the Monetizing new payments systems United States are making steady progress to- Financial institutions can monetize invest- ward modernizing their payments systems, ments in a faster-payments infrastructure and several other countries are developing in several major areas: new products and strategies for improving their systems. services in both consumer and corporate In most of these countries, the banking in- payments, increased loyalty and retention, dustry is expected to pay for the new real- and new customer acquisition. The exam- 24 McKinsey on Payments May 2015

Faster payments, defined

Faster payments may also be referred to as immediate payments, funds are transferred from one account to another, and where instant payments or real-time payments. While faster payments confirmation back to the originator and receiver of the payments is have been defined in various ways, in this article we refer to them available in one minute or less” (Clear2Pay). The most important broadly as the modernization of payments clearing systems to in- features of these systems are real-time (or nearly real-time) clear- clude a “faster” component. Included in our definition are “domes- ing and availability of funds. tic, inter-bank electronic payments systems in which irrevocable

ples provided in these areas are not com- without the cost of a wire. (Taking the ex- prehensive but are meant to demonstrate ample even further, one could imagine a the potential for innovation—and thus new single mobile app for the entire purchase revenues—in a faster, modernized pay- process: researching and identifying cars, ments infrastructure. finding local sellers and prices, and making test-drive appointments.) New products and services in consumer payments Bill payments: A real-time infrastructure combined with a ubiquitous merchant- A faster, modernized payments system will biller directory—which would store and accelerate the convergence of mobile com- manage electronic payment identities for merce and consumer payments by enabling businesses so that they could be paid elec- real-time funds transfers that have value for tronically—and integrated into mobile both merchants and consumers. banking applications could create a fric- Person-to-microbusiness payments: tionless bill-payment experience involving Thus far, most innovation in the person-to- push notifications, a single-button and microbusiness arena has been on the front real-time confirmation of payment receipt. end, with products that make it easier for Consumers would have more control over microbusinesses and small businesses to ac- their cash flow, a less costly and more cept payments (e.g., Square and PayPal convenient way to pay bills, and more Here card readers). A faster back-end infra- certainty when making “consequence” structure would further improve the con- payments (e.g., payments to restart a sus- venience of these apps. For example, in a pended utility service). The revenue oppor- used car sale today, a buyer usually gives tunity here is significant, as bill payment the seller a check, sends a costly wire trans- touches every household. In India, for ex- fer or carries a sizable amount of cash to ample, 10 billion to 12 billion bills are paid pay for the car. Faster-payments infrastruc- each year, and in the U.S., over 20 billion bills are paid per year. ture will enable car buyers to send a real- time payment to the car seller on the spot, Online commerce: With retail e-commerce and drive away in a new car without the sales worldwide forecast to grow to $2.5 risk of a bounced check or a cash theft, and trillion by 2018, real-time payments infra- Faster payments: Building a business, not just an infrastructure 25

structure can pave the way for new prod- New products and services in ucts and services based on nearly immedi- corporate payments ate delivery of online purchases. Since As with consumer payments, a faster infra- goods are typically released when a pay- structure alone is insufficient for creating ment is received, real-time payments can value in corporate payments. However, enable real-time shipment and delivery. banks can use that infrastructure to build Online technology and e-commerce players valuable, next-generation payments tools for such as Amazon and eBay are already mov- corporate customers that offer the same ing toward faster and faster delivery; real- ease-of-use, simplicity and customer experi- time funds transfer and availability can ence found in today’s emerging mobile and enable more merchants to do the same— digital payments technology for consumers. with comparable payment speed and im- Just-in-time payments: Real-time pay- proved risk management. A new, real-time ments allow businesses to control when clearing system should enable more retail- payments are made and to increase their ers to match the standard that offerings certainty. Real-time payments are most like Amazon Prime have set, thereby in- salient for one-time, lower-value, business- creasing customers’ choices and furthering to-business payments, which account for an estimated $11 billion in payments volume in the U.S. alone, according to McKinsey’s Real-time payments may create a Global Payments Map. Particularly for need for corporate customers to small businesses that need to tightly man- age cash flow, faster clearing with real-time manage their intra-day liquidity more notification of payment would offer a way closely. Banks could generate to avoid late payments and adopt just-in- time business models. For example, retail- additional revenue by offering liquidity ers might be able to reduce their inventory management services such as levels, since immediate payment receipt would enable immediate shipment of or- intra-day loans or overdraft protection. ders. Moreover, real-time payments may create a need for corporate customers to the shift toward mobile commerce. Finan- manage their intra-day liquidity more cial institutions thus have the opportunity closely. Banks could generate additional to provide improved e-commerce payments revenue by offering liquidity management services such as intra-day loans or over- services to consumers and merchants. As draft protection. an example, iDEAL in the Netherlands, an e-commerce payments system based on on- Direct deposit for temporary and hourly banking, enables consumers to make workers: In the U.S., the current ACH Di- real-time, lower-cost payments by directly rect Deposit system requires a transaction transferring funds from their bank account to be initiated at least 24 hours in advance. to merchants. Consequently, many businesses have 26 McKinsey on Payments May 2015

Poland’s Express ELIXIR

The Polish national clearing house, Krajowa Izba Rozliczeniowa S.A. • Weak differentiation from legacy ACH system: The legacy ELIXIR (KIR), introduced Express ELIXIR in June 2012 after market research system completes transactions at a relatively high speed, with revealed high demand among end-users for real-time payments. three cycles of settlement per day and funds availability within a Supporting credit-push transfers with real-time clearing and settle- few hours (i.e., same-day ACH). Consequently, end-users are less ment, Express ELIXIR transactions are processed separately from likely to see significant added value in the faster payments sys- the batched ACH payments system, ELIXIR (also operated by KIR). tem, particularly when the Express ELIXIR is priced at a premium Express ELIXIR has yet to achieve widespread adoption, however, compared to the legacy ELIXIR. processing fewer than 1,000 transactions per day on average. (By • Alternative faster payments options: Intense competition in the contrast, Singapore’s FAST system processed over 33,000 transac- Polish payments space means that end-users have access to tions for over S$64 million in its first two days of operation.) cheaper payments options—such as Blue Cash, which began as The reasons behind the tepid rate of adoption can serve as lessons an e-commerce solution but has since expanded into a more for other faster payments systems: widely used payments system in Poland.

• Low bank participation: With only eight to ten banks out of about Despite these challenges, adoption is likely to grow in the coming 50 participating, the service lacks the ubiquity necessary to scale years, as major Polish banks are developing mobile payments solu- across end-users. The UK’s Faster Payments system and Singa- tions that will leverage Express ELIXIR. Additional services are pore’s FAST system, meanwhile, have the participation and in- planned for layering on top of the payments system, including a P2P vestment of all major banks. mobile service with the use of alternative identifiers. Ultimately, the • Lack of value-added products and services: At launch, Express experience of Express ELIXIR illustrates the importance of building ELIXIR’s participating banks had not developed payments solu- a business, not just an infrastructure, around faster payments. tions that leveraged its infrastructure. Without innovative prod- ucts and services that create seamless customer experiences, adoption is likely to remain low.

drifted away from direct deposit toward can be a catalyst for improved business-to- prepaid cards. A faster payments system business e-invoicing solutions. For exam- would allow more businesses to pay weekly ple, Australia’s New Payments Platform workers through direct deposit. Given that aims to provide more information-rich 17 percent of workers in the U.S. are tem- transactions by enabling commercial over- porary employees, the potential savings is lays on top of the basic invoicing infrastruc- significant. ture. It would then be possible to develop Automated e-invoicing solutions: products and services that automate e-in- Enhancements to payments clearing sys- voicing along the entire procure-to-pay tems could allow for new remittance data value chain, thus pushing the industry to solutions that digitize the back office for realize the potential of e-invoicing. Con- businesses. While payments system mod- verting invoices from paper to electronic ernization is not essential for e-invoicing, it yields a cost savings of up to about 70 per- Faster payments: Building a business, not just an infrastructure 27

The UK’s Faster Payments

With the launch of its (FPS) in May 2008, Launched in April 2014, the UK Payments Council’s service the United Kingdom initiated the global shift toward faster payments. enables customers of 16 participating banks to send and receive This real-time clearing infrastructure includes 10 member banks, payments using a mobile number as a proxy. Some banks, such as and enables phone and Internet payments through a continuous, HSBC, have extended PayM to business customers as well. real-time clearing system. Payments take one of four forms: single, Another mobile payments service that leverages the Faster Pay- immediate payments; forward-dated payments; standing-order pay- ments service infrastructure is Zapp, which is expected to launch ments; and direct-corporate-access payments. this year. Zapp is owned by UK banks and can be integrated into ex- Single, immediate payments are the primary use case, and grew 40 isting apps so that users can make in-store and on- percent CAGR from 2009 to 2014, reaching 8 percent of transactions in line purchases through mobile devices. 2014. Over 90 percent of transaction accounts in the UK can receive These innovations demonstrate the ability of a back-end, real-time FPS payments. Banks generally do not charge consumers for sending clearing system to facilitate products and services that create value payments through the system, but they do charge corporate customers. for customers and enable banks to compete more effectively against Since 2012, participating banks have been building customer-facing non-bank financial service providers. How widely adopted these products and services that leverage FPS. , for exam- products and services will be, and how banks will monetize them– ple, enables users to send and receive payments using a mobile whether through direct fees or through increased customer engage- number. More recently, the system has expanded to allow customers ment and cross-selling opportunities–is still an open question. to purchase and use bus tickets through their smartphones, and to send and receive electronic gift cards using mobile payments.

cent per invoice; the value of automated in- own P2P solutions as they seek to intensify voicing, then, is indeed significant. their engagement with existing customers and solidify their control over the mobile Strengthening customer relationships commerce experience. Person-to-person payments: Person-to- person (P2P) payments products and serv- A real-time payments system would allow ices enabled by a faster payments banks to offer a P2P product that provides infrastructure could play a critical role in immediate funds availability—something banks’ efforts to strengthen and retain ex- not widely available today, and a service isting customer relationships. This is par- that younger consumers are coming to ex- ticularly relevant today, as the space is pect. The product should be simple and under siege by non-banks. Emerging pay- easy to use, allow end-users to choose a ments players such as PayPal, , Al- payments speed, and be supported by a ibaba’s , and Tencent’s WeChat have P2P identity directory that stores users’ used P2P payments to gain a user base for payment information and enables ubiqui- adjacent services, particularly e-commerce. tous payments across banks. Banks that Large technology players such as Apple, offer a product with these features could Google and Facebook are working on their retain and increase their current cus- 28 McKinsey on Payments May 2015

tomers’ engagement, slow the shift in mar- underbanked into the mainstream banking ket share toward third-party providers, and arena; for example, small-dollar, immediate create new revenue streams in digital fi- loans could be provided in near-real-time nancial services. through text notification. A number of start- ups are already attacking this space; for ex- To capture the monetization ample, Affirm enables merchants to offer customers instant lines of credit for pur- opportunities presented chasing items on their sites.

by a modernized payments Infrastructure is only the beginning system, financial institutions While some existing revenue streams (such must relentlessly focus as paper-based services) will no doubt be impacted by a modernized system, the dig- on design, customer experience, itization of information, the rise of mobile accessibility and convenience. commerce, and end-users’ rapidly chang- ing expectations all create the opportunity for banks to boost customer engagement, Acquiring new and previously gain a greater share of wallet, and acquire underserved customers new customers.

A modernized payments infrastructure New revenue streams will be the primary would also enable banks to better meet the source of return on investment in a mod- needs of “underbanked” consumers. Ap- ernized payments infrastructure, but it is proximately 18 to 25 percent of the 25 mil- worth noting that additional cost savings lion underbanked consumers in the U.S. say could be significant if banks seize this op- they use non-bank/alternative financial portunity to integrate their payments ar- services providers because they are faster. chitecture. Some banks may gravitate The ability to receive payments and use toward payments hub architecture, which funds in real time could help banks win helps usher innovation into production— share among these customers. With the un- and thus to expedite revenue growth. derbanked segment spending $89 billion Often, however, it is more cost-effective for just on interest and fees for alternative fi- banks to integrate payments platforms nancial services, the value at stake in the through multiple, smaller integration U.S. alone is high. points, such as the fraud management sys- Furthermore, the prevalence of mobile tem or the transaction banking system. phones and mobile financial services among Based on case examples from around the world, McKinsey estimates that banks can underbanked consumers suggests that the reduce their payments-related IT spending mobile channel could be a cost-effective way by 20 to 30 percent when they integrate to scale distribution of mobile payments their payments architecture. tools built on a faster-payments infrastruc- ture. New products and services could be de- To capture the monetization opportunities signed specifically to bring segments of the presented by a modernized payments sys- Faster payments: Building a business, not just an infrastructure 29

tem, financial institutions must relentlessly potential. If they do, the investment in faster focus on design, customer experience, acces- payments will be well worth the return. sibility and convenience. Building the infra- structure is a necessary condition for Robert Hayden is a senior expert at GC Insights, a success, but banks will need to strengthen wholly owned subsidiary of McKinsey & Company. their front-end product development capa- Grace Hou is an associate principal in McKinsey’s bilities in order to fulfill the new system’s San Francisco office.