Literature title

Global Banking Practice The future of payments in Asia

November 2020 Introduction

Payments have never been as important to Asia’s financial services ecosystem as they are today. Asia has outpaced all other regions in terms of payments-revenue growth over the past several years. The region is also the largest contributor to global payments revenue, generating over $900 billion in 2019, nearly half the global total. The role of payments in Asia’s overall banking landscape has expanded as well, now representing 44 percent of aggregate banking revenues, compared with a third as recently as 2007.

The dollars involved tell only a fraction of the story, however. Payments remain the bedrock of the customer relationship for both consumers and businesses, representing the most natural opportunity for ongoing engagement, keeping the institution’s brand top of mind, and creating a practical reason to keep a healthy level of funds on account. Payments have never been more important for traditional banks, longstanding service providers, and fintech innovators aiming to disrupt the status quo.

The global effects of COVID-19 prompted a reset in the payments ecosystem. In most cases, the result was an acceleration of trends—such as increased digitization—that were already underway. Although we forecast a decline of 1 to 8 percent in Asia’s 2020 payments revenue, the industry’s solid foundation is poised to foster a relatively rapid return to mid-to-high single- digit growth rates. Asia’s payments sector remains well positioned to exceed $1 trillion in annual revenue by 2022 or 2023. The first chapter of this report explores these dynamics in greater detail.

Our perspectives are informed by ongoing dialogue with industry leaders and McKinsey’s global network of payments experts, and by our work with payments providers in the region. McKinsey’s Global Payments Map also provides a quantitative foundation of longitudinal revenue and volume data. Additionally, our recently launched Asia Payments Practitioner Survey (APPS) polled payments business leaders in 13 Asian markets to document their strategic perspectives and illuminate key themes and areas of consensus.

Asia’s future payments landscape will look quite different from the ecosystem currently in place. We have distilled the fundamental themes governing this future vision into a list we call the Five Cs: connected commerce, contactless consumers, a cashless economy, cross-border activity, and consolidation. Our goal is to identify a comprehensive set of trends that will reshape the payments industry, and to initiate a dialogue on how Asia’s payments ecosystem of 2025 will differ from the current state.

The second chapter of this report considers the likely scenarios for the Five Cs, based on our analysis of the APPS findings. The third chapter outlines a series of potential actions for various sets of players across the ecosystem: banks, acquirers, card networks/schemes, nonbanks and tech firms focused both on financial services and other areas, and governments and regulatory bodies. Naturally, significant interdependencies exist across these constituencies; notably, there are very few areas in which these groups’ objectives are in direct conflict.

We hope you find these perspectives illuminating. As always, we appreciate your comments and welcome the opportunity to engage in further dialogue.

Reet Chaudhuri Jacob Dahl Bharath Sattanathan Joydeep Sengupta Shaken, not stirred: The next frontier in Asia payments

Heading into 2020, numerous trends (selectively captured below) had set a clear path for continued payments growth across Asia. Chief among these was the rapidly expanding number of connected and digitally active consumers, with booming e-commerce markets reinforcing the need for digital solutions. The competitive landscape was simultaneously heating up, with the entry of formidable new players—including telecommunications firms, fintechs, “big techs,” and other conglomerates—spurring incumbents to step up their own innovation efforts. Meanwhile, regulators sought to standardize infrastructure while encouraging competition, fostering the introduction of real-time payments, digital know your customer (KYC), and various local payment schemes.

COVID-19 has permanently reset support. Players stepped up with educational payments trajectory resources on managing disruption and public- COVID-19 then upended expectations with a service activities such as fund-raising support. generational economic shock affecting both Banks forged partnerships with specialized supply and demand, resulting in an unprecedented fintech providers to launch new platforms to help drop in discretionary spending, shifts in spending merchants establish an essential online presence patterns for remaining outlays, lower trade volumes, (e.g., Shopify’s alliance with OCBC in Singapore) the loss of foreign-exchange revenues, and a and created incentive programs to foster online suppressed interest-rate environment. For example, shifts. Governments also played a vital role, waiving India recorded no car sales in the month of April, or reducing some charges related to electronic Thailand’s foreign tourism declined by 78 percent payments (e.g., UPI payments in India), increasing from the prior year in March and fell to zero the digital-transaction limits, and providing funding next month, and Singapore’s construction industry to small and medium-size enterprises (SMEs) to contracted by 45 percent in 2Q2020 while its overall support digital commerce. economy declined by 13.3 percent. Despite these efforts, we anticipate that in the near The payments industry was quick to respond to term, COVID-19’s impacts will cause a decline in these challenges, offering immediate economic 2020 payments revenue of up to 8 percent across relief in the form of faster settlement times, Asia (Exhibit 1). Excluding Mainland China, which customer-fee waivers, and short-term funding recovered from the depths of the crisis more rapidly,

2 The future of payments in Asia Exhibit 1 The impact of COVID-19 is expected to lead to a decline in near-term revenues of up to 8%.

Asia payments revenues,1 $ billion Underlying movements that will 998 contribute to the slowdown2

Decline of 10–15%, Asia GDP growth expected excluding Mainland China at −4% to −8% in 2020

937 10–30% expected decline in global trade in 2020 −8% to −1% 860–925 50–70% decline in Q2 2020 discretionary consumer spending

10–50 basis-point cuts in rates across Asia, depressing liquidity revenues 2019 payment 2020 expected 2020 payment revenues revenues revenues after prior to COVID-19 COVID-19 impact3

1 Asia includes Mainland China, Hong Kong SAR China, India, Indonesia, Japan, South Korea, Malaysia, Singapore, Taiwan, Thailand, Philippines, Vietnam. Revenues include domestic revenues from credit/charge cards, debit cards, prepaid cards, bank transfers, direct debit, current account, and overdraft, plus cross-border revenues from trade and nontrade, international travel, e-commerce, remittances, and B2C. 2 COVID†19 impact assessed using macroeconomic scenarios and econometric regressions, incorporating government actions, sector-speciˆcs, and views from local and global experts. Source: McKinsey Global Payments Map; World Trade Organization

the contraction is projected to be as steep as 14 both before and after the pandemic, payments percent. The extent of the contraction is projected to players seeking to engineer a sustained accelerated be the worst in 40 years—exceeding the severity of response to COVID-19’s irreversible shifts and the 1998 Asian financial crisis and the 2008 global position the ecosystem to realize its considerable financial crisis. potential must overcome several barriers facing Asia’s payments industry: Paradoxically, we anticipate that COVID-19’s impacts will ultimately serve to accelerate several established — Limited digitization. Despite meaningful payments trends. For instance, at the height of the progress in moving transactions to card and crisis, the proportion of consumer items purchased digital forms, cash remains quite popular in online nearly doubled, representing a 30 to 40 most Asian markets. Cash utilization has fallen percent growth rate in online spending, compared from 97 percent of transactions in 2010 to 71 with a 22 percent pre-COVID-19 projection. Across percent in 2019. Habit, security concerns, and emerging Asia, a 60 percent increase in contactless- perceived complexity remain roadblocks to payments usage during the crisis was double the speedier consumer migration. Meanwhile, many expected levels, and paperless B2B payment flows small merchants remain dependent on paper- grew eightfold. Although it’s reasonable to expect based systems and wary of the fees and tax some reversion to past practices as the most severe implications that accompany digital transactions. measures are lifted, the in-process digital shift has — Fragmentation. In many markets, consumers clearly received a permanent forward jolt. face a preponderance of choices at the expense of an integrated solution. Competition is Persistent structural changes require certainly desirable, but in an ecosystem that concerted actions requires universal access for efficient operation, Our intent for this report is not to detail COVID-19’s an excessive number of below-scale alternatives impacts, however. The past several months’ events can create consumer indecision and impede have exposed structural challenges impeding a convergence toward a market standard. truly transformative end state. Despite progress

3 The future of payments in Asia — Unsettled industry economics. Not surprisingly, the gains that occurred during the height of COVID’s the rapid transition away from an all-cash impact expected to remain for the long term (Exhibit economy over the past decade has prompted 2). We address the impact of these trends in greater some turmoil. Merchants, many of which do not detail in the next chapter. recognize the hidden costs of cash handling, Digital wallets and QR codes will become the have resisted the more visible acceptance next normal fees that accompany card-based and digital Despite recent migration to digital payment transactions. SMEs, lacking the scale benefits methods, Asia remains the world’s most cash- of larger enterprises, tend to face the highest reliant region, with cash representing 71 percent fees as a share of revenue. At the same time, of transactions in 2019. The recent momentum incumbent financial-services firms and new achieved by e-wallet providers and QR-enabled entrants alike are in the investment stage solutions is likely to accelerate moves away from of establishing next-generation payments cash, particularly in emerging markets, with infrastructure and must support these business contactless cards serving as a driver in developed cases in an increasingly turbulent environment. Asia. Account-to-account transfers also are — Uneven regulatory interventions. Countries have expected to play an increasing role. In the future, it chosen differing and not always compatible is likely that current payment methods (e.g., credit paths to fostering and/or governing emerging cards) will be reformatted to optimize their utility utilities such as real-time payments and national within digital-wallet front ends. payment schemes. Given the importance The battle between banks and platforms will of cross-border activity in the region (Asia intensify accounts for over a third of global trade in Banks, leveraging their incumbent position and goods, up from less than a quarter circa 2000), established customer-trust advantage, are seen any barriers to efficient funds flow, whether as the most logical payment providers in emerging intentional or incidental, can be problematic. markets. As real-time payments become the norm, — Varied levels of innovation across markets. A banks will have an added advantage over nonbank reasonable degree of interoperability between providers. In developed markets, experts view country payment schemes is essential to digital ecosystems (e.g., Kakao in South Korea) efficient operations. While one would not expect and big tech players (e.g. Google, Facebook) as all markets to progress at the same pace, better positioned to prevail, given the superior user marked disparities—particularly if paired with experience and ubiquitous reach of “super apps” restrictions on outside players—could impede (which address the full array of consumers’ digital regional growth overall. needs) offered by these players and increasingly connected to funding sources like bank accounts The megatrends accelerating Asia’s and credit cards. payments revolution Current-account relationships will unbundle In May, McKinsey launched its proprietary Asia Historically, Asian customers have maintained Payments Practitioner Survey (APPS), aggregating sufficient current-account liquidity to enable timely the views of 56 payments-business executives transactions. This has led to many banks investing spanning 13 Asian markets, to gather informed in payments despite pressures from declining perspectives on the key shifts expected to affect fee revenues. A majority of bank respondents (57 Asia’s payments landscape over the coming five percent) anticipate a decoupling of current accounts years. The resulting feedback revealed a fascinating and payments. As real-time payments and digital mix of consensus and sharply divergent views, wallets reduce friction and time to transfer, account the latter often segmented by one’s role in the holders may embrace a wallet for payments while ecosystem or operation in a developed or emerging cherry-picking a bank for current accounts. This will country. force banks in the region to rethink current-account propositions else risk hurting current account/ We see several key trends shaping Asia’s future savings account ratios. For example, banks in other payments landscape, with COVID-19 having fueled regions have already begun the rebundling process, an 80/20 rise in digital payments: a 20 percent augmenting current accounts with value-added increase in the digital user base, with 80 percent of

4 The future of payments in Asia Exhibit 2 Our research highlights seven emerging payments trends across emerging and developed Asia.

Rise of wallets Horns locked: Unbundling Shift toward Shrinking Bilateral driving Consolidation of and QR-enabled banks vs current accounts acquiring physical presence cross-border value chain payments platforms real-time payment

E-wallets and QR Banks have a Decoupling New sectors and Rationalization of Bilateral 64% of survey codes to ramp up “boon”: Banks and between current last-mile branch and ATM arrangements top respondents in emerging Asia bank wallets to accounts and merchants to networks (>20% driver for expect win emerging Asia payments digitize in some cases) cross-border consolidation Contactless credit capabilities real-time along value chain, cards in Platforms excel at Lower merchant While digital payments eg, ecosystems developed Asia customer Imperative for discount rates and currencies not purchasing issuers experience: banks to rethink faster settlements expected to Regional Deeper and payments Ecosystem current-account to onboard small become ecosystem player penetration of gateways players tied with propositions merchants; tax mainstream, Libra could deliver a phones and banks in concerns and CBDC may solution with 44% expect wallets likely to developed Asia, overstated gain traction regulatory consolidation boost nancial given superior approvals (seen as within value chain, inclusion Acquiring to more likely by eg, acquirers or user experience outpace issuing, bank respondents) e-wallets and captive use with >50% of consolidating by cases acquirer revenues buying smaller to be players nonprocessing

Unprecedented rise of digital payments: 20% increase in user base with 80% retention post-COVID-19 Tech enablers: Biometrics, AI, and blockchain

Source: McKinsey analysis

features not necessarily associated with financial through everyday banking services like deposits and services (e.g., football-score updates and video lending, the specialists have expertise in building highlights). out what is increasingly becoming a software business. Acquiring will see a resurgence, with new business models Reliance on physical infrastructure will shrink Merchant acquiring is expected to undergo a Just as the current environment gives Asia an significant shift as new lifestyles and business unprecedented opportunity to reduce its reliance models emerge. Acquirers will need to contend on cash, increased digitization will also spur a with a decline in merchant discount rates (MDRs), shakeout in physical infrastructure, with expected especially in offline settings; 87 percent of our reductions of more than 20 percent in branch respondents estimate MDR declines of 20 percent and ATM networks. As demand for cash declines, or more. This will induce a scale-up from mere banks can consider a utility model, outsourcing or payments processing to monetize adjacent value- sharing ATMs. In parallel, banks could play a service- added services, such as reconciliation, loyalty, provider role for digital currencies by providing local lending, and deposits. Such adjacent services could clearing and settlements. account for over 50 percent of acquirer revenues. Bilateral cross-border partnerships will Lower MDRs and faster settlements will drive accelerate adoption by smaller merchants, while competition Cross-border payments in Asia have been plagued between global specialist acquirers and local legacy by the twin challenges of long settlement times champions will likely intensify at medium and large and high costs. While over 70 percent of experts enterprises as well as in online acquiring. Although believe a regional infrastructure like the single euro banks possess the core processing related product payments area (SEPA) would be beneficial in the set and often the large merchant relationships Association of Southeast Asian Nations (ASEAN),

5 The future of payments in Asia they are skeptical of execution. The more likely even for countries in developed as opposed to scenario is a series of bilateral agreements (e.g., emerging Asia. For instance, whereas cash and NETS with NPCI). In addition, regional ecosystem prepaid-card usage is likely to decline across the players could disrupt this space by providing board, traditional offline commerce will continue comprehensive cross-border services. For instance, to grow in emerging Asia even as it is displaced in we could soon see a Singapore-issued wallet used developed Asia. to scan and pay for a meal in Jakarta or Bangkok. We believe this paradigm shift will alter usage Consolidation could drive value-chain patterns for several payment instruments (Exhibit “horizontalization” 3). As would be expected, given digitization trends, Rationalization among a fragmented payments cash and (already quite limited) check usage market is likely. Nearly two-thirds of experts expect is poised to decline, while account-to-account further consolidation, whether across the value transfers and stored-value wallet activity will chain (e.g., networks combining with merchant accelerate. Other patterns are more complex. For acquirers) or within a specific category (e.g., instance, we foresee debit-card usage declining e-wallets). Given reductions in venture-capital sharply in developed Asia yet continuing to grow funding of fintech players, we expect to see larger in emerging markets, given continued banking banks and tech firms make acquisitions to build out penetration in markets such as Indonesia, the their product portfolios. Philippines, and Vietnam. Likewise, traditional swipe-based card payment volumes are poised Payments products will look quite to contract somewhat in developed Asia while still different within a decade expanding in emerging Asia. Taken together, these trends carry numerous As the industry addresses these challenges and implications across constituencies (consumers, responds to these trends, we foresee a significant merchants, and businesses), payment instruments and permanent reshaping of Asia’s payments (e.g., cash and debit, credit, or prepaid cards) and industry, built around “five Cs”: the contactless

Exhibit 3 Payments in Asia are likely to go through a paradigm shift in the medium to long term.

Current usage and outlook for payment products, by customer segment Developed Asia1 Emerging Asia2

Consumers Merchants

Cash Cheques A2A3/pass- Stored-value Oine Oine through wallet4 traditional contactless

Credit cards Debit cards Prepaid Online/digital cards5 platforms

Cash usage ranges from 40–95% by transaction volume across markets E-commerce accounts for Checque usage is <1% across all markets and declining up to 20% of retail sales in select Asian markets Credit-card usage is <5% in emerging Asia and ≤25% in developed Asia Account-to-account transfers account for up to 65–75% of digital transactions in emerging Asia

1 Singapore, Japan, Korea, Hong Kong, Taiwan. 2 Mainland China, India, Indonesia, Thailand, Malaysia. 3 Account-to-account transfers. 4 Estimated based on expert input. 5 Includes closed-loop prepaid cards (eg, Hong Kong Octopus card). Source: McKinsey Global Payments Map; World Trade Organization

6 The future of payments in Asia Exhibit 4 Given the trends, we expect a gradual recovery in Asia payments revenues.

Growth rates ~400 bps below pre-COVID-19 levels, due to margin and current-account net interest margin compression

Asia payments revenue,1 $ billion

5–7% Historical per year Projected 1,150–1,220 12% per year 937 860–925

664

2016 2019 2020 2025

1 Includes Mainland China, Hong Kong SAR China, India, Indonesia, Japan, Korea, Malaysia, Philippines, Singapore, Taiwan, Thailand, Vietnam. Assumptions for post-COVID­19 impact for Mainland China, Japan, Singapore, Indonesia, Malaysia: bottom-up projections on liquidity and transaction revenue impact post-COVID were used; ˆgures for remaining markets (India, Hong Kong SAR China, South Korea, Taiwan, Thailand, Philippines, and Vietnam) based on expected GDP growth rate post-COVID and projected multiplier of payments revenue to GDP. Source: McKinsey Global Payments Map; World Trade Organization

consumer, connected commerce, cross-border of electronic payments across both consumer linkages, consolidation of the industry, and an and business flows. Various ecosystem players, increasingly cashless economy. The Asian payments spanning traditional banks and fintech start-ups, industry—with an estimated compound annual have already adapted operating models and product growth rate (CAGR) of 10 percent (excluding portfolios to address the increased digital demand Mainland China) and nearly $300 billion of additional and other disruptions brought on by the crisis. And revenue at stake by 2025—deserves strategic focus just as the impact of COVID-19 spurred greater for players of all stripes, including banks, nonbank contraction in payments revenues outside Mainland financial institutions, and regulatory authorities. China, the broader Asian landscape is expected to Although these themes have existed at a high level return to its established healthy growth curve in the for the better part of the past decade, a new set of pandemic’s aftermath. underlying dynamics will greatly accelerate the pace COVID-19 has further fueled profound changes of change. already under way in Asia payments. However, it At the pan-Asian level, economists expect a gradual has brightened the long-term outlook and could payments-sector recovery over the next few years propel growth in Asia payments via increased cash (Exhibit 4). Although hard to predict with certainty, displacement and digitization. Winning in the new this assumes a gradual pickup in travel towards normal will require players to reimagine their value the second half of 2021—leading to a rebound propositions with a digital-first business model, in cross-border spending and foreign-exchange potentially mirroring the traits commonly associated opportunities—as well as government actions to with technology companies. curb some excess liquidity and reverse a portion

of 2020’s decline in interest rates. The longer- term outlook remains quite robust, particularly given the accelerated shift away from cash in favor

7 The future of payments in Asia The five Cs shaping the future of Asia’s payment sector

Asia’s future payments landscape will look quite different from the ecosystem currently in place. We have distilled the fundamental themes governing this future vision into a list of five Cs (Exhibit 5). It’s worth noting that these trends are not new; what is evolving, however, is the extent to which the forces are playing out at a tactical level across Asia’s ecosystem. COVID-19’s impact over recent months has further reinforced several of these trajectories. The next decade will see the gradual mainstreaming of these trends.

Our perspectives are informed by ongoing has existed for some time, hygiene concerns have dialogue with a wide array of industry leaders, prompted customers to actively seek out touchless including McKinsey’s global network of payments alternatives in a variety of daily activities, and experts and a vast array of client work. McKinsey’s payments are no exception. Even as payments proprietary Global Payments Map also provides a volumes declined overall during COVID-prompted solid quantitative foundation of longitudinal revenue quarantines, the contactless user base grew by as and volume data. We recently launched our Asia much as 20 percentage points for select payment Payments Practitioner Survey (APPS), for which providers in the region. Moreover, we expect 70 to we polled payments business leaders in 13 Asian 80 percent of new adopters to continue long-term markets to document their strategic perspectives use of these new forms. and illuminate key themes and areas of consensus. E-wallets to lead; account-to-account transfers In this chapter, we will explore the likely scenarios make great strides for the five Cs, drawing from our own expert Excluding Mainland China, where the use of mobile assessment and APPS findings, regarding important payments is already well established, McKinsey developments, including emerging business expects the number of mobile-payments users to models, digitization, the monetization of payments more than double by 2025, exceeding two billion. data, cross-border cooperation, and industry Our APPS reveals interesting nuances regarding consolidation. industry leaders’ views in this area. Industry leaders share our assessment of digital wallets becoming Contactless consumer the preferred form of payment by 2025, with credit cards ranking a close second. Looking a level From a payments perspective, arguably the greatest deeper, however, bank-affiliated experts continue and most lasting impact of COVID-19 will be in the to see credit cards as the instrument of choice, contactless arena. Although the wallet medium

8 The future of payments in Asia Exhibit 5 The ve Cs reshaping Asia payments.

Consolidation and industry- Contactless consumers structure shifts Rise of ecosystems vs. bank wallets Integration across value chains Horns locked: Banks have trust; ecosystems have CX¹ Rise of payments specialists QR preferred mode for emerging markets Global/local partnerships Rise of transaction credit (POS lending)

ON CO Unbundling of CASA² and payments

I N

T T

A A

D C

I

L T

L

O E

S S

N

S

O

C

C

R Cross-border links Connected commerce

O

E

S Accelerating bilateral real-time payments C Revenue opportunity beyond payments

S R

arrangements - E B Digitizing long tail of merchants Rise of digital money-transfer operators O M R M Lower merchant discount rates, faster D O B2B options proliferate E C settlements R

Revenue shift from issuers to acquirers

CASHLESS

Cashless economy Diminishing role for ATMs Digital currencies—a speck on the horizon

1 Customer experience. 2 Cash account savings account. Source: McKinsey analysis

whereas nonbank professionals give e-wallets the anticipate that within five years, 30 to 40 percent of nod. retail transfers will be executed over real-time rails. Incorporating loyalty programs and a wide array of Account-to-account transfers also are seen payment options (including points redemption for as gaining in prominence, particularly across a portion of the amount due) also could serve as developed Asia, where they are forecast to become powerful wallet differentiators. the third-most-favored instrument, particularly for small-ticket items. The advent of real-time payments Payments are increasingly unbundled from will help fuel this transition, and lead to a gradual current accounts erosion of stored-value wallet usage, as funds can The twin forces of e-wallets and open banking also be pulled directly from a bank account at the time of increase the likelihood of the further decoupling need—an added boon for banks. of checking and savings account (CASA) balances from payment capabilities. Fifty-seven percent of Banks and nonbanks wage a battle for wallet APPS respondents see such decoupling as likely supremacy over the coming five years, with the majority of those A similar dichotomy exists in perceptions of likely deeming it “very likely.” Not surprisingly, nonbank winners on the retail-payments battleground. Banks experts are most bullish on this view. This dynamic and digital ecosystem players rise to the top of reinforces the imperative for banks to rethink their the list; however, bank experts are more bullish on CASA value proposition, potentially rebundling their sector’s solution, pointing to consumer-trust current accounts with nonbanking features and incumbency factors. Nonbank participants, such as football-score updates to drive ongoing meanwhile, are evenly split between these options, engagement, as discussed in Chapter 1. It also citing the ubiquitous reach and sleek design of serves as a call to action to solidify banks’ digital “super apps” as key advantages. experience, as the liquidity from retained balances We believe execution and first-mover advantage will is an important component of payment revenue be keys to determining the winners in each market. streams. Further evolution of real-time payment capabilities Notably, business leaders differ by geography in can foster a more seamless customer experience, their expectations for cash. Twenty-one percent of particularly for cross-border commerce, and may experts in emerging Asia say they expect cash to give bank wallets an added differentiator. We remain the preferred consumer-payment vehicle,

9 The future of payments in Asia compared with single-digit response rates in business, with merchants in prominent categories developed Asia. Few experts expect cash to be fully such as healthcare facing an unexpected immediate retired; it likely has a long tail, even in developed need for remote payments acceptance and small Asia. offline merchants suddenly seeking solutions beyond cash (Exhibit 6) Fundamental business- The wallet space remains quite active, with various model changes will be necessary to meet these constituencies—banks, telecommunications requirements, extending beyond the traditional role providers, big tech, and digital ecosystems—seeking of the merchant discount rate (MDR) in defining entry points, leveraging supporting capabilities as the economic proposition for both providers and a means of monetization. This dynamic could leave merchants. pure-play e-wallets vulnerable: the APPS revealed little to no expectation of stand-alone players Merchant expectations of payment service or telcos prevailing in this space. This is likely a providers are growing beyond traditional payments reflection of monetization challenges. The discrete functions to encompass tools for helping them payment event remains unprofitable, and regulation manage and grow their businesses (Exhibit 7). In typically precludes such players from adjacent response, acquirers are evolving into technology revenue streams such as lending. The market is and software companies delivering “one-stop already crowded, with over 150 wallet licenses being shop” experiences that harmonize channels and issued in Southeast Asia. We expect the number are personalized to merchants’ needs and sizes. of wallets to decline by two-thirds via industry This value proposition includes more seamlessly consolidation, even as new players attempt to gain a embedding payments into the commerce flow and foothold. extending offerings to address merchants’ financing and growth needs as well. QR codes drive emerging Asia traction Emerging markets will be more inclined to adopt The most important factors driving merchants’ solutions based on QR codes, which are viewed digital adoption over the next five years will be as easier and more cost-effective to implement lower MDRs, faster funds settlement, and ease of and better suited to mass-market consumers. onboarding. We will also see innovations in hardware Developed markets, by contrast, will favor “tap and solutions, such as lower-cost point-of-sale devices. go” (which is considered faster and more closely Offerings like static QR stickers, dynamic QR codes, aligned with global standards), account-to-account and low-cost scanners make it increasingly feasible transfers, and card-linked mobile solutions, such for acquirers to service even small merchants with as Apple Pay. Banks completing a robust digital limited payments volumes. transformation will be particularly well positioned Shift in dynamics from issuers to acquirers to lead in consumer digital payments, leveraging Since card issuers have historically realized the institutional trust and an established infrastructure. majority of MDR revenue, such pricing pressure As always, government’s role in market evolution is likely to be borne disproportionately by issuers. will be pivotal. Regulators must strike a delicate Compressed revenue margins of as much as 20 balance across multiple factors: ensuring safety percent will be borne largely by issuers. Value- and ubiquity, fostering innovation, and maintaining added offerings will become an increasingly an environment conducive to healthy competition. essential component of merchant acquirers’ product These are essential ingredients of initiatives suites, as unit revenues from payments alone such as real-time payment networks and e-KYC will become insufficient to support an attractive enablement. In addition to these endeavors, APPS business model. As a result, acquiring will grow to respondents voiced strong support for greater comprise a third of transaction-based payments adoption of cashless transactions to and from revenue, up from 23 percent in 2019, with the government entities and for granting necessary majority of growth derived from value-added regulatory approvals to advance open-banking services (particularly for small merchants) beyond protocols, thereby fostering greater competition. core payments processing.

The revenue opportunity stemming from further Connected commerce merchant digitization over the next five years could The dramatic surge in demand for digital capabilities grow by over $5 billion annually, based on McKinsey has driven unprecedented shifts in the acquiring analysis. Although cash displacement is a natural

10 The future of payments in Asia Exhibit 6 Digital acceptance in some sectors has increased since the emergence of COVID-19, leading to new frontiers for digital payments.

Healthcare Telecom High Logistics E-commerce

Mobility

Advertising Entertainment Sector size1 Social media Medium

Music and radio Online gaming Online travel Online education Digital print Low Limited Signi cant Major

Impact of COVID-19 on digital acceptance

1 Based on total global 2019 revenue: low = <$200 billion; medium = $200 billion to $1 trillion; high = >$1 trillion. Source:! McKinsey analysis

Exhibit 7 Merchant increasingly want payments service providers to help them manage and grow their business.

Hygiene factors Distinctive value

Make it easy “Anything that can make the A 1-stop shop “I have 1 to 2 person days per Provide a natural, customer journey better, Provide a single source month to do reconciliation convenient way to serve increase service speed, and of truth uniting and balancing. My sta† customers and run the turnaround.” payments with extract reports from business. accounting, operations, payments gateways and and marketing. bank to identify discrepancies.”

Delight my customers “Promotions drive footfall. A growth partner “We are exploring Help us deliver value to We need synergies with Help us grow and stand automation and self customers, because if partners to get customers to out in a competitive, payment kiosks to reduce we do, they stick with us. come in and shop with us.” crowded marketplace. cash handling and risk. Let’s discuss initiatives beyond periodic agreements.”

Deliver superior “We need the service level to Provide value from “Its hard for SMEs. I have reliability be high; lapses will damage data been looking for analytics Be a responsive partner [banks’] reputation as solutions to know my who keeps pace with my custodians. Merchants are customer better, for needs as I run my fearful of putting all eggs in targeting, sta€ng, and business. one basket.” productivity positioning.”

Source: Merchant interviews

11 The future of payments in Asia contributor to this expansion, the key drivers are multiple POS terminals, a significant merchant spending growth and, more importantly, value- pain point. The players best suited to enable the added opportunities that go beyond transaction merchants in this process, according to the APPS, fees to leverage data analysis and other related are fintech specialists and e-commerce and financial or merchant services. ecosystem players; banks are not seen as playing a leading role on this front. Accelerated digitization of the long tail of small merchants An example of how ecosystems are enabling end- The digitization of small and midsize merchants to-end digitization of retail supply chains, removing represents a major opportunity, both in building out cash from the journey, can be found in JioMart’s a suite of additional payments-adjacent services initiative to create online grocery shopping/delivery and in fostering financial inclusion. The process capabilities for a network of mom-and-pop “kirana” of digitization has been rapidly accelerated by shops, connecting them with larger hubs and COVID-19; we project that digital acceptance across enabling broader services like access to credit for Asia will approach 90 to 95 percent of merchants consumers and volume purchasing discounts for within five years, driven by both simplified KYC shop owners. processes and low-cost acceptance methods (e.g., smartphones). As a greater share of commerce Cashless economy inevitably moves online, it becomes increasingly To be clear, cash is not expected to disappear; important for all populations to have access to however, its use will continue to decline across noncash instruments. SME enablement is a step in Asia. Over the past decade, cash usage in mature this direction. Western economies has fallen by roughly 30 Acquirer growth driven by leveraging adjacent percentage points from beginning levels of revenue streams approximately 55 percent of transactions. The The lasting consumer behavior shifts prompted target level of payments electronification will differ by COVID-19 illuminate several business sectors across Asia, given starting points that vary from less in which digitization opportunities exceed what than 3 percent of transactions in Indonesia to as was widely perceived just a few months earlier. much as 60 percent in Singapore. E-commerce has long been seen as the natural Cash will decline more rapidly but not vanish target, with sales volumes expected to nearly Countries in both developed Asia and emerging double by 2025 to $2 trillion, but the sudden Asia remain in the relatively early stages of cash surge in downloads and time spent on streaming displacement. Cash usage, as measured by platforms moves entertainment into a higher- percent of transactions, remains higher than in the priority category as well. Likewise, the remarkable European Union and United States. Furthermore, growth of telehealth and popularity of wellness with the exception of Mainland China, the roughly and fitness apps elevate the healthcare focus for 20-percentage-point rate of decline in usage payments providers. Supply-side requirements over the past decade—even in developed Asian for faster and seamless delivery of food and other countries—has lagged reductions in developed online purchases are upping the ante for optimized Western countries. logistics processes. Based on learnings gleaned from other countries’ Given the daily working-capital needs of small experience, any expectation of overnight merchants, more rapid settlement and access transformation is unrealistic. Prior attempts at doing to funds—including same-day availability at a away with cash completely, such as Singapore’s minimum—will be critical to the achievement of efforts to eliminate cash from the public transit universal access. Market forces will play a leading system, have met with backlash. An extended role in the evolution of both of these factors, period of coexistence between cash and electronic although a role for regulatory authorities cannot be instruments is a near certainty. Even as digitization discounted. Another key to adoption will be ease delivers added convenience and new revenue of use and onboarding, including the advent of opportunities, existing cash processes will not be low-cost point-of-sale solutions and dramatically fully retired in the foreseeable future. Therefore, reduced merchant onboarding costs. Thin terminals more efficient models must be implemented to with “soft switches” will supplant the need for address these ongoing needs.

12 The future of payments in Asia The role of ATMs will diminish Utilities will rise in significance Among consumers, COVID-19’s acceleration of Specific use cases and counterparties warrant digital-banking trends has similarly reduced the special attention. Consumer payments to dependency on branches for routine transactions, businesses and/or governments account for more such as those involving cash. Despite Asia having than half of transaction volumes, making them a lower ATM penetration than other regions, significant electronification opportunity. Similarly, reductions in cash reliance will lead to a likely the business-to-business (B2B) payments last-mile decline in ATM prevalence (Exhibit 8). Even as cash challenge accounts for a large share of potential use declined over the past decade, ATM machines value generation and is ripe for innovation. The in use grew by 16 percent across Asia, thanks to payments infrastructure between small merchants onboarding of the formerly unbanked population and the wholesalers or distributors serving them combined with banks’ desire to establish brand can be extended (as noted in the earlier JioMart identity in many regional markets. example), and retail ecosystem providers can bring integrated ordering, invoicing, and payments to An increasing number of machines are failing to market. generate sufficient activity to attain breakeven status, however. McKinsey projects that the In an effort to buffer their economies from COVID- number of ATMs will stagnate and eventually 19’s severe impacts, most governments have added decline slightly by 2025. Two paths are possible in significantly to their national deficits. In due time, this area. We expect many banks to begin viewing this will result in quests for additional tax revenues, these machines as standard utilities, looking to which can be achieved in part by plugging leakages outsource their operations and/or pool resources via payments electronification, particularly in the across institutions. An alternative approach may be B2B space. This includes e-invoicing, which delivers to invest in differentiated ATM offerings to sharpen the added benefit of lower costs for payables and branches’ focus on value-added activities oriented receivables processing. A McKinsey study across to customer experience. a broad sample of enterprises estimates such

Exhibit 8 ATM networks are expected to shrink as transactions move online.

ATM usage in Asia is already declining as … leading to a likely decline in number of ATMs over consumers switch to digital channels… the next 5 years

Annual ATM withdrawals per customer, Asia1 Expected decline in ATMs over next 5 years1 % of expert respondents,² n = 56 16 No experts from developed Asia foresee ATMs remaining “at or growing 36

15 25 21 18 14

13 Remain “at Decline by Decline by Decline by 2015 2016 2017 2018 2019 or grow 0–10% 10–20% > 20%

1 Based on data collected from a sample of 39 banks across Mainland China, Hong Kong SAR China, India, Indonesia, Japan, Malaysia, Singapore, Taiwan, Thailand, Vietnam. 2 Q: In the next 5 years in your market, what will be the change in the number of ATMs? Source: Finalta; McKinsey Global Payments Map

13 The future of payments in Asia costs at 1 to 2 percent of the total base, with a in other Asian markets. Per the APPS, most experts savings opportunity of one-half to three-quarters if (87 percent) say that such e-commerce platforms e-invoicing is fully implemented through digitizing are best positioned to migrate SMEs online. payables and receivables. Emergence of bilateral real-time payments Digital currencies remain a long play arrangements While the potential of distributed ledger technology The heterogeneity of payments systems’ maturity remains on financial institutions’ R&D road maps, the and design across countries in the region— current prominence of cryptocurrencies owes more including the lack of a common currency—presents to their role as investment vehicles than their use hurdles to functional interoperability. Although as mainstream payment methods. Various central initial conversations regarding build-out of regional banks have begun experimenting with central- infrastructure have begun and 70 percent of APPS bank-issued digital currencies (CBDCs), which respondents find a SEPA-like structure desirable, would leverage a distributed ledger backbone while most experts assign a horizon beyond five years to addressing KYC and stability concerns. If launched, such an endeavor, given the challenges of aligning however, these vehicles will likely strengthen rather multiple jurisdictions. In the meantime, a series than replace the usability of existing digital wallets. of bilateral real-time payments arrangements are being formed. Two-thirds of industry experts responding to the APPS do not expect material adoption of digital Rise of digital money-transmittal operators currencies over the coming five years. Nonetheless, (MTOs) the latest iteration of Libra v2.2 and the People’s With regard to retail cross-border remittances, Bank of China’s blockchain-based digital RMB digital money-transfer operators (MTOs) have currency called DCEP (digital-currency electronic proven adept at capturing market share by offering payment) have the best potential for traction. Libra— a better user experience at lower cost. Traditional assuming it can resolve KYC and AML concerns MTOs have responded by launching online versions posed by US and EU regulators—has the benefit of with similar functionality, while some banks have a large, highly engaged user base from consortium invested in or partnered with these players. Most partner Facebook and an array of digital-commerce small, purely local banks will likely opt to partner with partners likely to build apps leveraging the currency, a provider like TransferWise or Instarem, generating once established. DCEP has the early advantage revenue through a fee-sharing arrangement. Digital of government and regulatory backing, as well remittances should reach 40 percent market share as a target market already accustomed to digital across Asia by 2025, up from 17 percent today. payments. Additional scale and international Choices on B2B servicing acceptance could result from a proposed East The B2B arena, a significant driver of Asia’s Asia digital currency, serving as a counter to the payments revenues, also faces intensified dominance of the US dollar. Such a move could lay competition. Incumbents are upgrading the the groundwork for a compelling proposition. correspondent-banking model through initiatives such as SWIFT gpi, while fintech disruptors have Cross-border linkages altered the value chain by creating alternative Cross-border revenues have been a key contributor payment methods circumventing banks in some to Asia’s ongoing payments growth, increasing by country corridors. an average of 6 percent annually between 2011 and On the corporate payments side, banks will face 2019. As the economy emerges from COVID-19’s a trade-off. One option is to maintain a traditional near-term shock, consumer-related cross-border correspondent-banking network spread across payments will again become the largest opportunity many markets—a model that is proving increasingly for additional penetration and innovation. risky and cost-inefficient. An alternative is to limit Another major opportunity exists in enabling the the longstanding nostro/vostro route to a few region’s disproportionate SME population for large corridors and rely on solutions like Visa B2B international e-commerce. COVID-19 has helped Connect or Ripple to service the long tail of markets to propel the already impressive growth of regional with limited flows. This option adds operational players like Lazada and Shopee. One can anticipate complexity, however, given the need to plug into adoption trends achieved in China to be replicated alternative payment rails. Players with established

14 The future of payments in Asia global scale and the willingness to fund ongoing markedly by country, is notable for its high degree of innovation are best positioned for success with fragmentation. For example, more than 150 e-wallet this option. While technology breakthroughs like licenses have been issued in Southeast Asia alone. blockchain could still change the game, local Asia’s lengthy economic expansion afforded an regulatory hurdles remain an impediment for unusual amount of runway to a variety of subscale regional and global ecosystem schemes. players, thanks to liberal capital availability, and it limited the need to stress-test business models Another divergence of opinion between banks and under challenging circumstances. While such an nonbanks emerges among APPS experts regarding environment benefits early-stage innovation, it can the cross-border outlook. Nonbank experts most impair the market’s ability to coalesce around a often view the building of bilateral arrangements limited number of solutions when scale and ubiquity between countries for real-time settlement—like are required. the approach taken by NETS and Paynet—as the most important driver of real-time cross-border With venture capital becoming even more difficult to transactions over the next five years (the option attract during the COVID-19 pandemic, stand-alone selected by 35 percent of nonbank respondents). firms with negative cash flow face a daunting climb. However, a similar share of bank experts see Deep-pocketed companies, both banks and big regional ecosystem players such as Grab and Ant tech, should have opportunities to integrate across Financial offering cross-border solutions as a likely the value chain and bolt on particularly innovative outcome, subject to regulatory approvals. solutions at valuations that would have seemed unlikely mere months ago. Consolidation of disparate players This shakeout could provide the added benefit Asia’s payments value chain, whose players vary of rationalizing excess market capacity—for

Exhibit 9 Potential investment ideas in Asia payments

Observations regarding COVID-19’s impact on payments Potential investment What you would need ideas to believe Positive impact Neutral impact Negative impact

Merchant services Merchants will continue + Tailwinds – Headwinds such as onboarding and transitioning online and will managing subscriptions value digital-speci€c E-commerce/ Closing of Economic slowdown functionality that helps with card not physical locations hitting key spending migration as a di‚erentiating present and increased categories; margin feature demand for compression convenience generally seen as Integration platforms New ecosystems are sticky fueling ~50% volume growth in to connect merchants even after crisis and will be a growth in online POS/card present to multiple ecosystems di‚erentiating feature to the sales (CP) (eg, Instacart, merchant Doordash)

POS/ Reopening of the Closed locations Payout solutions for Online marketplace volume card present economy should shrinking volumes online marketplaces will continue to increase as bring rebound ~30–40% in short SMEs transition online term

Consumer payment Analytics will play an C2C and B2B Consumer: B2C CNP: Volumes enhancers that layer increasing role in payments, cross-border Volumes up for in travel and on top of card and value-added services P2P remittances entertainment are payments can penetrate existing user and B2C card not down base present (CNP) B2B: Volumes B2B: Long-term down, timing trend of di‚erences for increased recovery, reopening globalization

Source: McKinsey analysis

15 The future of payments in Asia instance, in the e-wallet space. If Europe is any should explore payment-enhancement solutions to guide, payment specialists are poised to absorb layer on top of card payments. If online marketplace meaningful portions of the value chain, such as volume is considered a key growth lever as SMEs acquiring, that have long been served by banks. transition online, payout solutions supporting these Such specialists have emerged in the United States marketplaces become a wise play. (e.g., Stripe) and Europe (Adyen, Worldpay). No such An increasing role for partnerships specialist has yet to separate from the pack in Asia. In addition to outright acquisitions, global players will likely capitalize on the same conditions, navigating Integration across the value chain regional ownership constraints by striking We expect players to make moves within and partnerships with key players (e.g., Facebook and across the payments-industry value chain to bolster PayPal’s stakes in Indonesian ride-hailing firm their pan-Asian positions. Several archetypes Gojek). Asian bank incumbents can also pursue could govern these consolidation scenarios. partnerships with fintechs built around another Banks seeking innovation, talent, and return could valuable commodity at their disposal—customer bolster their solution sets via fintechs or buy online referrals—in pursuit of new value propositions and merchant acquirers to address revenue pool shifts. adjacent markets. E-wallets can address the existing need to build The rise of payment specialists critical mass, consolidating stand-alone offers and The net effect of these dynamics will be a blurring creating linkages across countries. Acquirers can of the lines between global and local acquirers. expand through acquisition into fast-growing Asian Local specialists will contribute licenses, access, markets and/or integrate with fintechs to diversify market knowledge, and bandwidth to complement from a pure-processing revenue model. Meanwhile, global players’ scale, technology, and domain ecosystems players can pursue adjacencies on both expertise. The evolving landscape also raises the the acquiring and issuing sides to acquire stronger provocative question of whether national payments fintech offerings, and big tech can strategically players across Asia could explore combining to form expand into new markets while making payments a regional powerhouse akin to NETS in Europe. inroads by advancing diversification from existing Approaching the opportunity from another lens, advertising revenue streams. regional banks could investigate the potential Asian incumbents have an uncommon opportunity to unlock greater value from their payments to acquire payments capabilities and talent, businesses by spinning them out as separate extending an existing pattern of strategic global entities, at which point several may be combined to deals, potentially at quite different scale and price generate scale. points (Exhibit 9). COVID-19’s aftermath has created a new set of headwinds and tailwinds that should be considered, depending on the use case being Each of these five Cs will ultimately increase market considered. For instance, those who believe newer complexity, forcing payments players from all ecosystems will remain sticky after the crisis and corners to rethink their strategic objectives and provide differentiating features for merchants could monetization strategies. In Chapter 3, we explore a consider investing in platforms (such as Instacart series of imperatives that each constituency should and DoorDash) connecting merchants to multiple consider as ways to harness these forces to their ecosystems. Those who see analytics playing an advantage. increasing role in payments, with value-added services as a key to deeper merchant relationships,

16 The future of payments in Asia Thriving in the next normal: Potential actions for key players

Industry participants will need to respond swiftly to the evolutions driven by the five Cs. Different actions will be required, however, from participants in various aspects of the value chain and at varying stages of their own evolution. Naturally, significant interdependencies exist across these constituencies. While most attention is normally afforded to banks and fintech firms, the success of merchant acquirers in profitably building broader acceptance for noncash payment forms will be critical. Regulators and payment networks also have key roles in a region keenly focused on digitization.

Banks: Taking back the turf fully digital account-onboarding experience As the longstanding leaders in the payments space is rapidly becoming a core expectation. In who have defined the consumer experience for many markets, existing mobile-banking apps decades, financial institutions also have the most can be upgraded to deliver an e-wallet-like to lose. To defend their incumbent advantage, experience spanning the desired use cases, banks must reinvent themselves: adopting a including rewards cofunded by merchants and growth mindset, investing in a compelling value related marketing firms. The increasing power of proposition, and building out a portfolio of advanced analytics can serve as a key enabler ecosystem partnerships to defend and deepen in this area, given the potential for transactional current positions. Emerging-market players in spend analysis to drive more sophisticated and particular will face conscious trade-offs, driving customized customer offers. speed to market while embracing payments as the — Profitability in credit cards. Card programs are key enabler of their consumer or SME franchise. A key drivers of most banks’ payments P&Ls, so series of no-regrets moves is likely applicable to the banks should closely examine strategies to vast majority of the region’s institutions: find opportunities to reenergize credit-card — New value proposition for consumer payments. profitability. Given sea changes in spending Given a rapidly changing ecosystem, banks are behavior, revisiting targeted propositions for in the best position to revamp the consumer distinct client segments may well yield new payments proposition, designing a user- opportunities. Advances in data analytics can centric, integrated payment experience help banks optimize loyalty programs as well as applicable across a broad array of use cases cross-selling and bundling propositions. With and enabling flexible form factors, including account-to-account transfers cannibalizing wallet-like functionality and virtual cards. A a portion of traditional debit spending, for

17 The future of payments in Asia instance, some banks may consider rebalancing propositions will vary by institution size and their portfolio to rationalize debit costs while type. Large commercial banks can win over focusing on account-to-account transfers and merchants by building a comprehensive value credit schemes. proposition for their business, leveraging a full suite of banking products (e.g., combining — Optimization of legacy distribution. An payment solutions with financing, and value- accelerated shift toward digital channels added services such as reconciliation, inventory necessitates the optimization of legacy management, inventory programs, and distribution networks, including ATMs. Banks streamlined lending processes). Smaller banks should consider rationalizing long-standing may consider exiting the merchant acquiring structures, exploring innovative, customer- market altogether, given its technological oriented branch formats, and/or establishing complexity and the need to prioritize resources a collaborative shared utility model for the elsewhere. declining but still essential provision of ATM services. For business customers, banks should — Enhanced cross-border offerings. Banks focus on mutually beneficial avenues to help can take several steps to enhance cross- automate invoice processing and remove cash border offerings and international payments from their workflows wherever possible. propositions. These include rationalizing correspondent bank relationships, establishing — Investments in technology. In the back office, close alliances with smaller institutions in other it’s a natural juncture to reassess vendor countries, upgrading technology standards (e.g., relationships and partnerships, given the need to enabling SWIFT gpi and potential alternatives enhance technology platforms. With a long list of like Ripple), and actively engaging with projects on their task lists, banks should closely regulators on bilateral or regional partnerships. consider pursuing the next stage of growth through technology investment, partnership, — Payments as a service. The payments-as-a- or acquisition. Recent turbulence may provide service model is gaining traction and offers uncommon opportunities to address portfolio intriguing opportunities for banks willing to gaps in a depressed valuation environment. provide “banking in a box” services to nonbank third-party providers. These may include — Partnerships with fintech. Similarly, all parties syndicating in-house expertise, such as e-KYC, may be receptive to embracing fintech ATM distribution, clearing-as-a-service, and partnerships at scale to drive innovation and white-label digital MTO remittance solutions. reach new customer segments. (e.g., e-wallets, consumer-to-consumer remittances, acquiring — Centralized payments organization. Finally, capabilities). Financial institutions must invest in many banks’ operations could benefit from the newer technologies such as biometrics, AI, and creation of a central payments organization. By blockchain to test and reset the boundaries of reorganizing traditionally segregated business future payment experiences, or they risk behind silos (e.g., retail and wholesale) into a centralized left behind. Technology investments should be agile organization focused on a shared payments concentrated in areas where a given institution agenda with aligned goals and performance is marking a concerted push; otherwise, targets across cross-functional teams, banks partnerships and/or tactical outsourcing are can better capitalize on subject-matter expertise likely better avenues. and scale efficiencies, and they can eliminate some of the channel conflict that inevitably — Strategic analysis of the payments journey. emerges from silos. Banks must visibly and actively shape the next generation of the payments journey. This includes determining whether to defend their Wallets and digital ecosystems: Playing existing payments turf or aggressively invest for for long-term value growth. Additional opportunities abound for the Wallet providers face a do-or-die situation. Although latter, often suited to banks targeting specific domestic retail payments are the battleground sectors and niches. on which players are competing to achieve scale, meaningful monetization opportunities lie beyond — Comprehensive value proposition. Value the near-term horizon. Successful digital-wallet

18 The future of payments in Asia providers will not only build scale but also retain of ubiquitous solutions. Well-funded players can customers over time, executing a business plan that explore M&A opportunities to append specific instills patience for the eventual payback. capabilities in a potentially attractive valuation environment, perhaps including “acqui-hire” Toward this end, players should focus on campaigns arrangements. Pure-play e-wallets with limited designed to rapidly onboard first-time digital users, funding and/or market share may consider timely with retention strategies to encourage continued consolidation with larger players. usage. Given the need to rationalize marketing spending to align with P&L realities, go-forward To accelerate the path to return on investment, models may include partnerships with online wallet providers might pursue monetization merchants and investments in loyalty programs, opportunities beyond pure payments—for instance, co-funded by merchants wherever possible. across financial services (insurance), merchant services (SME lending), and data services. In addition to creating compelling consumer Ecosystem-oriented wallets can also extend propositions, wallet providers should strive to value propositions beyond payments use cases by enhance merchant-payment capabilities, ensuring pursuing the build-out of a “super app” catering to a value add for all ecosystem players and fostering lifestyle offerings, say, encompassing chat and other greater acceptance. Internal processes can be social functions (Exhibit 10). reconfigured to enable faster merchant settlement workflows created to integrate payment flows Those deciding to double down could smooth across online and offline channels. the path to critical mass by addressing additional business and government use cases. Possibilities As the wallet market matures, many players will include supplier payments, payroll solutions, face a decision to acquire or be acquired. Most and consumer-to-government collections and Asian countries are typified by fragmented e-wallet disbursements. These scenarios will not only landscapes, leading to excess capacity and a drive payment volumes but also help companies lack of clarity in convergence around a short list acquire customers at scale. Other clear market

Exhibit 10 Wallet providers can build a full nancial platform on top of payments by o ering their own or third-party services.

Additional monetization layers Insurance Consumer credit Deposits and Personal Merchant to fund payments proposition investments nancial nancing management Acquire or partner to obtain speci c capabilities or product (eg, injury/ (eg, checkout (eg, short-term (eg, spend analysis, (eg, working value proposition accident, travel) nancing, deposits, wealth budgeting, goal capital, invoice Oer 3rd-party services via microlending, management) savings) discounting, marketplace model auto loans) transaction nancing)

Data services (eg, customer and sales analytics, marketing)

Acquire and retain critical Payments wallet user base Pure-play wallets to partner with large merchants across dierent Retail/commerce Travel and Healthcare P2P and social Logistics sectors to expand use case hospitality transfers rapidly Ecosystem players embed payments as a service into other adjacent business units Food Transport Media and Bill payments Lifestyle and groceries and mobility entertainment services

Loyalty proposition

Source: McKinsey analysis

19 The future of payments in Asia needs are cross-border payment capability, which Fueled by the wealth of information generated would be an attractive e-wallet differentiator, and by payment transactions, data analytics can assistance in implementing e-invoicing solutions. be leveraged to enhance offerings by reducing Overseas partnerships with other payment systems processing costs (e.g., through fraud detection can expand retail use cases, and regional wallets to reduce chargebacks and analysis of payment- could bolster risk management capabilities such method success rates) and to provide deeper as KYC and AML by engaging with regulators and business insights. The resulting value from lower stakeholders such as foreign-exchange brokers to costs and better-informed decisions can justify a enable closed-loop cross-border solutions. new revenue stream incremental to the existing processing run rate.

Merchant acquirers: Innovating the Additional opportunities for acquirers committed product to greater investment and strategic focus include Merchant acquirers are in something of a golden provision of an integrated suite of merchant era. Although these firms continue to play a key role solutions for merchants extending beyond payments in customers’ acceptance of digital payments, they processing to support core business activities such will find themselves increasingly reliant on value- as inventory management, lending, accounting, and added revenue streams as core payment processing tax reporting. Global and local acquirers can benefit becomes more of a utility. As a result, many of by forging cross-border partnerships, involving the future standout players will likely resemble collaboration or consolidation to combine scale technology or software companies. and technology with local licensing and market knowledge to enable more successful international The immediate imperative, however, is to win in payments. Targeted acquisitions, such as PayPal’s innovating the product to broaden digital-payments addition of iZettle, can deliver specific capabilities to acceptance, particularly across Asia’s SME bolster acquiring platform offerings. merchant base. A key to lowering barriers to digital- payments acceptance is to develop simplified, Networks and schemes: Enabling at scale digitized onboarding experiences and demonstrably enhance SME sales capabilities. Acquirers also Global payment networks face headwinds, given have an opportunity to build share by investing in a recent push to establish local schemes and the development of omnichannel, technology-led increasing regulatory fee scrutiny. Given their wealth solutions capable of efficiently servicing even small of existing relationships, however, global players merchants as they start to go online, continuously remain in a position to shape the future of the sector expanding the breadth of digital-payment methods by diversifying their infrastructure capabilities offered, to ensure reach and relevance. This may (to include real-time payments, for instance) and also include expanding to new payment rails, integrating at scale across the global economy. enabling faster settlement to satisfy the daily With next-generation payments platforms such as working-capital needs of many small merchants. e-wallets and digital banks still in their relatively Scale also is of critical importance, because it can nascent stages, networks can use their domain flatten the cost curve, further ensuring an attractive expertise to assess which are best equipped merchant proposition. The volume necessary to for long-term success. Then they can embrace generate such scale efficiencies—two billion to the most promising of these platforms to enable three billion annual transactions per year—may broader issuance and expand product reach. An not be viable within most Asian markets. That example could be offering virtual card solutions for fact illustrates the need to explore international e-commerce merchants. combinations. In conjunction with governments, local schemes Another key acquirer opportunity is the can invest in country-level payments and “beyond development of sector- and segment-specific payments” solutions, championing digital adoption solutions meeting the needs of specific business aimed at extending both consumer penetration types. Examples include platform disbursement and merchant acceptance. These campaigns may solutions for gig-economy and e-commerce include awareness promotions for specific use marketplaces and recurring payments for cases (e.g., transit systems, smart-city solutions), as subscription-based models well as rewards incentives.

20 The future of payments in Asia On a related note, networks should continue to leaders must determine which they choose to innovate on form factors, enabling new payment pursue. experiences that deliver increased convenience to Although these responsibilities are relatively customers, including consumers and merchants. intuitive, they carry added weight in a region that This can be achieved through technology is experiencing such rapid growth and evolution partnerships within and beyond the payments and that is so dependent on cross-border fluidity sphere. Examples might include biometric-based for the success of all constituencies. Therefore, we payments and an even simpler peer-to-peer model respectfully suggest that the relevant authorities leveraging mobile-phone networks. closely consider the following measures. International schemes have an opportunity to work One key to fostering competition is ensuring a closely with governments in emerging markets to level playing field. Governments are uniquely establish real-time payments infrastructure and positioned to accomplish this, whether by creating offer ongoing management services to support this public payments rails or establishing ground rules critical go-forward capability. Developed nations providing equitable access to privately owned are engaged in a similar transition to RTP, where infrastructure. This role is particularly important, the cut-over is often more complex because of given the likely launch of new payments systems existing volumes and ingrained processes. In this over the medium term. sense, RTP can serve as an equalizer for frontier countries, which may face fewer entrenched barriers Regulators can carry out an important convening that inhibit leapfrogging to next-generation digital function by setting an agenda for enabling models. interoperability, notably while introducing and/ or strengthening nascent real-time payments In a similar vein, open-banking models have infrastructure in several countries. This opportunity established clear momentum as the de facto extends to open banking, which promises to go-forward model for core banking infrastructure. accelerate digital adoption by enabling a broad In smaller markets, networks and schemes range of use cases for incumbents and new entrants can explore a natural facilitator role in open- in order to achieve the goal of digital adoption in banking development, streamlining application- regional payments systems. This objective has programming-interface (API) platform connections taken on greater resonance because the economic with a focus on secure, trusted connections landscape is likely to include budget deficits for the between open-banking interfaces and third-party foreseeable future. With support for tax increases service providers. This opportunity also applies increasingly difficult to muster, plugging leakages in to cross-border payments, where schemes can existing schemes becomes increasingly appealing. facilitate bilateral and/or multilateral partnerships Migrating payments from cash to digital carries the by integrating infrastructure across domestic and added benefit of shining additional light on the gray international payment networks, further serving in a economy. key facilitator role by engaging regulators and other commercial players to push for regional real-time Such digitization programs could encompass infrastructure. A relevant model can be found in the inducements to the various customer groups. P27 initiative, which aims to create a single pan- For consumers, an example is the tax incentives Nordic clearing platform. offered to South Korean consumers for the use of “electronically traceable payments,” part of a Regulators and governments: Setting broader effort to reduce the shadow economy. the pace For providers, inducements could include R&D tax credits for new infrastructure. And merchants could Governments and their regulatory authorities play be given MDR subsidies to encourage adoption of an essential role in framing a country’s aspirations digital technology and ongoing backbone upgrades. for a digital economy by creating incentives, Given the relatively long payback periods faced improving infrastructure, and fostering competition. by providers and reluctance on the part of “long- This involves a delicate balance among capitalizing tail” cash-based merchants, sovereign authorities on innovation, ensuring consumer protection, and may have the best chance to fuel a virtuous cycle, establishing a sustainable economic foundation. seeding the market in order to more quickly reach Several archetypes are plausible; government the desired result.

21 The future of payments in Asia Maximizing digital adoption also requires removing when national interests are not fully aligned, the friction from the process wherever possible. Hurdles removal of friction typically benefits all parties. in digital account setup remain a primary barrier Finally, regulators must rethink their own to less technically savvy consumers’ embrace of organizational structures, given the dramatic what is intended to be time-saving proposition. evolution of the payments industry it is tasked Authorities can foster fully digital onboarding with overseeing. Standard banking supervisory processes for consumers and merchants by structures alone are no longer sufficient. They revisiting existing regulations and updating them to have been tweaked to address the growing role reflect the new operating environment and available of fintechs, but as the lines blur between payment technologies. Please note that this need not—and services and other big tech offers, such distinctions should not—equate to relaxing critical safeguards are unlikely to remain sufficient. In some cases, it but rather should involve harnessing new models to may also make sense to create an independent unit ensure security. tasked with digital-payments oversight, to focus For instance, KYC is as important as ever and expertly trained resources on the landscape and poses distinct challenges in a digital environment. track digitization efforts. Regulators could build or facilitate an e-KYC utility, accessible to all players either directly or through a third party, to address this pain point. Within reason, These calls to action can, of course, be applied regulators could also relax restrictions such as differently based on each individual player’s daily or monthly e-wallet transaction limits, after strategic objectives and competitive position. And implementing appropriate safeguards, including while it would be naive to expect members of the five KYC/AML. constituencies to proceed in lockstep, fortunately there are very few areas in which these groups’ Engagement with regional counterparts also is objectives clearly conflict. The greatest challenge essential, given the importance of cross-border will likely arise in cross-border coordination; a capabilities. Government entities should evaluate solid track record of country-level successes may regional partnerships (e.g., creation of a SEPA-like facilitate that process as well. infrastructure and/or governing body) to facilitate streamlined real-time cross-border payments. Even

22 The future of payments in Asia Conclusion

The events of 2020 caused a reset in the payments ecosystem, in Asia and across the globe. Still, the sector’s solid foundation points to a relatively rapid recovery—with a return to mid-to- high single-digit growth rates and, by 2022 or 2023, more than $1 trillion in annual revenue in Asia’s payments industry.

The Five Cs described in this report will shape for unbanked populations, for instance, creating the future of Asia’s payments sector. A number potential societal issues as well as avenues for of actions will be required of players across the innovative players to deliver valuable solutions. ecosystem, including traditional banks and financial It’s no exaggeration to suggest that a trillion-dollar services firms, newer fintech challengers, and opportunity is at stake. The question is how these established companies in adjacent sectors like big revenues will be divided. tech and telecommunications pursuing avenues for expansion.

A fundamental shift in the market’s approach to Reet Chaudhuri is an expert associate partner, commerce is undeniably in flight. While aspects of Bharath Sattanathan is a partner, and Joydeep this evolution will proceed organically, there is plenty Sengupta is a senior partner, all in McKinsey’s of room for various players to influence the outcome. Singapore office. Jacob Dahl is a senior partner in The cashless revolution has clear implications the Hong Kong office.

23 The future of payments in Asia Literature title November 2020 Copyright © McKinsey & Company www.mckinsey.com @McKBanking