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Thousands of wallets are buried in a glass box to raise awareness of mobile payments in Shanghai, China. Source: VCG/Getty Images

By Jennifer Surane and Christopher Cannon May 23, 2018

Wandering the streets of Shanghai to admire the architecture, the head of one of the largest U.S. consumer banks recently found himself surrounded by a gaggle of teenagers.

Entranced by their phones, they hardly made way for the banker. The teens were messaging, shopping and sending money back and forth, all without cash. Instead, they were using Alipay and WeChat.

The scary thing for the American: Banks never got a cut.

The future of consumer payments may not be designed in New York or London but in China. There, money ﬂows mainly through a pair of digital ecosystems that blend social media, commerce and banking—all run by two of the world’s most valuable companies. That contrasts with the U.S., where numerous ﬁrms feast on fees from handling and processing payments. Western bankers and credit- card executives who travel to China keep returning with the same anxiety: Payments can happen cheaply and easily without them.

Chinese vs. U.S. Payment Systems Americans more typically involve banks and cards when paying with apps China U.S. Paycheck is deposited into employee’s bank Paycheck is deposited into employee’s bank account account

Consumer transfers money into their wallet at Consumer uses debit Consumer uses bank Alibaba’s Alipay or Tencent’s WeChat Pay app in card to shop, or... account, debit or order to... credit card to fund Consumer uses their wallet at PayPal Shop online at many Shop at brick & mortar credit card to shop, Apple, Google, Chinese e-tailers stores or... Samsung, etc. in order to... Send money to Transfer money Send money to peers friends or family abroad or make with Zelle Pay friends or family purchases on vacation with Venmo

Shop online at stores accepting wallet

Shop at brick & mortar stores accepting wallet

Some retailers like Starbucks have their own wallet

Source: Bloomberg reporting

Alibaba Group Holding Ltd. created Alipay in 2004 to let millions of potential customers who lacked credit and debit cards shop on its vast online marketplace. Tencent Holdings Ltd., similarly, debuted its payments function in 2005 in a bid to keep users inside its messaging system longer.

Alipay and WeChat have since swelled in popularity, boasting 520 million and 1 billion monthly active users, respectively. Consumers sent more than $2.9 trillion inside the two systems in 2016, equivalent to about half of all consumer goods sold in China, according to the payments consultancy Aite Group.

In contrast, U.S. consumers still rely on banks for most non-cash payments—whether it’s by check, debit, credit or a growing number of other payment systems tied to their bank accounts. Connected to that is a universe of wallets and payments systems operated by the likes of PayPal Holdings Inc., Apple Inc. and Alphabet Inc.’s Google. From the perspective of merchants, too much of the U.S. system siphons oﬀ enormous amounts of money.

Transaction Breakdown In a typical $100 credit card purchase... $97.25 $2.20 23¢ 19¢ 13¢ Goes to the merchant Issuing bank Payment processor Acquiring bank Card network

How That $100 Credit Card Purchase Is Processed Established players face potential disruption owns Consumer Mobile devices New payment companies ① ⑨ (Square, PayPal) Makes a $100 Authorizes credit card transaction threaten threaten purchase

Provides point-of-sale Merchant Payment Independent processor Sales (Verifone, NCR) Organizations ⑩ ② ⑧ (ISOs) Bills cardholder Requests Authorizes Set up businesses $100 authorization for transaction, keeps to accept credit $100 19¢ in acquiring cards fees and pays ⑦ merchant $97.25 Paid remainder of merchant fee 23¢

Acquiring bank (Chase, Bank of America, First Data, Vantiv)

③ ⑥ Requests Keeps 13¢ in Fees add up to authorization network fees about $90 billion for $100 a year in the U.S.

Supplies Card network consumers with (Visa, Mastercard) credit cards to make purchases ④ ⑤ Requests Approves authorization transaction and for $100 transfers money, keeps $2.20 in interchange fees

Issuing Bank (Capital One, etc.)

Sources: Glenbrook Partners, Plaid, BI Intelligence

For now, no company in the U.S. commands the kind of clout that Alipay and WeChat wield back home. Instead, everyone is trying to replicate their success. “This is going to be the battle of all time—like who dominates all those services—and it’s still not known,” Jamie Dimon, chief executive oﬃcer of JPMorgan Chase & Co., told his company’s investors in February. “Everyone wants to be the place that is the one place you go to do that.”

The nightmare for the U.S. ﬁnancial industry is that a technology company—whether from China or a homegrown juggernaut such as Amazon.com Inc. or Facebook Inc.—replicates the success of Alipay and WeChat in America. The stakes are enormous, potentially carving away billions of dollars in annual revenue from major banks and other ﬁrms. What follows is a breakdown of what that could look like—theoretically—using the explosive growth as China’s apps as a rough guide.

Perhaps the clearest opportunity lies in siphoning oﬀ some of the fees that U.S. merchants pay to accept cards and mobile payments—about $90 billion a year, according to the Nilson Report, an industry newsletter. That money gets parceled out to card networks such as Visa Inc. and Mastercard Inc., payment processors and banks, which pocket the largest share.

In China, analysts expect third-party payment providers to earn about 40 percent of such fees by 2020. If apps were to start grabbing market share in the U.S. at roughly the same rate they did in China, it would take a $43 billion revenue bite out of a business banks count as among their most proﬁtable.

Merchant Fees Financial ﬁrms would lose billions if the U.S. embraces third-party apps at a rate like China’s

Fees collected by banks Fees lost to third parties China U.S. Projected Projected $150 $43B in merchant fees 150 could be lost to third-party payment companies by 2020 100

2010 2012 2014 2016 2018 2020 2010 2012 2014 2016 2018 2020

Note: No estimates are available for Chinese third-party fees for 2017–2019 Sources: Kapronasia, Nilson Report But that’s just one way that U.S. banks impose fees. They also generate revenue by dispensing cash. If payments apps were to replace paper money—as they have in many situations in China—another form of income could take a big hit.

Easy Money Checking accounts generate about $3 billion in bank fees, which would dwindle if consumers embrace apps

$1.8B in overdraft fees $412.0M 410.0 Bank of America Wells Fargo

126.9 102.2 333.0 U.S. Bancorp PNC JPMorgan Chase

89.2 75.6 Regions SunTrust

139.5 76.0 41.9 28.0 TD Bank BB&T Woodforest Citigroup National Bank

$783.3M in maintenance fees 282.0 Bank of America

162.0 118.0 Wells Fargo JPMorgan Chase

53.5 38.0 21.0 TD Bank Citigroup BB&T

15.3 Regions 40.6 31.8 12.4 8.7 U.S. Bancorp PNC SunTrust WNB

$341.4M in ATM fees 69.0 85.0 JPMorgan Chase Wells Fargo

23.2 13.6 12.0 TD Bank U.S. BB&T 83.0 Bancorp 11.4 9.2 Bank of America Regions SunTrust 15.9 9.1 PNC 10.0 Citigroup WNB

Source: S&P Global Market Intelligence

Soon, U.S. bank executives won’t have to travel far to see China’s systems up close. Alipay, owned by Jack Ma’s Ant Financial, has spent the better part of the past year inking deals with payment processors that will allow it to bring its technology to America. Already, many New York taxis oﬀer it as a payment option to customers.

So far, Alipay has said the expansion is meant to help Chinese tourists, and that it’s focusing on cities they tend to visit. But few in the payments industry believe it will stop there.

Meanwhile, Chinese consumers are starting to park more of their savings with the apps. In 2013, Alipay began offering money-market accounts. By last year, it had built that business into the world’s largest money-market fund with about $243 billion. For banks, that’s yet another bite. They traditionally hold customer deposits and use that money to fund loans—generating significant profits. If U.S. consumers were to start storing their extra cash with apps, banks would have to find an alternate—probably more expensive—source of funding.

Deposits Even a relatively small bite to deposits would be a lot of money

Deposits collected by banks Deposits lost to third parties China U.S. $242.9B in deposits lost to $15T Alipay (1.6% of total) $188.3B in potential lost deposits if the U.S. followed this pattern

2011 2012 2013 2014 2015 2016 2017 2011 2012 2013 2014 2015 2016 2017

Sources: Bloomberg Intelligence, Kapronasia

To be sure, U.S. banks have formidable advantages on their home turf. They have longstanding relationships with their customers, many of whom still like ‘visiting their money’ at a local branch. Consumers love credit card rewards programs and other perks, which have gotten sweeter in recent years, as well as the ability to charge back purchases that don’t go well. And U.S. bank deposits are backed by the Federal Deposit Insurance Corp.

Still, banks and payment networks have a lot to lose if technology firms succeed in grabbing market share—and there are signs that Alipay and WeChat aren’t the only firms that may flex their muscles. Amazon is said to be interested in offering its own product to mimic checking accounts while offering to lower costs for retailers who use its online payments service.

“What happened in China was not an even playing field,” Al Kelly, Visa’s chief executive officer, said at an investor conference in March. “What I hope happens around the rest of the world as they migrate is that at least it’s an even playing field.”

Editors: David Scheer and Peter Eichenbaum

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