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Global Banking Practice A perspective on German

What is the long-term relevance for , , and cards?

September 2019 Authors and acknowledgements

Dr. Franca Germann Associate Partner Frankfurt

Reinhard Höll Associate Partner Dusseldorf

Marc Niederkorn Partner

The authors would like to acknowledge and thank Dr. Dr. Helmut Heidegger, Dr. Philipp Koch, Kai Schindelhauer, Prof. Dr. Uwe Stegemann, Birgit Teschke, Dr. Andreas Thurn, and Dr. Eckart Windhagen for their contributions to this paper.

A perspective on German payments What is the long-term relevance for banks, cash, and cards?

Germany has a reputation for being a high-tech country with a cash-dominated economy. Its cash usage is indeed high (67 percent of total number of consumer-to-business transactions in 2018), but the payments infrastructure is well developed, with approximately 165 million cards, roughly 1.1 million terminals, and a well-established processing landscape (Exhibit 1, next page).

For incumbents, payments are an important current accounts, or instruments); the remaining 20 source of revenue and the most important percent are generated from interest margins. customer touchpoint. The question now is Importantly, most customer touchpoints with their whether developments such as or are payments related and linked to current , ubiquitous card acceptance, and emerging accounts, generating approximately €12 billion specialists such as and lead in associated revenue in . Leaving aside to a leapfrogging moment that relegates banks interest rate effects on the net interest income on to the role of high-cost providers of cash, current accounts, the revenue from payments has cards, and infrastructure, pushing them further increased in recent years (Exhibit 2, next page). The away from the heart of the vibrant payments growth has been driven by the following trends: industry. Or more succinctly, will nonbanks and fintechs be able to reap the benefits of the shift —— A steady 1 to 2 percent annual decline in cash away from cash? usage across all age groups, leading to an increase in use of card and digital payments Noncash payments are growing —— A steady 5 percent annual increase in card Payments can be defined as covering issuing usage, albeit with moderate revenue growth activities—transactions made through accounts, (mostly due to regulations such as MIF—Multi- credit and debit cards, and (new) payments types —regulation ) such as PayPal, Apple Pay, and . —— An increase of approximately 10 to 15 percent It also covers payments acquiring (terminals, per year in e- and m-commerce channel usage merchant payments solutions) and ranges from the “traditional” (POS) to the growing In a European context, German payments revenues e- and m-commerce channels, as well as the are lower than average; at about €22 billion, they underlying processing and current-account, cash amount to 0.7 percent of German GDP, compared supply, and logistics activities. More than 80 percent with the 1.0 percent European average and the 1.3 of payments revenues in Germany are fee based percent US average. German banks rely more on (either directly or usage based from merchants, account-related liquidity than most other markets

A perspective on German payments 1 Exhibit 1 An overview of the German payments market. ayments in Germany

as is sti iy reevant billion Transactions by payments type, % of bank revenues consumer- are payments to-business Cash related transactions per year Cards of banks’ Transfe r customer million touchpoints are cards payments t se mosty or sma amonts related Ø transactions volume in € 74 million terminals 49 of payments revenues in 13 Germany are generated by Cash banks

Source: McKinsey analysis

Exhibit 2 German domestic payments are dominated by current accounts, transactions, and debit cards.

Growth p.a. Growth p.a. evenes in te German payments maret in € billion1 2012€17 2017€22

27 24 25 22 -4% 1%

2 Current accounts 19 13 15 12

2% 2% 3 Transactions 6 2% 3% Credit cards 5 6 5 Debit cards 2 0% 5% 1 2 4 1 3 1 0 2 0 2 0 1 20% 16%

2007 2012 2017 2022E

1 Excluding cross-border business. 2 €13 billion assuming constant interest rates, 2017-22; €17 billion assuming rising interest rates. 3 Includes cash, checks, transfers, direct debit, documentary business, remittances. 4 E.g., AmazonPay, PayPal, Sofort, paydirekt, , ApplePay, GooglePay. Source: McKinsey Global Payments Map

2 A perspective on German payments Exhibit 3 Germany falls into the current account-related-liuidity-driven country archetype.

Payments revenue drivers for dierent country archetypes in 2017, share in %, total in € billion

28 57 78 40 60 7 7 12 12 2 5 14 Revenues from 29 30 11 payments1 payment type 24 11 12 10 9 7 Cross-border 26 8 transactions 11 15 23 24 Current

13 6 12 Business accounts 12 payments1 22 13 Transactions 22 9 26 11 63 9 5 8 5 5 Cards 6 Germany Liquidity Cards Retail Commercial driven driven driven driven UK

1 Retail versus business split dependent on revenue recipient. Source: McKinsey Global Payments Map

(Exhibit 3), making them more vulnerable to the specialists and utilities—will continue to gain current low-interest-rate environment. ground, particularly in non-customer-facing areas such as cash logistics and processing. While German payments behavior is unlikely to Banks will continue to hold the balance sheet, suddenly rival that of , where mobile payments and big technology firms are likely to focus on the methods such as Alipay are now used for 28 percent customer interface to support their core business. of consumer-to-consumer and consumer-to- business payments, some trends are evident: We believe that customers, not technology, will be the key driver of change, as they increasingly expect —— The number of digital payments methods will seamless experiences across channels. continue to increase in the near term, enabled by increased adoption of mobile technology. However, other than in niche applications, A -term proliferation in digital this growth in payments methods will likely be payments methods temporary, with merchants and consumers Online, Germans still mostly pay through traditional pushing for convenience and less complexity. means: direct debit and bill pay account for 63 percent of all transactions, with PayPal and credit —— Germany may follow the trend in other European cards carving out most of the rest (20 percent and 11 markets and experience a continuing decline in percent, respectively). Meanwhile, mobile payments cash usage to 30 to 50 percent in the next three are still seen as distinct from online and brick-and- to five years, as increasing numbers of people mortar payments. Actual mobile payments are still pay by or cards. very low (less than 1 percent of all transactions) —— The customer interface remains the competitive in Germany compared with countries such as focus of banks, card schemes, and payments Denmark, where mobile payments now make up 14 specialists. Nonbanks—that is, payments percent of total noncash payments.

A perspective on German payments 3 However, digitization, the advent of PSD2, and methods may decline, given that merchants and strong e-commerce growth have paved the way for customers prefer simplicity and that payments the development of many new payments methods solutions are highly scale sensitive. This may (Exhibit 4). The emergence of Apple Pay, , even lead to a leapfrogging moment when market and mobile payments solutions from banks, such as volatility leads to more fluid customer preferences Kwitt, are likely to fuel mobile growth. It remains to where alternative payments methods may gain be seen, however, how deeply digital payments will a significant market share. In this competitive penetrate, given German consumers’ skepticism environment, it is unlikely that payments providers toward new providers. Experiences from other will be able to charge payers significantly, as a markets such as Switzerland, where the increased large user base will be crucial in gaining scale and usage of TWINT has not led to a fall in card usage, ensuring enough merchant . Moreover, in imply that cards are here to stay (mostly at the some very specific, niche use cases (e-gambling, expense of cash) and are likely to continue growth in for example), distinct digital payments methods are either physical, contactless, or digital form. likely to endure. Overall, we expect both mobile and online payments To succeed in this race, many payments providers volumes in Germany to continue to grow in the high have already started to enhance their offers with single digits. However, the number of payments omnichannel service and more seamless shopping experiences—for example, allowing consumers to

Exhibit 4 The estimated number of payments methods in Germany has grown signi cantly, but in the midterm future, we expect this number to decline.

> 50

> 15 > 5 ? 1990 2005 22020E 02530

Examples Plus Cash /VPay6 VisaDebit/Debit Kwitt Bank transfer2 Geldkarte Mastercard Transferwise Checks OLV/ELV Masterpass ApplePay Cards3 giropay6 paydirekt GooglePay Mastercard/Visa/ PayPal Amazon Pay AliPay TPay7 BarPay bluecode ClickandBuy8 RatePAY Payback Pay MyBank Paymorrow Sofortüber-weisung4 Barzahlen 5 … BillPay … Billsafe

1 Includes cash on delivery. 2 Includes payments in advance. 3 Later . 4 Since 2014 part of Klarna. 5 Since 2017 part of Klarna. 6 Since 2006. 7 Until 2010. 8 Until 2016. Source: McKinsey analysis

4 A perspective on German payments use the same PIN and password credentials online Cash usage in Germany today is like that of Sweden and on mobile. PayPal has significantly updated in 2003, Italy and Poland in 2015, and its mobile payments app; Visa and Mastercard overall in 2006 (Exhibit 5). Cash remains a major are facilitating connectivity to multiple channels value proposition for most banks: ATMs are a key including third-party digital wallets; and Alipay is customer touchpoint and major reason for charging working with acquirers to offer an omnichannel current-account fees. experience (so far focused on Chinese tourists). The trend in cash usage in these markets has been Admittedly, banks have not yet been able to a steady decline. In some countries (for example, translate their relevance in POS transactions to the the Netherlands, Poland, and Sweden), this decline online and mobile arena. Still, girocard as a national accelerated in recent years. Germany will likely debit system has around 58 percent of noncash follow the same trend with an acceleration of transaction volumes, and banks have led several noncash usage within the next three to five years. initiatives to upgrade girocard (for example, by allowing contactless payments) and their digital As cash becomes less relevant, so too do the assets such as paydirekt. existing cash/ATM value propositions, particularly at a time when supermarkets are offering free The future of cash in Germany cash withdrawals. According to McKinsey analysis, banks in Germany currently spend about €2 Although the number of cards per capita in Germany billion on services to support cash transactions: is comparable with that of other European countries, a combination of setup and maintenance of ATM domestic card usage is comparatively low, with 75 networks, cash logistics, and other related costs. It transactions per capita per year, versus 84 in Spain, is likely, therefore, that banks will cut cash-related 173 in France, 279 in the , and 401 in Norway.

Exhibit 5 trongly declining cash usage in Germany expected given experience from other European countries. as sae in seecte ropean contries in % of card and cash consumer-to-business transactions 100 90 For Germany, cash usage in 80 2022 will be ~ 30 50% if 70 development follows that of other European countries. 60 50 Germany 40 Italy 30 Poland 20 Europe overall1 10 Netherlands France 0 Sweden 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022

1 Includes Austria, Belgium, Czech Republic, Denmark, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Netherlands, Norway, Poland, Portugal, Romania, Russia, Slovakia, Slovenia, Spain, Sweden, Switzerland, and the UK. Source: McKinsey Global Payments Map

A perspective on German payments 5 costs aggressively while actively managing potential A value chain of specialists: Are banks public reactions. While market forces may prefer falling behind? no use of cash at all, this seems unlikely, as there Germany has mirrored European trends toward are some groups (tourists and senior citizens, a non-bank-driven consolidation in payments as for example) who lack easy access to noncash banks’ value chain share has steadily decreased payments methods, and access to ATMs is often over the past decade (Exhibit 6). This is particularly seen as a public good. the case in digital payments and non-customer- Germany’s banks will therefore need to address the facing areas: costs of running the roughly 50,000 ATMs in the —— Issuing revenue shares are dominated by country. The number has been relatively stable, as bank-related entities and nonbanks. In debit falling usage is counteracted by branch substitution cards, girocard—the national debit card (ATMs replacing bank branches). Banks could follow run by the banks—is the market leader, with the example of payments markets in Sweden and cards held by around 95 percent of the adult the Netherlands and pool their existing networks. population. However, girocard has very limited This approach could likely start with banks’ non- online and mobile capabilities, which constrains customer-facing, back-office areas, and potentially its contributions to related bank-internal result in a model like the Dutch Geldmaat, in revenue growth. Germany has low credit card which all banks pooled their cash/ATM activities penetration, serving around 36 percent of in 2015 and rebranded all ATMs under a common the adult population. International schemes brand in 2019. (Mastercard, Visa) have focused on their debit solutions (for example, ) and

Exhibit 6 German banks share of revenue generation in payments is declining.

evenes € billion ontrition to revenes y canne

100% = 27 24 22 252

61 67 Banks 82 77

Bank-related entities (revenues of bank-related 22 entities; ie, subsidiaries or near-bank utilities; 18 eg, FinanzInformatik, paydirekt, BCB) 14 11 Nonbanks and external third parties (eg, First 15 17 Data, Mastercard, Concardis) 7 9

1 Excluding cross-border business. 2 In the event of rising interest rates 2017-2022, total revenues reach €29 billion (67% banks, 19% near-bank, 14% non-bank). Source: McKinsey analysis

6 A perspective on German payments started to add online/mobile capabilities that beneficial to banks, providing them with customer were originally developed for credit cards. and data access. Digital and mobile payments are growing rapidly from a low base, with only small market What should market participants do? shares for bank-based solutions. As cash loses relevance, cards and digital —— Acquiring is mainly performed by nonbanks, payments expand, regulation fuels competition, and which account for more than 80 percent of these consolidation looms, firms need a clear strategy for revenues. It has not been a focus for banks of strengthening their value proposition. While German late, either in Germany or across Europe. The banks are struggling to generate returns on equity bank-owned Concardis was divested in 2017, (ROEs) of more than 5 to 10 percent and losing their and currently only the Sparkassen continue share in the payments value chain, the valuation to own a significant (albeit minority) share in and total shareholder returns (TRS) of payments ’s German operations after Ingenico’s specialists have been high. For example, Wirecard’s acquisition of BS PAYONE. price-to-earnings ratio is about 43 (as of September 6, 2019), with a 21 percent ROE in 2018, and the —— Payments processing in Germany is still overall payments TRS since 2010 is more than 20 relatively fragmented, mainly between percent per year. Given that payments-related bank-related entities and nonbanks. While activities are a primary customer touchpoint and a and the cooperative banks key to cross-selling, payments should be a central have partially outsourced processing to larger theme for almost everyone. European nonbank players, the market-leading Sparkassen still run their own system (i.e., near- Individually, banks should decide on their ), as do some of the private banks, such as strategy and whether they will be a differentiator— . that is, play for a competitive advantage—or aim to just keep pace with market developments. —— Current accounts, cash supply, and logistics Independent of the strategy, for most banks a have remained firmly in the hands of banks, significant share of their banking revenues will still with the help of their contractors; related be payments related, and banks should make sure revenues are mainly earned by banks and to have clear management responsibility. Similarly, bank-related entities. Unlike in other European all banks should focus on achieving operational countries, such as the Netherlands, the United excellence, particularly pricing power (for example, Kingdom, Sweden, and Finland, cash supply and considering fees for cash usage by businesses), the logistics utilities across sectors have so far not ability to accelerate sales, new product and service emerged at scale. propositions, and further digitization. Overall, the trend toward specialists and utilities A more ambitious differentiation will require in noncustomer areas is set to continue; scale strengthening the bank’s current position effects in processing and cash, as well as regulation through integrated offers, ecosystem plays, and (such as PSD2) and security remain important. In partnerships with fintechs and—selectively—big customer-facing areas (cards and digital payments, technology firms. Regulation such as PSD2 and for example), the picture is complex. Specialists the proliferation of APIs may support such moves such as PayPal are focusing heavily on digital but will also put pressure on laggards as third payments but have not achieved broad market parties can more easily gain access. As advances leadership. Banks clearly aim to strengthen and in technology and the accelerated growth of digital defend their customer touchpoints. They have an commerce rapidly reduce the viability of legacy asset in girocard, a significant stake in credit cards, systems, banks should consider divestment or and at least a foothold in digital payments with outsourcing of assets where scale or differentiation paydirekt, giropay, and other methods. Customers cannot be achieved. An example is payments seem to trust banks with sensitive payments data, processing, where leading European players (such but so far banks have not significantly benefited as Worldline) generated an estimated €2.2 billion from this advantage. Card schemes are both their in revenue, compared with €5.7 billion in revenue allies and competitors; their networks act in direct in Germany for transactions overall. Nonetheless, competition to girocard and may siphon significant selective insourcing of assets appears possible, value away from banks. They may, however, still be when they may play into a differentiation strategy.

A perspective on German payments 7 Moreover, for certain players, such as small private- a provider’s services to less penetrated markets. banking players, a complete exit from offering Specialists should continuously evaluate technology payments services may be advantageous. architecture and options for integrating systems as part of any deal. This consideration should Banks as a group need to acknowledge the also encompass evaluation of the strategic focus, threats inherent in industry trends but also grasp whether to partner up or compete with other the opportunities, such as where they may want to specialists in the market. Specialists may also cooperate to enable superior propositions vis-à-vis extend their payments offers to leverage into payments specialists and new market entrants. They cash management, corporate accounts, and even should give industry utilities serious consideration, other areas such as leasing and factoring for large given successful examples such as TWINT for digital merchants. Some specialists (e.g., Adyen) have payments in Switzerland aiming at the customer already obtained a banking license and are offering interface and Geldmaat for ATMs in the Netherlands services such as cash management and foreign aiming at cost efficiency. exchange. Similarly, credit card schemes may want For customers, banks need to accelerate the to focus on enriching their omnichannel offers to development of payments solutions and create solidify and expand their business in both the offline highly convenient, omnichannel offers. With (particularly in debit) and digital channels. girocard, banks have an asset, but compared with So far, big technology firms have not treated their peers in other European countries, German German payments as a core target and have banks’ response to non-cash-related payments generally been agnostic toward payments methods has been fragmented. Offers focus on separate used on their platforms. Most digital wallets, solutions, such as girocard (offline), paydirekt and for example, have been open to what payments giropay (e-commerce), and Kwitt (peer-to-peer). methods they consider to work with. Some big Banks could also their current accounts more tech firms look at payments methods in terms directly with the digital world (for example, by of control of the customer interface. Others see making credentials/apps usable for payments as a value driver from a sales funnel e-commerce payments). management perspective, meaning they favor the Banks may want to consider acting on statements methods that will increase the number of consumers by European politicians on the development of a who click, buy, and pay while minimizing risk and European consumer-to-business/business-to- complexity. Of course, they may still try to introduce consumer scheme (potentially involving girocard, their own payments methods, which could lead Europe’s largest domestic scheme). They might to a marginalization of banks. An example of this even reach into payments issues around mobile-to- might be an overarching customer interface for mobile payments and the Internet of Things, with payments where all scheme/interchange as well applications to, for example, machinery, automotive, as transaction fees are captured. However, if truly and insurance. distinctive, omnichannel offers emerge from banks With regard to cost, banks need to collectively or specialists, tech players are likely to integrate improve their structure, ensuring that cash stays them into their platforms. affordable, through cross-industry consolidation Merchants should take a more holistic view of the and optimization of cash infrastructure and by cashless trend and focus on the effects of payments redistributing the true costs of cash between all complexity on buying behavior, data generation, users (banks, consumers, and merchants). This and costs. The growth of digital payments opens means banks will almost certainly need to develop possibilities for creating transparency on revenues new value propositions without cash. Indeed, and actively using payments data to manage withdrawals may even become free for customers of sales funnels. These advantages are also more all banks, as they are in many other EU markets, to and more accessible for smaller retailers. Larger compete against payments specialists. merchants may also opt to actively push selective Specialists should be cognizant of what leads payments methods. to success: mainly convenience and scale. In conclusion, all players, and banks in particular, Further consolidation might be a smart strategy. need to decide whether payments is a differentiator; Acquisitions—often of payments assets divested they can play for a competitive advantage or just by banks—can deliver cost synergies or extend keep pace with market developments. Playing for

8 A perspective on German payments competitive advantage requires a flexible approach always essential. On the other hand, a fast-follower that can deliver superior value propositions to strategy will rely on third-party providers and may customers. Here technology is important but not be more cost-efficient. In each case, customers decisive, whereas keeping pace with changing can continue to expect more convenient payments customer needs, as well as a sharp focus on creating offers and more tailored solutions. scale at selected points along the value chain is

A perspective on German payments 9 September 2019 Copyright © McKinsey & Company www.mckinsey.com/industries/ financial-services/our-insights @McKBanking