Payments’ Darwinian Future: Lasting change may be defining legacy of 2020

By Fawn Hudgens, VP of Global Content at Money20/20

Like many other industries, 2020 has been an incredible year for payments. While those with exposure to e-commerce have seen volumes soar, those tied to the physical economy and cross-border transactions have had a tougher time. With struggle comes adaptation, however, and this year will undoubtedly shape the nature of the industry for decades to come. While it is impossible to predict the exact long-term impact that the year’s events will have on payments, it is likely to be a catalyst for two key trends.

First, efficiency will be key. Whether it’s defined by return on equity or unit cost economics, businesses big and small are being reassessed for how well they contribute to cashflow. Second, a new wave of disintermediation is coming. New means of making payments have the potential to upend the how of payments in a way not seen since the arrival of the card rails.

Urgent efficiency

In 2020, businesses that make money survive. Those that don’t, don’t. This had led to an urgent refocus on profitability over growth across payments fintechs. Fintech firms that rely on interchange fees for a large portion of their revenue have suffered through 2020 as personal spending dropped, while those that have more diverse or revenue that is less reliant on consumption were still able to profit, according to research by FXCIntelligence. The result is that fintechs have had to rethink their product – and in some cases, platform – structure in terms of revenue generation.

For incumbent banks, the threat to payments revenue has been known for some time, but 2020 has refocused executives. Those that have already begun to modernise their payments services have reaped the rewards while those who had simply been exploring through accelerators and Proof of Concepts are aggressively trying to find solutions. It’s worth noting that in strained economic times, especially where interest rates remain historically low, banks’ search for return on equity means innovation centres that do not impact the bottom line may be under threat. Turning innovation efforts into efficiency gains is a must for banks going into 2021.

Next wave of disintermediation

A few years ago, payments and payments processing was considered by some to be a relatively dull industry: modest profits and modest growth. This couldn’t be further from the truth now. The first new payment rails in a generation and the advent of Central Bank Digital Currencies (CBDCs) are bringing real change to the way payments get made, both for consumers and for businesses.

New rails

In B2B payments we are seeing a significant push for new payment rails. While lagging behind other jurisdictions, the US Federal Reserve’s encouraging moves toward a real-time payment system is a major development given the nearly US$13 trillion size of the domestic market. An important layer of this evolution is not just the potential replacement of existing rails, but enriching existing ones. The ISO 20022 standard has emerged as a potential tool for increasing the amount of information contained in a payment. This gives a major boost to alternative credit models in consumer payments and a big boost to achieving straight-through processing for B2B payments.

CBDCs

The biggest long-term development, however, is certainly CBDCs. While Facebook grabbed headlines with the Libra initiative, countries are quietly beginning to roll out digital versions of their currency, in some cases to facilitate interbank payments and in others, for use by consumers. This is a seismic shift for the payments industry, as payments and the use of the current account underpin the business models of most incumbent retail banks. If, for example, The People’s Bank of China chose to continue their method of directly putting their digital currency into the digital wallets of Chinese consumers, banks stand to lose a major source of cheap funding. What’s more, as digital wallets have been adopted in Asian markets, consumers have still typically relied on transfers to and from established banks to fund and withdraw from digital wallets.

The National Bank of Cambodia has just launched its own digital currency, Bakong. As smartphone penetration has outpaced bank accounts, the central bank took action to enable unbanked smartphone users to move into the digital economy. These may be an entire cohort of Cambodians that no longer see a need to open a formal bank account.

What we’re seeing is the beginning of a sea change in the payments industry. Efficiency will be the medium-term priority for the industry as both fintechs and incumbents alike weather the pandemic-induced recession. However, the long-term changes brought by new payment rails and spreading CBDCs will create the type of opportunities and challenges that have made the payments industry exciting for a long time to come.