By Patti Murphy
Banks and credit unions take note: a report from the international consultancy McKinsey & Co. suggests as many as 2,000 financial technology (fintech) companies are now trying to stake claims on banking turf. These firms pose real threats to the banking status quo. A separate report, The disruption of banking, published in 2015 by The Economist, shows billions of dollars of venture capital pouring into fintech firms, especially those seeking to disrupt the payment and lending activities of banks and credit unions.
In its 2016 report Cutting Through the FinTech Noise: Markers of Success, Imperatives For Banks, McKinsey urges financial institutions to take action or risk disintermediation. "Absent any mitigating actions by banks, in five major retail-banking businesses – consumer finance, mortgages, lending to small and medium-size enterprises, retail payments and wealth management – from 10 to 40 percent of bank revenues (depending on the business) could be at risk by 2025," McKinsey wrote.
Not everyone is worried. "Banks aren't going to sit still," said Mark Ranta, Head of Digital Banking Solutions at ACI Worldwide Inc. "They will continue to evolve and to create new value-added services." Results of a survey conducted by Ovum for ACI revealed that across the globe, financial institutions (FIs) and retailers are planning for increased spending on payment systems.
Seventy-one percent of executives surveyed identified new competitive pressures and the burgeoning fintech market as the drivers of anticipated spending growth. "It's no longer just about maintaining the status quo," Ranta said. "We're starting to see increases in innovative spending as well." And increasing numbers of FIs are working in partnership with fintech firms to further drive innovation, he added.
"Banks have always been at the center of commerce," said Mickey Goldwasser, Senior Vice President of Marketing at Payveris LLC, a digital payment platform. And banks have been great innovators (think magnetic ink character recognition encoding of checks, sophisticated accounting systems and mag stripe credit cards). "With the right tools, banks and credit unions can be innovative again," Goldwasser added.
That's where Payveris comes in. It was initially developed as a service of Webster Bank N.A., a $29 billion bank headquartered in Connecticut. Webster still maintains a small ownership interest in Payveris, which was spun off several years ago. Goldwasser said that since the spinoff, Payveris has been focused on applying banking industry experience to modern problems, such as demand for faster payments, and has developed a cloud-based platform – the Payveris Unified Digital Payments Platform. It's an application programming interface (API)-driven platform that supports multiple types of payments – consumer bill pay, business bill pay, account-to-account transfers and person-to-person (P2P) payments. "We are the payments engine, or you could think of us as the payments plumbing," Goldwasser said.
The Payveris solution is catching on, with over 90 financial institutions signing contracts in 2015, the company reported. "We attribute the interest in our open API payments platform to the fact that our technology is successfully enabling financial institutions to increase control and consistency of the user experience, create more innovative payment services, and cost-effectively deliver these services through a single platform, enabling them to compete more effectively with nonbank payment disruptors and large banks," Jeff Weikert, President of Payveris, said in a statement.
First United Bank, a Texas-based $1.1 billion institution, integrated Payveris payment apps with mobile banking software from Malauzai Software Inc., so that customers can securely conduct payments via email or text messaging, with next-day availability. First up: P2P. "We knew demand for P2P would start growing, especially as the big banks in the area started promoting it," said Kevin Carson, Executive Vice President and Chief Technology Officer at First United.
Two of the largest banks in the country – Bank of America N.A. and U.S. Bank – recently rolled out real-time P2P payment products leveraging clearXchange, a network owned by Early Warning Services LLC, which itself is owned by five of the top 10 banks in the country.
P2P payments have been available for many years but have failed to take off in large part because legacy banking systems (like the ACH network) are too antiquated to support real-time payments. What Payveris and some disruptors (notably Dwolla Inc.) have done is to build networks from scratch, using 21st century technologies that bypass the ACH and card networks.
"We don't use the ACH to make payments, just to settle payments," Goldwasser said. When a customer initiates a payment request, Payveris checks the individual's FI account directly, only completing the transaction when there are sufficient funds to cover it. "We ensure the money is available," and if it isn't, the request is declined, Goldwasser added.
Technology giant Fiserv Inc. enhanced its Popmoney P2P payment service, which has been available for over a decade, with similar real-time capabilities – a natural development because Fiserv drives core banking systems for thousands of community banks and credit unions. "We're actually seeing increases in adoption and usage around Popmoney," Matt Wilcox, Senior Vice President, Marketing Strategy and Innovation at Fiserv, stated during a recent interview. He added that more than 2,400 Fiserv FI clients are part of the Popmoney network.
Aside from technology shortcomings, FIs also tend to be risk averse and revenue hungry. Real-time (or near-real-time) payments aren't going to generate huge revenues like cards. Disruptors like PayPal Inc. and Dwolla have convinced consumers and businesses that fast payments can be cheap, several experts noted. "Where the benefit comes [for banks and credit unions] is from operational savings," Goldwasser said, adding that if "financial institutions can offer competitive P2P products, they don't have to worry about" losing customers to disruptors.
"Where the disruptors really do a good job is with the user experience," Wilcox added. They also help create awareness, he said. Fiserv recently enhanced its Popmoney P2P service to support bill payments and account-to-account fund transfers. Traditionally, Popmoney has been an ACH-based solution. With pressure mounting for real-time payments, however, Fiserv has had to look to other networks and technologies to enhance Popmoney with faster payment options. "Transactions will settle at the end of the day [via the ACH], but the funds can now move instantly," Wilcox said.
Fiserv recently launched an accelerator program to foster fintech startups. U.S. Bank is involved, too, and is providing mentorship and opportunities for proof-of-concept initiatives. "There are many nuances to navigate when developing and delivering new solutions in our industry, and we have the expertise to help ensure technologies that can transform the way people interact with financial services can make their way to the market," Wilcox said in a statement about the accelerator program.
According to Goldwasser, technology is a great equalizer. "It empowers financial institutions to control the [customer] experience and keep customers happy," he said. "And if you keep customers happy they won't want to go someplace else."
It's not just banking's payment franchise that has been under attack. The proliferation of short-term, small-dollar lenders and market and regulatory pressures to reach the financially underserved have caused banks and credit unions to rethink lending strategies, too.
The idea of offering small-dollar, short-term loans (for example, payday and title loans) has come up numerous times in strategy sessions over the years at USAlliance Financial, a $1 billion asset credit union based in the affluent Westchester County area of New York. It never really gained traction, however, until 2015, when USAlliance assumed the assets of a credit union serving low-income residents in the Bronx, one of five boroughs that make up New York City.
"It may sound like a relatively straightforward idea, but when you start diving into it, it becomes an incredibly complicated situation," said Kris VanBeek, President and CEO of USAlliance.
USAlliance is working with QCash Financial LLC, an automated, cloud-based lending platform originally created for the Washington State Employees Credit Union. The QCash platform relies on customer-member financial history with the lending institution to underwrite and fund loans in about a minute. Ben Morales, QCash's CEO, described it as a "relationship-based lending engine."
"We know a lot about our members," Morales said. "We use the data we have to underwrite the loans." In addition, interest rates are substantially lower than the rates payday lenders impose. Although Morales declined to elaborate on the QCash fee structure, it's not uncommon for payday lenders to charge triple-digit interest rates. He estimated that 95 percent of loans originated through the QCash platform over the past year have been paid off.
Payday lenders have been increasingly controversial with consumer watchdogs and with lawmakers and regulators. Efforts have been underway at both the state and federal levels to rein in this relatively unregulated market, which generates about $50 billion a year in interest and penalty fees, according to the Consumer Financial Protection Bureau.
The CFPB has been threatening to regulate payday lenders, and urging regulated financial institutions to develop small-dollar, short-term loan products that challenge the market dominance of payday lenders. Several states and municipalities have been closing their borders to payday lenders altogether, in effect pushing them online. Morales said QCash aims to help credit unions unseat payday lenders with better and less costly loan products.
VanBeek said having access to a platform like QCash was key to USAlliance's plan to offer short-term loans in an unsettled legal environment. "We could have done this ourselves," he said. "But then what would we do if, say, in a year [the regulatory environment] changes?"
And chances are good that will happen. In April 2016, the CFPB issued a report slamming payday lenders for tactics that often place borrowers' bank accounts at risk. "Bank penalty fees and account closures are a significant and hidden cost to these products," said CFPB Director Richard Cordray. "We are carefully considering this information as we continue to prepare new regulations for this market." The CFPB has said proposed new regulations addressing payday and other short-term consumer loans are imminent.
In May, the U.S. Department of the Treasury issued a white paper – Opportunities and Challenges in Online Marketplace Lending – warning that new credit models and operational approaches to online payday loans remain unproven. The payday loan market, which took off in the aftermath of the Great Recession, "remains untested through a complete credit cycle," the department wrote.
The white paper, which analyzes responses to a request for comment the Treasury Department issued last year, also pointed to a consensus opinion among all stakeholders that "small business borrowers should receive enhanced protections." The paper also suggests there is a need for "interagency coordination through the creation of a standing working group for online marketplace lending."
FIs have a long history of dealing with disruptors and threats of disintermediation. It wasn't that long ago that the dot-com revolution was threatening to upset traditional banking relationships. McKinsey estimated there were more than 450 nonbank initiatives involving new digital currencies, wallets and banking networks then.
"Fewer than five of these challengers survive as stand-alone entities today," the consultancy wrote. The most notable of those is PayPal. Yet, PayPal wasn't able to go it
alone – the company uses leading acquirer Wells Fargo & Co. to process and clear payments.
"We see many [nonbank] companies entering this market because they see a lot of potential, but few succeed," Goldwasser said. "Banks that adopt and use the right technologies, we believe their best days are ahead of them."
A recent survey by Oracle Corp. illustrates one reason why: consumers trust banks and credit unions more than they trust nonbanks. Even a majority of millennials (60 percent) view their FIs as safe places to store money and facilitate financial transactions, according to that survey. In fact, 88 percent of millennials surveyed by Oracle indicated they trusted banks for advice – above family, friends, personal financial advisors and online resources.
A recent Accenture PLC survey echoes those findings. Among North American consumers polled by the firm, 86 percent said they trusted banks most when it comes to their finances; just 7 percent said they trusted payment companies more, and just 2 percent gave a nod to mobile phone providers.
"Despite the many threats that banks face, they still possess competitive advantages that are critical in today's digital world," said Dave Edmondson, Senior Managing Director of the North American banking practice at Accenture.
Dwolla Inc. developed a payment network specifically for merchants to sidestep the card networks and to replace the automated clearing house (ACH) network as a key alternative to cards. Now the company is vying for a chance to work with the Federal Reserve, as the Fed seeks to prod the nation toward real-time payments. Dwolla is one of several hundred organizations participating in the Fed's Faster Payments Task Force, which is striving to get the banking industry behind a new payment network that supports real-time or near-real-time payments. It also is one of more than 20 organizations that recently submitted proposals for task force consideration. The evaluation process is expected to culminate with an assessment report in 2017, according to a spokesman for the Fed.
Dwolla submitted FiSync for consideration. It is a specialized communication and interoperability protocol Dwolla developed for executing real-time money transfers. Dwolla founder and Chief Executive Officer Ben Milne, a thirty-something whiz kid who founded his first company at the age of 18, said the submission "reveals how FiSync works today and could work tomorrow."
The Clearing House, a bank-owned consortium that supports ACH, check and wire transfer payments also submitted a proposal to the Fed. In 2015, TCH partnered with the banking technology firm FIS to develop a real-time payment network for consumer and business payments. FIS said a pilot run is planned for the first quarter of 2017.
The debit card network Shazam also submitted a proposal to the task force. Shazam has a P2P app that supports immediate payments using mobile devices and riding the debit card network rails.
The Fed hired McKinsey & Co. to assist in reviewing and analyzing submitted proposals. The Fed stated that the process is not intended to produce any one winner, but rather a dialogue on the viability of and suggested improvements to the proposals.
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