By Brandes Elitch
In July 2016, I attended the 2016 Global Payments Symposium in Manhattan hosted by the American Bankers Association and the Bankers Association for Finance and Trade. The ABA was founded in 1875 to support the now $13 trillion U.S. banking industry; BAFT was founded in 1921 as a subsidiary of the ABA to support cross-border banking. BAFT has about 240 bank and nonbank members, half of which are in the United States.
Banking is an industry ripe for disruption. One conference attendee said we have a disco-era payment system in the United States (not true, I say). Remember, banking is a batch process. Imagine if your emails were processed in batch. Among the disruptors mentioned during the event were PayPal; Venmo (which PayPal acquired with its 2013 Braintree acquisition); and Dwolla. Someday banks will provide banking-as-a-service to developers and get others to propagate their solutions via APIs, with something like Facebook credentials.
Other discussion points included Community Reinvestment Act ratings (outdated, some said); totally rewiring banks for fraud protection; pressuring big banks to be better capitalized and get smaller; the dwindling market for correspondent banking; blockchain's potential to disintermediate banks, particularly for cross-border transactions; and the obsolescence of the consumer finance model reliant on credit cards, home equity loans and payday lending. These are big issues for banks. Except for the larger processors, most of us in the acquiring industry pay only cursory attention to our sponsor banks. But there is good reason to study the issues all banks face because, ultimately, all of us will be impacted by them.
The question for community banks is whether they will survive the increasingly onerous burdens imposed by federal bank regulators for compliance, regulatory and cybersecurity issues. The four bank regulators (the Federal Reserve, Office of the Comptroller of the Currency, Consumer Financial Protection Bureau and Federal Deposit Insurance Corp.) all have different cultures and want to participate in how banks operate.
When I started in banking, there were over 10,000 commercial banks. Today, there are around 6,000, and about 300 are merged out of existence every year. At that rate, we will be down to around 4,500 banks in the next five years. No new banks were chartered in 2011, 2012 and 2014, and none so far this year either. This is due to higher compliance and capital requirements and a low interest rate environment. It's community banks that really connect with small business customers and entrepreneurs. Bankcard salespeople will be affected, because with less credit being granted by fewer banks, it will be more difficult for small to midsize businesses to start, incubate, build a sales force, create inventory and find working capital.
If your portfolio has 20 percent attrition annually and no new businesses are being formed in your market, you are on a downward trajectory. It's bad enough that half of new businesses fail within the first five years, and 75 percent are gone in 10 years, but finding a new bank partner is one risk you don't want to confront. Conference presenters listed three tiers of banking: big banks (over $50 billion in assets), segment two ($10 to $50 billion in assets), and "small" banks (less than $10 billion in assets). Community banks comprise at least 90 percent of all commercial banks. I've always thought of community banks as those that have less than $1 billion in assets, but here the emphasis was on big banks. Community banks must make enough of a return to cover their cost of capital, which is challenging in this unusually low-interest-rate world. Even with higher rates and a steeper yield curve, how fast can a bank grow to meet the needs of its shareholders? Regulatory and compliance staffs do not generate revenue; they are pure expenses.
New banks fail at twice the rate of established ones. It is vitally important for ISOs and processors to have an ongoing dialog with their acquiring banks, and beyond that to understand how banks operate, particularly in relation to market share and growth potential. Your bank is your most important partner in the payment processing business, period.
Other topics covered at the conference included payment trends, faster payments, mobile wallets, new products, new regulations and fintech collaboration. Regarding fintech, a few years ago, the fintech sector proclaimed, "We'll beat the banks." Then it became, "We'll compete with the banks," followed by, "We'll partner with the banks." Now it is, "We want a bank to acquire us." This is not universally true, but what is true is that fintech companies have one goal: to sell their product. Banks have a different goal: to manage complementary, yet conflicting priorities related to return on assets, return on equity, risk-based capital, loan losses and annual audits.
Bank CEOs are focused on managing reputational risk; they aren't going to take a big risk to beta test a new fintech product with their best clients. However, banks know they have to innovate to keep their best clients, or they will lose them to bigger banks that have already innovated.
A recent PricewaterhouseCoopers study showed that fintech companies differ from banks in three primary areas: operational processes, management and culture, and business models, compounded by regulatory uncertainty and the need for IT security. For banks and fintechs to work together, they must learn how to talk to each other. A cultural gap exists here that may or may not be bridged.
Banks can choose internal incubation, a strategic partnership, an acquisition or have their own venture capital arm. At the conference, five fintech CEOs gave five-minute elevator pitches about their firms. Topics included a distributed loan ledger, managing innovation with third-party vendors, loan warehousing and securitization, an enterprise blockchain platform for trade, and fraud and identity management.
It might take a year for a money center bank to get through the due diligence process, legal agreement and proof of concept for one of these innovations, by which time the fintech will have run out of money and closed its doors. Another conference topic was faster payments. Both the Federal Reserve and The Clearing House presented solutions. The Fed's, which is public knowledge, has 36 criteria, including six segments: ubiquity, speed, efficiency, governance, safety and security, and legal.
The Fed has the rest of 2016 to assess proposals and will finalize and publish assessment results next year. Information about the Fed and The Clearing House is at www.frbservices.org and www.theclearinghouse.org, respectively. Fedwire and the Clearing House Interbank Payments System (CHIPS) were also discussed. Fedwire is mostly domestic; CHIPS is 95 percent cross border.
Representatives of the CFPB, perhaps the most controversial public agency in the financial community, talked about their objectives. These include giving the consumer control over payments (interfaces and interaction), data and privacy, fraud and error resolution protections, transparency, cost, access, funds availability, security, and strong accountability.
Global banks are investigating blockchain. It has potentially huge value in securities, trade finance, payments and smart contracts in corporate bonds. There could be two types of products here: a censorship-resistant digital cash and an industry-wide system of record. For global trade finance, there could be instant settlement, no broker trades and zero transaction costs. Digital payments and mobile wallets are big topics throughout payments. I have covered these in detail in previous columns in The Green Sheet (See www.greensheet.com/search.php?flag=bylineDetail&byline=Brandes+Elitch). There are browser payments, proximity payments and in-app payments. The four pillars of support are digital convergence, new payment channels, complex security risks and a world-class consumer experience.
Banks need to solve three major problems. First, data security and privacy cannot be compromised. Second, regulatory compliance is not optional in a regulated industry; it is mandatory. Third, banks run on core systems, typically provided by companies such as Jack Henry & Associates. Someone has to figure out how to integrate new products into legacy systems and how to get them up and running quickly.
Given all of this, you might wonder how a bank CEO can sleep at night. Remember, banks own the demand deposit account, and they are trusted by consumers more than any other player in the payments space. In this respect, they hold all the important cards, but the rules of the game are shifting, and banks will need to understand the implications and plan how to address them.
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at firstname.lastname@example.org.
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