Enabling innovation through payments platform transformation
01 / 09 / 2021
In this white paper, we examine how a rapidly changing financial environment is driving banks to rethink their business strategies and back-end operations. What are the key elements and options that banks should take into account when driving the necessary changes to their payments platforms?
Executive summary
Today, global trends including globalisation of the payment market as well as changing customer demands, new entrants, innovative technologies, regulatory pressure, higher costs, and lower profit margins are driving significant changes to the financial services market. The complexity of today’s world in a post-pandemic society with tense geopolitical dimensions has caused tightened regulations and increased compliance costs for financial institutions. The pressure to remain innovative is at an all-time high within this environment where real-time payments became the norm and global real-time payments are representing the new normal. In the wake of rapidly evolving customer expectations, new digital standards for financial services are now increasingly met by a wave of agile fintech companies that leverage technological advances to enhance customer experiences.
Navigating these uncharted waters, banks are challenged on their traditional value chain by two driving forces: first, the struggle for banks to retain customer relations through innovative front-end services in an environment where both challenger banks and tech giants are vying for the end-users’ attention; second, the demand for increased efficiency and scalability as a way of lowering costs of non-differentiating operations in the back-end. Dealing with these forces, banks need the following in a payments solution:
- flexibility to handle different payment types and adapt to future needs, such as global real-time payments
- modern open connectivity options for sending, receiving, and sharing data (through informed consent) with clients, suppliers, networks, and partners
- 24/7 capabilities as a global, connected world demands systems to be always available
- accelerated time-to-market for new products and services
- support of compliancy with current and future regulations
- scalability for large transaction volumes without a negative cost impact
- ability to extract valuable analytics from transactional data
- delivery of economies of scale through the bundling of transactions across several parties
However, expenditures for maintaining and upgrading existing IT infrastructure are limiting the resources banks can devote to innovation and investments in new digital technologies – driving the need for banks to pursue alternative options.
To thrive, banks need a clearly defined strategy that focuses either on front-end initiatives or back-end operations for leveraging scale and volume, as maintaining both at par and excelling in one is difficult to achieve on their own. In the first scenario, it would make sense for banks to lower back-end costs and leverage scale through sourcing of payments operations to a third party.
In the second scenario, it could make sense for them to become platform players at the back-end themselves and then work with fintechs on frontend innovation. For this second scenario to play out, these banks would need to attract transaction volumes from other banks or third parties to achieve sufficient cost benefits to be competitive.
In this white paper, we examine how a rapidly changing financial environment is urging banks to rethink their business strategies and back-end operations. We also present a string of key elements and options for banks to consider when driving the necessary change to their payments platforms.
Introduction
Following the rational approach to standardisation in the old economy, modern banks are facing a similar need to streamline their operations and free up resources to produce quality products that will help them stand out from their competition.
This need is driven by a series of correlated external trends in the financial markets, and indeed society – most of these are motivated by increasing customer expectations and technological advancements. It is further complicated by the internal challenges of conservative banking cultures and archaic legacy systems, which exhaust IT budgets and make it difficult for banks to accommodate modern client needs. In most cases, banks are relying on individual craftspersons who can cut, carve, and wedge the various components of the legacy systems to fit into others.
Against this backdrop, many banks are still trying to understand how to best adapt to a new digital era of banking. What strategy should they use to address the key challenges of the industry – and where should they begin the modernisation process? Is a new front-end what is needed, or should banks consider even more fundamental changes to their back-end operations?
The following chapters present the thought process and options for banks that aim for long-term success in a new financial reality.
Key market drivers to support payments platform transformation
“I can’t change the direction of the wind, but I can adjust my sails to always reach my destination.”
Jimmy Dean
In an effort to balance short-term growth with long-term strategic transformation, banks grapple with a multitude of challenges, including the following: complex regulations, margin pressures, increased competition, innovative technologies, and the demand for real-time payments and more efficient cross-border payments in multiple currencies based on real-time payments.
The following section describes the key market drivers that affect the financial services industry and banking in particular.
The demand for real-time payments and more efficient international payments
The steep rise in demand for real-time payments and more efficient international payments across sectors provides banks with an opportunity to pursue internal payments restructuring.
Real-Time payments
In many European countries, banking and banking services have a history of being “sector-driven,” with little or no differentiation on standard services like payments. As banks are beginning to realise the value of enhanced payment services like real-time payments as part of their “license to operate,” the inability of legacy systems to incorporate new real-time payment infrastructures is becoming a significant threat to their survival. Looking ahead, it is clear how the major trends of today are evolving into de facto standards of tomorrow globally.
More and more countries around the world have implemented real-time payment schemes, while others are planning to launch them in the near future. Also, regional cross-border real-time systems like the European real-time payment solution, SCT Inst, are expected to gain traction and help define the future of payments.
Moreover, the interconnection of these regional cross-border real-time systems will determine the future of payments on a global scale.
Global payments
Today, a growing number of individuals, businesses, and organisations depend on the ability to send and receive money across national borders. And they all expect the same efficiency, speed, and cost from international payments as received from their domestic payments schemes. However, seeing that no ubiquitous global payment scheme is currently available, most international payments are handled through an intricate web of correspondent banking networks involving multiple intermediaries. This makes them costly, slow and untransparent.
The next few years will continue to see the cross-border payments landscape transformed by a variety of advancing technology alternatives like distributed ledger technology and fintech service offerings. Increased competition as well as the increasing interest and involvement in the space will drive players to improve and innovate their products and services, while incremental service renewals, e.g. SWIFT gpi and ISO 20022 XML, and real-time payment services will continue to yield benefits on a global scale. This forces banks to maintain access to various payments networks.
The increasing interest from central banks could further change the landscape. Central banks have joined forces in providing leadership within global payments, as seen within market initiatives such as Bank for International Settlements (BIS) Innovation Hub, which supports interoperability on a global scale.
Interoperability in the cross-border arena has been attempted from big banks and local automated clearinghouses, for example with SCT Inst, however this has not achieved the global scale as needed within the market. National Central Banks are taking action to get global payments on course, supporting local automated clearinghouses to also have a role. This shows global payments as a priority for the central banks in addition to their critical role in providing an ecosystem for financial stability, and most importantly, international foreign trade.
The aforementioned BIS Innovation Hub has launched the Nexus initiative as a Proof of Concept for real-time payments to connect to automated clearinghouses globally within a payments platform. It is a clear signal of the future for realtime global payments.
The compliance burden
The growing volume and complexity of financial regulation places a great strain on banks’ compliance functions.
Looking across the globe, payment ecosystems look much different today than they did five years ago. The implementation of real-time payment systems in many markets has created new opportunities for payment system participants to deliver value-added services, such as request-to-pay, but it has also created new challenges, e.g. real-time fraud and Anti-Money Laundering risks. The ability to support innovation and facilitate interoperability while remaining compliant with regulation is crucial within the current payments landscape.
Frequent scheme changes and more stringent regulatory oversight have made compliance challenging and more costly. The rigidity of legacy technology limits a system operator’s ability to put in place the changes needed to jumpstart innovation while maintaining compliance.
The prolonged and costly migration of ISO 20022-based payment messaging in many markets is one compelling example. Payment systems should reassert their value by facilitating cross-border interoperability between other infrastructures.
The recent launch of the Immediate Cross-Border (IXB) initiative between the commercial real-time payment networks in the U.S. and Europe is one approach. Meanwhile, central bank digital currencies (CBDC) have the potential to become yet another disruptive event that will force national payment systems to reassess their role in the payments world. Payment system operators need to be ready to facilitate interoperability between global real-time payment, CBDC, and existing systems.
The advent of so-called emerging technologies, such as cloud computing, will help overcome IT issues, support critical business and realise market expectations like timeto- market or the aforementioned global real-time payments. Although such innovations create partial uncertainty and risk, it is the premium opportunity to embrace the ongoing evolution in the payments industry.
The pressure on margins
The strategic response by banks to the pressure on margins should be transparent fees and increased efficiency of payment processing to offer a viable product.
In the past, banks’ intuitive and logical response to margin pressures has been to steer the strategic focus away from low or zero profit margin products like payments and focus on more profitable banking products like lending and investments. Low revenue combined with increasing operational and compliance costs has led to payments getting gradually handed over to card schemes and payment processors to commercialise. For many years, these players have focused on increasing efficiency through scale and thereby driving down costs by increasing the transaction volume. This more infrastructural approach has not been seen by the banks as a direct threat to their core business. However, the threat is real, as some of these players are now starting to address the consumer market directly, which potentially puts them in competition with the banks – not for services delivered but for the consumers’ attention. It is a clear shift in the market that has also been driven by PSD2 within which non-banks are encouraged to invade the space traditionally occupied by banks.
The increase in competition
If banks focus on creating an open banking economy, they can better mitigate the threat of disintermediation from new fintech entrants, challenger banks, and tech giants outrunning them on innovation speed and time-to-market capabilities.
With the introduction of PSD2 in Europe, traditional banks are being pushed to open their data pools and accountbased payments capabilities to third-party providers. These companies are typically better at delivering innovative financial solutions at a faster pace due to their distinct advantage of being unburdened by complex legacy systems and processes. Challenged by conditions of high costs for customer acquisitions, tightened regulations, and the continual threat of becoming irrelevant to customers, banks must decide how best to accelerate innovation and time-tomarket capabilities, either through partnerships, acquisitions, or internal initiatives. Most banks choose a combination.
Moving from a more competitive perspective, both banks and fintechs are beginning to realise the benefits of collaboration – or co-innovation. To this end, the industry shows a synergetic effect where banks are leveraging the knowledge, technology, and resources of fintech companies to fasttrack new innovative products and engage high-demanding customers. Conversely, fintechs leverage the banks’ infrastructure, key capabilities, broad client base, and capital. Within this context, it is imperative that banks collaborate with fintechs with differential capabilities that will set them apart in a competitive industry.
The impact of innovative technologies
Huge advances in technology innovation are transforming the very core of financial services, challenging banks to reassess their front- and back-end platform architecture.
To improve efficiency, security standards, and reliability of operations while reducing costs significantly, banks are expected to explore disruptive technologies such as the following:
- Application Programming Interfaces (APIs) In the continuous quest to enhance customer experiences, open APIs provide banks and fintech companies with the opportunity to leverage complementary strengths and deliver customised services across the banking ecosystem.
- Cloudification Closely linked to the use of APIs, the cloudification and more specifically its public flavour help banks and other businesses to decrease significantly time-to-market and time to initiate new value-added services to their clients. Public cloud supports business to be anywhere and anytime.
- Machine learning and predictive analytics As more data becomes accessible through the APIs, sophisticated tools are needed to analyse and derive value from it. Machine-learning and predictive analytics are becoming key drivers for both customer-facing services, as well as fraud monitoring and analytics.
- Robotic Process Automation (RPA) With an increasing amount of data, analytics, services, and integrations, more advanced process handling is needed to reap the full benefits of the technology. Improved Straight Through Processing (STP) is also required in addition to automated responses, e.g. to fraud alerts.
- Distributed Ledger Technology (DLT) Blockchain technology and distributed ledger systems have demonstrated clear potential for the optimisation of processes and operations that involve decentralised networks, such as capital markets, trade finance, crossborder payments, and transaction banking.
- Central Bank Digital Currencies (CBDCs) With the rapid rise in circulation of stablecoins over the past few years, central banks have stepped up efforts to explore their own stable digital currencies, e.g. digital EUR. Although the impacts of the introduction of CBDCs can go far beyond the initial intentions, the main goals remain a greater access to central bank money for private citizens, reducing payments friction, and creating greater financial inclusion.
Back-end platforms as enablers of front-end innovation
“There is no way you can survive in a globalised internet economy with systems that are built for batch overnight updates – it is ridiculous”
Chris Skinner
In today’s changing payments landscape, banks are subject to many forces affecting their business. There is a fundamental shift in the understanding of the role of a bank from storing, moving, and lending money to a more service-driven entity that tailors for individual customers’ needs. This challenges the traditional value-chain of bank products. Two major forces impact different parts of the value chain: 1) the struggle for banks to retain customer relations through the front-end services where both challenger banks and the tech giants compete for the end-users’ attention and 2) in the back-end where the pressure for increased efficiency leads to demand for scalability and cost reductions.
Across these two factors is a constant pressure on banks to comply with the ever-increasing regulatory requirements presented at both ends of the value chain, as outlined in the previous chapter. And finally, banks are challenged by monolithic and inflexible legacy systems that impede their ability to:
- increase scale to reduce costs of operating core systems
- leverage the innovation of fintechs through (open) APIs
- deliver 24/7 domestic and cross-European (eventually global) real-time payment processing
- perform flexible payment process orchestration
- ensure faster time-to-market for new products
In addition, several interrelated large-scale movements are transforming payments and are forcing banks to reconsider their strategies and platforms. Some examples:
- mature domestic markets turning global and increasingly competitive
- continued growth in electronic transactions across channels and borders
- growing number of real-time payment systems going live
- commoditisation of payments that makes it difficult (and even irrelevant) for customers to tell banks apart
- further industrialisation of payment processing on a global scale
- substantial costs and capital expenditure allocated to nondifferentiating payment infrastructures
A core concern
Against this backdrop, banks are understandably concerned about the growth of their business in a future digital economy. These concerns point to one core issue: the challenge of outdated legacy systems. Decisions with regard to the update of legacy systems or order of new technology should be handled diligently. Technology strategy has lasting impact within the bank’s landscape.
Unlocking the legacy
Unlike data-driven fintech companies that have organised themselves around customer needs, the challenge for banks in Europe and North America is that legacy infrastructure ties data to product and process silos. This affects the banks’ ability to innovate at speed and perform necessary data analytics needed for both service development and product innovation.
As most banking services are transactional, the data generation is substantial and continuous. Yet few banks have tapped into the value that the transaction data holds.
The focus has been on core systems to serve missioncritical functions like deposits, accounting, lending, policy administration, and payments processing – which they do in a secure, reliable and resilient way – hence, banks are not looking to discontinue control over their core systems completely. To stay competitive and relevant, rather than ‘just compliant,’ banks need to find a way to ‘refresh and extend’ these backbone systems, in order for new digital platforms and technologies to connect to and utilise the immense value in transactional data they possess. Enabling
Payments platform transformation
“It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is most adaptable to change”
Charles Darwin
Digital payments – transactions that do not involve physical cash or cards – are on the rise and enjoy broad support from central banks around the world. The total transaction value of digital payments in Europe is still growing, and apart from new and exciting opportunities this growth rate also brings considerable risks to banks. If they fail to compete in the digital payments arena, they will surely lose shares to fintech companies. Although there is a clear focus on transforming the customer experience and front-end services to extend customer bases, banks should not forego the continuous dialogue with customers related to payments. Any reduction in dialogue around payments will result in less business conversation overall. Instead of banks going head-to-head with tech firms, there might be bigger opportunities to explore.
To combat this threat, banks need to abandon the ‘onesize- fits-all’ solutions and ‘business as usual’ approaches of the past, reassess their business strategy and value chain propositions, and redesign the payment experience to fit modern client demands.
As legacy systems appear to have reached their limit when it comes to delivering the flexibility and speed needed to keep up with business requirements, and banks assess their traditional front- and back-end platform architecture, they are faced with the question of what to do next. Should they adopt a ‘build-and-adapt’ approach, buy a ready-made solution ‘off-the-shelf,’ outsource the solution to an external party, or opt for a combination of the aforementioned options? Whatever approach they choose, in the end, banks must act to transform their core systems.
Considering the options
Updating the payments platform is a huge undertaking with considerable implications for the bank’s IT infrastructure, processes, human resources, costs structures and models, etc. This is why banks should always take the time to reflect on their current needs and future business requirements before making any definitive decision on the matter. For instance, to what extent are banks looking for a short-term fix (such as middleware software that can translate between existing systems and databases) or a long-term strategic solution that will be able to change with the market? And how are the added functionalities expected to support any technological, business, and strategic visions?
There are a number of different approaches with various pros and cons to consider.
1. Upgrading existing system
This option speaks to those banks that know what they have and like to stay in full control. The main benefits of this approach include the high degree of familiarity associated with working with the same vendor and that a bank does not need to make any upfront investment in the area of new software and solutions. With that said, bearing in mind the inherent issues of running and maintaining existing legacy systems, this approach might turn out to be costlier in the long run. Additionally, in the process of applying additional functionalities to old systems, it might be difficult to employ the right resources for the job. Developers with an expert understanding of the original system, e.g. Cobol, can be hard to find as many of them have retired and very few in the younger generation of IT developers have learned these (archaic) programming languages.
2. Building in-house
One advantage of a built-in solution is the possibility for a bank to remain in full control of every aspect of the development while ensuring the new system can be integrated with other adjacent in-house solutions However, building a custom payment processing system in-house is quite costly, and it does not remove any of the present or future maintenance, compliance, or improvement costs associated with keeping such a system running and competitive. Furthermore, the proliferation of services means that banks will have a hard time retaining enough people to cover all the skills needed to manage everything in-house. Finally, a single bank will not on its own be able to achieve scale-benefits compared to the volumes that shared solutions can generate.
3. Buying off-the-shelf
The benefits of buying a solution from a specialist third-party provider are considerable. It will provide the bank with a set of standardised, ready-to-use solutions and effectively reduce the time-to-market for new products and services. It also allows for shared Research and Development (R&D) and compliance costs with other clients of the solution. Offthe- shelf products, however, entail an upfront investment by means of license costs and will provide the bank little control over release cycles. While most suppliers do offer bespoke additions to the standard product, banks need to be conscientious about how much they want to adapt a standard system as the benefits mentioned above will not apply to those additions. This, in turn, can lead to increased cost and decreased flexibility. That said – as only few banks decide to replace everything at once, even a standardised system is likely to need bespoke integration to connect to the adjacent (legacy) systems with which it must interact.
4. Partnering to invent
Banks choose this approach if they feel that there is no appropriate solution available in the market. Partnering with a supplier can provide a bank with an agile and innovative best of breed system that includes scalable benefits. On the other side, partnership management is not a key competence for most banks, and scouting for the right partner can be a time-consuming process. In addition, any invented solution will need to be tried and tested thoroughly, which is also time-consuming.
5. Outsourcing to third party
Choosing outsourcing as an approach will help the bank to develop a more service-oriented banking IT infrastructure. It enables the bank to add new channels and services, phase out old core systems, and support their overall strategies. However, outsourcing comes with some of the same challenges as off-the-shelf products as it requires a certain degree of streamlining of current processes to fit those of the supplier (and other banks on the same platform). Without a structured assessment of current systems and processes, an outsourcing exercise could easily be limited to the idiomatic “your mess, for less” approach.
When properly utilised, outsourcing back-end systems can help a bank to streamline its business operations significantly. It can deliver a new degree of flexibility to the bank, where the bank is free to pick-and-choose new functions and services it wishes to integrate into the payments platform. In addition, transferring the payments processing functions – or part of them – to a specialised third-party provider will help to minimise the complexity, costs, and risks related to non-differentiating operations, as the provider will:
- handle the regulatory burden of staying compliant
- handle the HR burden of retaining payments experts
- make costs lower
- make operations more efficient
With most banks offering the same payments services today, outsourcing payments should also provide the bank with a degree of influence on the scope and the scale of the service. In other words, it should be flexible enough to accommodate the need for a bank to add additional functionalities targeted to a specific client base. Outsourcing back-office payments processing will enable banks to free up resources to focus on core competencies and differentiating activities like customer relationships, advisory services, client acquisition, and value-added services. This is the reason why more and more banks are considering outsourcing as a viable strategic solution to their challenges.
Outsourcing payments processing offers a compelling value proposition for banks as a means of:
- lowering TCO on non-differentiating back-end functionalities through economy of scale
- offering 24/7 end-to-end real-time processing of all payments
- managing many different types of transactional processes at high performance
- ensuring full compliance with current and future regulations and applicable payment schemes
- leveraging the provider’s investments in state-of-theart technologies and best of breed solutions
In addition to these key qualities, outsourcing helps to enhance efficiency through consolidating and centralising functions, share costs for compliance and R&D with other customers, and ensure connectivity with all clearing and settlement networks.
It should also be mentioned that every bank considering outsourcing as an option should begin by developing a business case to compare their current cost levels with cost levels on outsourcing. This way, banks will get a sense of the possible costsavings potential of the outsourcing option beforehand.
Selecting the right partner – and solution
Core banking functionalities are often referred to as the heart of a bank’s business as they sustain mission-critical operations. As a consequence, entrusting a core function as payment processing to a third-party provider can provoke strong feelings within a bank’s own ranks as well as a sense of losing control of the business. When facing these valid concerns, it is imperative for a bank to understand that outsourcing payments is by no means an ‘all or nothing’ procedure. Third-party providers typically present the bank with a vast selection of operating models to choose from, including ASP Application Service Provider (ASP) solutions and full Business Process Outsourcing (BPO) offerings, which ultimately enable the bank to stay in control by striking a balance between ‘do it yourself’ and outsourcing. This process is built on firm service level agreements and concludes with customised tools and services that match the bank’s specific business needs.
In this context, it is paramount for a bank to partner with a provider they trust - a provider with experience, expertise, integrity, and a long-term commitment to the payments industry. It is also important to take notice that payment processing outsourcing is often provided as modular solutions, meaning a bank can choose to be just compliant or it can commit to a holistic end-to-end solutions portfolio. Or anything in-between. A strong partner can increase efficiency in compliance, lower costs and improve operational excellence through consolidation and, ultimately, enable differentiation through standardised interfaces to thirdparties and value-added APIs for in-house product and service development.
Look before you leap
If banks want to remain relevant in the modern digital era, they need to change and develop along with the times - but change for the sake of change is never the right strategy. Before embarking on any transformative journey, banks should always ask themselves the following question: Are payments a strategic product for the bank? If the answer is yes, the next question should be: how do we support this strategy best? The bank should assess if it wants to continue investing in payments internally, or if it should treat payments processing as a commodity and make use of the competencies and infrastructures of a specialised third-party provider – thus getting payment processing as a service.
Conclusion
In an attempt to keep up with the competition in a fast-paced digital financial environment, banks are exploring ways to streamline non-differentiating back-end processes and transfer valuable resources to differentiating front-end developments. However, the attempt is often complicated by expenditures and resources allocated for maintaining monolithic legacy systems which, in effect, is limiting the banks’ ability to pursue innovation and investments in new digital technologies.
As a direct consequence of these circumstances, banks have started to reassess their business strategies and payment models to determine where to cut costs, reduce risks, and improve customer value.
For this purpose, banks are increasingly turning to experienced third-party providers, which are qualified in opening up existing functionalities and data in a controlled and modern manner, delivering fully integrated coverage of the banks’ payment value chain, and who offer a modular step-by-step-approach to payment processing that helps banks of all sizes to address their specific needs.
It is imperative for a bank to understand that outsourcing payments is by no means an ‘all or nothing’ procedure. It is all about seeking an optimal balance between ‘do it yourself’ and outsourcing.
By partnering with a specialised payment service provider, banks ensure they have a stable, scalable, and flexible payment environment with multi-channel coverage that is fully compliant and capable of accommodating modern payment requirements like real-time payments and fast time-to-market capabilities. In doing this, banks will be able to lower their TCO on non-differentiating back-end functions like payment processing and free up resources to focus on core business strategies and differentiating activities that help them compete in the new, digitised financial era.
Would you like to learn more?
Simply fill in a few details and our experts will get in touch.
