A penny here, a penny there
If you have money—and even if you don’t—you can now pay for your purchases in myriad ways
FINANCE, THE ADAGE goes, is the art of passing money from hand to hand until it finally disappears. This will ring true to anyone who has tried to send cash overseas and found their remittance whittled away by commissions and lousy exchange rates. Shopkeepers typically pay around 3% on sales made by credit card. Banks are involved in over $400 trillion of transfers every year and extract over $1 trillion in revenues from them, according to the Boston Consulting Group. As consumers in both rich and poor countries eschew cash in favour of paying with plastic or, increasingly, online and on their mobiles, that figure could reach over $2 trillion by 2023. But the banks no longer have the field to themselves.
Few consumers give much thought to what happens after they present their credit card at their local coffee shop, unaware of a tangled web of ever-shifting alliances and rivalries below the surface. Banks dominate an ecosystem which includes technology providers and payments networks—mainly Visa and MasterCard, which were themselves owned by a consortium of banks until a few years ago. The payments chain can contain up to seven links, every one of which will claim a tiny cut of each transaction. Most of the money ultimately goes to banks. Beyond collecting commissions on purchases, they profit because card users often pay with money they do not have, running up credit-card debts or overdrafts on which the banks charge steep interest.
Any change to this system would seem to threaten an extremely lucrative business at the core of the modern banking system. In practice the effect is more mixed. If the newcomers are increasing the size of the overall payments pie, they are actually doing the incumbents a favour. On the other hand they may be cutting the banks’ margins by forcing them to share the fees. And some may collect consumer data that banks want to hold on to.
One contestant might do all three of the above: Apple Pay, launched in October in America and expected to be rolled out globally this year. Paying with the tap of an iPhone or Apple Watch feels new to consumers, but it amounts to recreating a plastic card on a mobile phone. The tech giant is not trying to bypass the vital Visa and MasterCard “rails”, in the industry’s parlance—the heart of the system that banks know and profit from.
Less happily for the banks, Apple is taking a 0.15% cut of all payments made through its system. Banks fret that this “Apple tax” will rise once consumers have got used to paying with their iPhones, but hope that the increased use of their cards—probably at the expense of cash—will ultimately leave them no worse off. And in America they were lured by promises that Apple would neither capture nor use the data it acquired from purchases. However, that pledge might not apply in other markets.
A walletful of data
Google and Samsung are already setting up rivals to Apple Pay. Bankers suspect that their main motive is to get hold of the data, which would give them even more detailed insight into their customers’ lives. Any model that introduces an extra layer between consumers and their bank accounts—for example, by getting them to put money into an online “wallet” and spend it from there—makes the banks uncomfortable. If the wallets are filled in ways that bypass credit cards, the banks lose out both on fees and on access to consumer data.
Facebook is another tech giant barging into fintech by letting its users in America message each other money. Peer-to-peer money transfer in that country has boomed in recent years. Venmo, ultimately part of PayPal, a purveyor of the sort of online wallets banks dread, is widely used by American youngsters for sending each other small amounts of cash. By turning money transfer into yet another mode of teenage interaction (users speak of “venmoing” a few dollars to each other), it has grown from transferring $59m a quarter in 2012 to about $1.3 billion now (see chart). Moving money through a bank can take several days and attract a $25 fee. Venmo’s app is free and instantaneous. The company’s tag, “it’s like your phone and your wallet had a beautiful baby”, does not even mention banks.
In other areas, innovation has if anything played into the banks’ hands. Credit- and debit-card usage—and therefore banks’ profits—have benefited from new technology that has made it possible for just about anyone to accept plastic. Square, founded in 2009 by a former Twitter boss, led the way in America with a nifty gadget plugged into any smartphone that enables food trucks, market sellers and other transient merchants to accept cards in the same way as any shop. Copycats are rolling out similar technology in Europe.
The next frontier is online payments, particularly the mobile sort. What used to be a nuisance—pecking in a 16-digit credit-card number on a smartphone—is becoming ever more streamlined. Braintree (which acquired Venmo before itself being gobbled up by PayPal in 2013) and Stripe are among those doing for online merchants what Square did for food trucks: making it vastly easier for people to hand over money. Their pitch is that the less hassle consumers have to endure, the more likely they are to buy stuff online, justifying a small cut of the credit-card fee.
For merchants, payment systems that are easy to install on a website and help boost their all-important “conversion rate” from browser to buyer are worth shelling out for, says Scott Loftesness of Glenbrook, a payments consultancy. Apart from shopping on mobiles, users are already paying for plenty of real-world services online, too. Braintree processes money for Uber, the taxi app that is so convenient partly because customers do not have to hand over any cash: at the end of the journey a stored credit card is automatically debited.
Soon enough, consumers should be able to walk out of a clothes shop, say, and have their accounts automatically debited with their purchases (sensors, smartphones and cheap RFID tags on the labels will do all the work for them). That will not disrupt payments incumbents as such, but there is a risk that people will bypass credit cards in making these payments, thus cutting off the banks’ lucrative commissions.
How payments evolve, and what role fintech will play in that, will depend largely on local circumstances. Every country has its own payments system, based on traditions and consumer preferences. Cheques are now a rare sight in Scandinavia, say, but they are still widespread in France, Canada and America (where, in a nod to innovation, banks encourage customers to cash them by taking pictures of them with their smartphones). In China, digital payments are ubiquitous and banks make much lower commissions.
Regulators can and do upend entire payments systems at will. Britain in 2008 forced banks to allow customers to transfer money instantly. The banks complained about the costs, but the change removed an opportunity for Venmo-like insurgents. American regulators are also planning to speed up bank payments, having already put pressure on the banks to reduce their credit- and debit-card fees. Come October, retailers in America will in effect stop processing fraud-prone cards with a magnetic strip (which are swiped at the till) and switch to safer ones with chips (which require a PIN number). That will require 16m terminals to be upgraded, says Osama Bedier of Poynt, a maker of snazzy payment terminals that is hoping to gatecrash the market.
All this adds up to a mix of opportunities and threats for banks. On one hand, startups like Square and Stripe are helping them find new merchants to use their cards, so generating more fees. On the other, those interlopers are getting a cut of the action—though not always enough to be sustainably profitable, critics suggest—and consumers may in time bypass the debit- and credit-card system that is so lucrative for banks. Millennials are already eschewing credit cards altogether.
Some payments groups are now starting to intrude on banks’ traditional preserve of lending. Square is offering cash advances to merchants who use its payments systems; others are extending credit to buyers. PayPal Credit, once known as Bill Me Later, allows buyers to defer payments on purchases; Amazon now offers a similar instalment scheme to customers buying larger items. Klarna, a Swedish startup, and Affirm, an American one, offer merchants immediate payment even as customers are given several months’ grace. Yet the gradual shift from cash to mobile and plastic payments still leaves the banks sitting reasonably comfortably, even if they resent impositions such as the 0.15% fee they have to stump up to get the Apple Pay business. The fintech insurgents work with banks as much as against them.
But what if someone were to come up with an entirely new way of transferring money that no one has thought of before? Many think that such a system is now within reach.