While payment preferences may change, payment types are rarely completely replaced. Payment types have proliferated exponentially in recent years, driven by a rise in mobile and contactless capabilities and a demand for convenience. Finding themselves challenged to support ongoing changes to existing payment methods and rapidly adopt new ones without sacrificing efficiency, financial institutions have increasingly looked to a payments convergence strategy as the answer.
Payments convergence has often been framed as a rapid transition away from card toward non-card payments, with cards themselves to be phased out. The reality is that both payment categories are likely to coexist for some time, with additional payment methods emerging from both categories. Therefore, financial institutions need to seriously consider implementing an architecture that allows both card and non-card payments to operate alongside each other while providing a holistic customer view and delivering a consistent experience.
Driving payments convergence
Payments have traditionally divided between those that are card-based and those that are non-card-based, with clearly defined use cases for both. Card payments were designed for a customer to pay for goods at a physical point of sale (POS). Non-card payments covered use cases related to the movement of money between bank accounts, with different schemes emerging to support real-time, high-value and cross-border transactions.
Innovation in the card space has been focused on the initiation of the payment, with tokenized digital wallets, contactless cards and integrated POS systems, as well as security mechanisms, such as EMV® and 3D secure, to reduce fraud. In the non-card space, there has been a proliferation in the range of underlying payment types, including the rapid adoption of credit transfer push instant payments, inter-bank settlement models, and the overlay services that these modern, ISO 20022- based instant schemes have at their center.
The proliferation of payment methods has been driven by a combination of factors. One factor is regulation, such as PSD2 and the European Processor Initiative, implemented with the intention to drive innovation and competition in the payments space. Technology has also played a part, with mobile devices and new POS technology driving innovation and expansion in payment initiation.
At the same time, consumer behavior has been changing, partly due to willingness to adopt new types of payment technology, and also due to changing perspectives on the use of traditional products such as credit cards. The historical clear divide between the use cases for card and non-card has broken down, and non-card payment types are increasingly arriving at the physical POS.
This development has increased the pressure for convergence at the back-end to facilitate processing and data management. Financial institutions want to provide a consistent customer experience, regardless of payment method. This requires creating a holistic view of customers’ data. Adjacent services, such as fraud prevention, also need to be consistent and connected across the customer’s payment channels if they are to be truly effective. Convergence is not just about the payment rails used, it is about the complete customer experience - which includes recourse and the charges made - for consumers, merchants and businesses.
The infrastructure implications
A further driver for convergence of payment processing is the need to optimize technology spend. The alternative of mirroring every new payment initiation method with a new dedicated set of payment processing rails is clearly impractical - in terms of initial spend, ongoing maintenance and operational support.
While card payments have required 24/7/365 support, the same has not always been true of non-card payments. Until recently, only high value Real-Time Gross Settlement (RTGS) systems needed this level of resiliency, and then only for defined business days. This has now changed. The adoption of instant payment schemes requires the processing of non-card payments in a 24/7/365 environment. This has required core banking systems to evolve to ensure that they can deliver funding decisions and provide availability of funds at the same speed the payment is processed, with the same availability.
Continuing to modify existing core banking systems is both costly and risky, as many existing systems were built with a very specific set of needs in mind and were not designed to be frequently reconfigured.
In response, many financial institutions are opting for a ‘shrink and surround’ or ‘hollowing out the core’ approach, which consists of putting core banking systems into cotton-wool and building new functionality around them. This means that the core banking system is maintained as a ledger, allowing it to be upgraded and operated in the new environment without having to replicate the entire existing functionality previously associated with core banking.
Strategic flexibility for the future
Many institutions have put in place the process of copying (‘streaming’) data into a high performing copy database, known as a cache, to service digital channels. This approach also can be adopted for payments.
This caching methodology offers an important benefit - it does not require the external payment application be built or maintained by the financial institution. The segregation of the core banking system from payments makes it relatively straightforward to use a third-party software as a service (SaaS) provider to deliver necessary payment functionality seamlessly across both card and non card payments for some, or all, customer segments.
This approach requires an architectural separation of payment initiation, processing and fulfilment, with adjacent capabilities, such as risk, fraud, limit management and alerting, moving from channel-specific to enterprise-level capabilities. Alongside this, there needs to be a decoupling of payments from the core banking (or any account of record) system. While it may make sense for some banks to create this functionality themselves, there are advantages to outsourcing it, both now and in the future.
One of these advantages is the reduction of operational risk. A qualified payment technology provider will implement new payment types and the associated consolidated processing infrastructure on behalf of multiple financial institutions. It will therefore have ample experience of any potential issues and how to resolve them, plus all the necessary multi-level redundant and resilient infrastructure.
Furthermore, this approach also offers considerable economies of scale, particularly in situations where a new payment initiation method may become popular in a local context but not globally. An individual bank attempting to support this method may find the relatively low transaction volumes do not justify the capital expenditure. By contrast, the pay-per-transaction model of a global SaaS payments provider avoids this issue of poor return on investment, as the spend is amortized across a much larger number of transactions from multiple bank clients.
While this option confers a measure of future proofing for new payment types, it also enhances preparedness for other payment-related innovations. Payment technology providers are looking at payments holistically from payment acceptance through to transaction financing. Being able to access payment-related innovations through a managed service delivers a strong competitive edge through a combination of lower costs and risks to any individual institution, as well as faster time to market.
Embracing the future of payments
Recognizing the payoff of payments convergence will require routing new payment types from channel specific gateways into a consistent, holistic transaction processing and data management environment. Financial institutions will have to consider how best support new payment methods in the most effective way – whether that is building capabilities in-house or leveraging partnerships – whist providing a consistent customer experience.
Pete Tobin, Vice President of Product Solutions, Fiserv