Whether or not payment services are critical revenue and profit drivers for banks is no longer a debate in the industry. Strangely enough, most banks still lack a comprehensive payment strategy.
At a time when dramatic changes and challenges are hitting the payment space, banks should empower a senior executive with enough clout to execute an enterprise-wide payment strategy.
The number of issues faced by banks in transaction processing and payments is comparable to the complex challenges faced by banks on the manufacturing and distribution side of their organizations. Left and right, banks' payment-driven economics are threatened.
Among the questions banks are facing are:
* As check volume declines, what steps banks should take to avoid rising unit costs? Check electronification is all the rage, but how shall banks manage the various options available, from ACH conversion to ECP and check imaging?
* As the Fed is divesting from recycling cash activity, should banks call in new partners to share the burden? Online bill payment is booming, but pricey arrangements with processors are putting a strain on banks' bottom lines.
* Should banks do more processing in-house? As fraud hits debit cards, should banks encourage customers to enter a PIN instead of signing, and thus lose the associated interchange revenues?
* An increasing number of exotic ACH transactions (from lockbox converted items to Internet-initiated items) are popping up, opening the gate to new fraud schemes. Should banks lobby the NACHA to shut down the new ACH items? Or outsource ACH processing? Or invest in enterprise-wide fraud management solutions?
The list seems endless.
The declining volume of consumer checks--and its impact on banks' revenues--is a very good example of the economic pressures banks are facing today. It clearly points to the need for payment czars.
Historically, banks have been well entrenched in the consumer check payment value chain. Total annual fee revenues generated by the consumer check payment value chain are US$6.7 billion (excluding clearing, mailing, and transport services). Banks capture US$4.9 billion or 73 precent of this amount, while non-banks capture US$1.8 billion or 27 percent of it. Banks' revenues come from fees charged to merchants, billers, and consumers. The four major fee revenue sources are: fees charged to merchants for depositing checks, lockbox fees charged to billers for collecting payment by checks, checkbook sales, and, last but not least, non-sufficient funds (NSF) fees.
NSF fees are the largest component of banks' revenue stream, accounting for 65 percent of banks' consumer check revenues. Deposit charges, checkbook sales, and lockbox fees account for the remaining 35 percent. Interestingly, across the entire consumer check value chain, NSF fees drive the highest margins. NSF fees offer a 90 percent gross profit margin, far above the margins of the check printing industry (19 percent), of check distribution (25 percent), of retail lockbox services (15 percent), and of check verification services at the point of sale (19 percent).
The problem for banks is that NSF tends to be so check-driven that, the more consumers use electronic payments, the fewer NSF revenues banks are likely to generate. This phenomenon is particularly obvious with point-of-sale (POS) payments.
At the point of sale, checks increasingly compete with PIN-debit transactions, which interrupt transactions when funds are not available in the bank account. Although banks often permit overdrafts with signature-based debit, overdrafts are unlikely with a PIN-debit transaction. Despite various steps taken by some large Visa/MasterCard issuers to encourage signature transactions and discourage PIN-debit, various forces--including the settlement of the class-action suit Wal-Mart vs. Visa & MasterCard, consumers' convenience, and fraud--support the use of PIN-debit. By 2004, PIN-debit volume should outpace the volume of signature-based transactions for the first time. As a result, PIN-debit is more likely than signature-debit to cannibalize revenues from check payments. Of the total number of checks and PIN transactions, checks' market share will fall from 57 percent in 2002 to 26 percent by 2007. PIN market share will skyrocket, however, from 43 percent in 2002 to 74 percent in 2007. As a result of the move from checks to PIN-debit, banks will miss out on US$212 million in revenues by 2007, up from US$56 million in 2002.
The downward pressure on banks' revenues is not driven by the intrinsic nature of e-payments. Neither is it driven by the presence or activities of non-banks. As a matter of fact, credit cards have been incredible revenue and profit drivers for both banks and third-party players in the past decades. The problem today is the relationship between checks, NSF fees, and banks' revenues and profits. Banks make significant money from NSF fees. And some e-payment alternatives, such as PIN-debit, are cutting into NSF events. To confront such a challenge as well as a multitude of others tied to the evolution of the payment space, retail banks should appoint payments czars with profit-and-loss responsibility, and charge them with the task of developing and executing a enterprise-wide payment strategy.
Gwenn Bezard is a senior analyst in the banking group at Celent Communications, a financial services research and advisory company headquartered in Boston, Mass.