Banks that are large enough to develop new technologies themselves face two problems: (1) trying to determine exactly which technology or technologies to invest in; and (2) adoption and ubiquity: a technology platform is useful only to the degree that it is widely adopted.
Correspondent banking has been the means and model for international payments for more than thirty years, and for good reason: it is based on what are typically long-standing relationships among global banks that ensure a high degree of safety, trust and client service. Supporting primarily cross-border wires, this fundamental structure has persisted, incorporating over time such improvements in payment execution as changing technologies have provided. But these have been incremental, not transformative improvements.
There was some acceleration in the rate of change in response to regulatory demands in the wake of the 2008 recession, and these created some upheaval in the payments business: complying with new regulations was often costly, thinning profit margins enough that many banks were forced to consider whether the payments business was sustainable within their business models. But overall, the new regulatory environment improved the safety and transparency of the existing model and its continued viability was never in question.
Given this history, it is remarkable how quickly new technologies and technology providers have challenged, and in some cases disrupted, the correspondent banking system, offering new means of effecting payments that challenge older modes of business and compel banks to begin transforming themselves and the means by which they do business. This is so much the case that today scarcely anyone doubts that the future of payments will be very different from the current and historical model. What is less clear is what form this will take and whether it will be an unadulterated good thing.1
The residual bad feeling toward banks in the aftermath of the recession has for many given rise to the idea that alternatives to banks – perceived as too big, too profit driven, too indifferent to client needs, too resistant to change – can’t come soon enough. This point of view is held notably among younger consumers, many of whom don’t share the feelings of trust and safety with which their parents associate banks and are very unlikely ever to develop the loyalty and relationship stickiness that their parents did. This makes increasingly unrealistic the initial response of some banks that new technologies would have difficulty gaining traction on a large-scale basis, lacking the established global rails and networks that banks maintain. Banks’ scale, experience and proven record of safety are formidable challenges for new and disrupting technologies; but the idea that banks could, for the most part, ignore the challenges these technologies present was clearly not realistic.
Can banks instead make significant enough improvements to existing methods and technologies to stay abreast of and competitive with what the new technologies offer? The answer, at least in the short term, is yes. Venmo, Transferwise, and Paypal are examples of how consumer experience can be improved by applying new approaches to existing payment rails and banks can do likewise. But are there limits – of speed, simplicity, accessibility – that ultimately will render the banks uncompetitive unless they develop, adopt and incorporate new technologies themselves? And, if that is the case, how many banks can afford the investment while simultaneously trying to maintain and improve the status quo?
Those banks that are large enough to develop new technologies face two problems: (1) trying to determine exactly which technology or technologies to invest in and (2) the issue of adoption and ubiquity: a technology platform is useful only to the degree that it is widely adopted. This lack of network effect has hindered the development of newer payment platforms as early adopters rely on market acceptance to achieve true benefits while others wait on the sideline to see when and if the network and the volume truly ramp up.
It is likely that banks will never be entirely free of such issues and compromises, particularly in competition with nimbler, smaller, less regulated non-bank providers, so they will need instead to maximize their advantages – size, reach, experience, global presence.
Despite the high degree of speculation and uncertainty concerning the future of the payments business, there are a number of changes to the payments business that are not speculative. These include:
PSD2 (Europe) and the Open Banking Standard (UK), in order to force collaboration opportunities between banks and third-party providers, mandated that, beginning in 2018, banks are required to share – with client approval, via APIs – access to client accounts and account information with third parties, mainly fintech providers. Providers will be allowed to access and extract client information – balances, history, transaction data – and will be allowed to initiate and make online payments, drawing directly from a client’s account, without bank intermediation.
The ways this access can be put to use are myriad. The ability, say, of a third-party provider to compare offerings from numerous banks and provide them to clients: examples might include car loans, mortgages, business loans, savings account returns, checking account charges. For businesses or banks themselves, a client’s creditworthiness can be readily and directly ascertained, without the intermediation of a ratings company. Third-party providers might serve as financial advisers to both corporates and individuals, with the ability to manipulate and analyze massive amounts of data virtually and provide investment information in real time. They will be able to advise that monthly bills are coming due, pay those bills, oversee spending and provide budget advice. Competition will drive ideas and shape the market, all to the consumers’ benefit.
Distributed Ledger Technology (DLT) has the potential to greatly improve banking, supply chain, and other transaction networks. It is a shared, decentralized, distributed database architecture that can keep track of ledger accounts and balances. It eliminates the need for central or intermediary authority to process, validate, or authenticate transactions and will bring, I believe, positive disruption to multiple sectors within financial services, across many asset classes.
Real-Time Payments launched in the US in November of 2017, allowing participating US banks to settle payments in real time twenty-four hours a day, seven days a week. Ubiquity, – all or nearly all US banks being on the system – is projected to occur by the end of 2020, when the full scope of the system’s transformative power will arrive. Beyond that lies the potential to engage with real-time systems in other countries and to settle payments cross-border in real time, which could be a reality before 2030.
Providers such as Zelle® are working with banks to create databases of customers that will allow banks’ clients to process payments using minimal numbers of identifiers, making a payment to an email address or phone number, for example, rather than necessitating knowledge of a beneficiary’s bank account number or even the name of his or her bank.
Will traditional correspondent banking cease to be? Perhaps, but not tomorrow. What we know today is that greater transparency and new competition have been reducing margins, and clients are demanding better solutions. The responsibilities involved in offering payments –compliance, cyber security, risk management – have never been greater, and the models that bring the most significant change and benefits (reduced cost, increased speed, transparency) are not traditional, so there are major hurdles to address before we can deploy completely new operating and execution models for cross-border payments. But institutions leaning toward total transformation, and particularly those keeping sight of customer satisfaction, are likely to prevail.
Incremental change will continue to be the order of the day, but the pace of change will likely accelerate as pressure ratchets up on banks to retain and grow their client bases. But the question, finally, remains open as to what success will look like in a still-undefined future payments world.
1 It is already clear that the rise of new technologies is not wholly positive. Digitization has opened payment flows to increasingly sophisticated means of criminality: identity theft, money laundering and fraud. Millions of dollars can disappear in seconds via cybercrime and one opportunity for banks vis-à-vis third-party providers in that regard is that the long-established relationships that form the backbone of the global correspondent bank network can likely achieve a higher degree of risk management than can a more loosely defined amalgam of non-banks. But we are all going to be dealing with this sort of crime for some time to come.
The views expressed herein are those of the authors only and may not reflect the views of BNY Mellon. This does not constitute Treasury Services advice, or any other business or legal advice, and it should not be relied upon as such.
©2018 The Bank of New York Mellon Corporation.
Managing Director and Head of Global Payments, BNY Mellon Treasury Services
Michael Bellacosa is a Managing Director at BNY Mellon and Head of the Bank's Global Payments Product Management group. In his current role, Mike is responsible for managing strategy, financial performance, product development, and industry issues for U.S. dollar, EUR, and GBP direct clearing services, multi-currency wire transfer, correspondent banking, U.S. and international ACH, and Network Management.View Profile