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COVID-19 accelerates digital agenda     |     Acquisitions and partnerships will be key     |     Rise of central bank digital currencies     |     Data and software at the heart of the digital economy

 

Technology is changing how we live. One of the most visible effects of this is a revolution in how we pay for goods and services and transact with each other financially. From cash and checks it has rapidly transitioned into real-time transfers, contactless payments and app-based banking.

This transformation is now set to quicken at an accelerating rate, with the changes we have seen so far likely to pale into insignificance compared to what is to come. It may only be the matter of a years before some societies, or portions of societies, are virtually cashless and perhaps routinely transacting in digital currencies of one form or another.

These shifts raise significant questions for today’s established banks. Where will they play, what roles will they take in a digital payment ecosystem as demand for branch services and cash-dispensing ATMs falls?

COVID-19 accelerates the digital agenda

Without doubt, the COVID-19 pandemic that shook the world will prove to be an additional accelerator. During the outbreak, cash usage steeply declined as did use of ATMs. Correspondingly, there was a huge spike in online and mobile banking. Ecommerce and cashless PoS transactions accounted for around 60% of total transactions in countries such as the UK and Germany, up from 20-30% pre-COVID-19 according to discussions with local financial institutions. New online banking registrations rose sharply, for example in the US.

But mass digital adoption is not a foregone conclusion: banks and payment companies will need to ensure that consumers’ experience remains seamless and easy if new converts are to retain digital as their primary channel.

The payments arena is one of the busiest areas of change and innovation. As tech giants steadily grow their payment services, and new fintechs emerge offering mobile e-wallets or flexible ‘buy now pay later’ options that have seen increased take-up recently in some geographies, traditional financial institutions risk seeing their market shares being eroded around them and losing the primacy they hold in the customer relationship.

Banks need to respond. Significant investment needs to be driven into their own digital offerings and into developing API strategies that link their banking platforms to payment services, data providers, ecommerce platforms and other services.

Acquisitions and partnerships will be key

But it is by no means just a question of developing their own services. For many organizations who need to accelerate their digital agendas in a quick time frame, a key aspect will be to make acquisitions of high potential technology payment companies and to forge partnerships and joint ventures. Figures from Pitchbook show that the payments market is already booming in the context of COVID-19, with some 420 deals announced since March, worth a total of around £12bn.

In the wake of the pandemic, this is set to grow even faster. Banks have woken up to the fact that creating digital payment products and services is not just a nice to have, but a must have. While they have developed some strong digital offerings of their own, generally traditional banks’ systems are not sufficiently ‘straight through’, and speed to market is not where they would like it. Making the right collaborative partnerships could be a key determinant of success.

In addition, banks are also likely to need to make more alliances with some of the network giants such as Visa, Mastercard and Worldpay. Through significant acquisitions of their own, these businesses are already curating a set of fintech, data and payments capabilities that banks can leverage to quickly access new capabilities, without the significant integration complexity and costs.

Another growth area is likely to be the provision of merchant and payment services to small businesses. Many banks have focused on providing services to large corporates, but as more small businesses embrace digital services and PoS systems, there is an opportunity to supply them with treasury management and liquidity services and become real business partners in supporting their growth and development. The key to success here will be ensuring the banks can deliver simple, easy to use, digitized solutions.

Rise of central bank digital currencies

More transformatively – and probably only a few years off – central bank digital currencies (CBDCs) have started to actively move onto the agenda. By making digital currencies ‘official’, they could change the face of how money operates. China and Sweden are perhaps at the forefront of this, but the French central bank has also begun a proposal process to develop a coin while the Bank of England recently published an extensive white paper on the subject. There is a regulatory desire to match or get ahead of the development of Facebook’s Libra digital currency – a race could be developing. It may only be a matter of a few years before we see a major CBDC launched, with the smart money (or crypto money) likely to be on China. Being essentially a piece of code, a CBDC will be like programmable money with many use cases and services possible beyond being simply a digital replication of physical cash. Being centrally created and backed by governments, they have the potential to support and enhance financial stability. In China, a CBDC could be a significant step towards eradicating the black economy.

CBDCs could also be important for the unbanked, giving them access to payment services, and enabling people to cheaply transfer or ‘send money home’ to developing economies, where presently cross-border payments carry high remittance fees. Central banks could ‘programme’ money in foreign aid programs such that it is only usable for the aid or other agreed purposes for which it has been remitted.

Add to this major regional drives like the European Payments Initiative (EPI) which is designed to create an innovative and integrated payments system across the EU, and projects such as X-Pay in Germany to harmonize digital payment offerings there, and it is clear that there are huge developments ahead.

Data and software at the heart of the digital economy

The other significant trend to emerge is the development of new digital services using data as the service. Increasingly, transaction data is being connected with other information to support new digital service development and capitalizing on open banking – this is the thesis behind some of the largest payments deals announced recently by card providers, cloud services and e-commerce platforms.

Software is traversing traditional sector or retail/ wholesale payments divides and importantly connecting “real economy” use cases with financial services. These are the new business models owned by Go-Jek, Klarna, PayPal and many others. Banks will need to compete through their data assets, which will likely result in material acquisitions of data capabilities in order for them to retain relevance in the digital economy. Skills, mind-set and culture will be as much a driver for M&A as will the ability to novate legacy technology and organizational debt with scale as opposed to incremental change from within which remain outpaced by the market.

Skills, mind-set and culture will be as much a driver for M&A as will the ability to innovate legacy technology and organizational debt with scale, as opposed to incremental change from within which remain outpaced by the market.

Through all of this, every bank needs to act decisively to find its own niche. In a low interest rate environment offering thin margins, they need to find ways of maintaining profitability from payment services at the same time as preventing themselves being disintermediated by new agile service providers. Operational resilience and strong cyber security will be key, as will operating efficiency, with increasing amounts of non-core services likely to be outsourced.

Money is transforming itself – banks must do the same.

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Country Insights

Explore how these trends are unfolding in in your country using the interactive map below.

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— Sweden — Denmark Spain — Columbia — Canada (English) — — Canada (French) UK — China — Australia — — Germany US —