The wholesale payments and cash management (PCM) business provides corporate and institutional clients with solutions that facilitate payments to suppliers, collect funds from customers, and optimize their global cash and liquidity positions.
Banks earn fees from payment processing and account management services, as well as interest income from deposits and operational account balances. The business is an important source of stable funding for banks. And it is an anchor relationship product, providing opportunities to cross-sell other products, such as foreign exchange and trade finance.
Fee margins have compressed in recent years due to increased competition and banks cross-subsidizing low fee income with interest income or ancillary business, and we expect this trend to continue.
PCM REVENUE POOLS AND OUTLOOK
Wholesale Payments: The $250 Billion Battleground That Needs Defending
Wholesale PCM has long been a stable and comfortable business. The high cost of building and maintaining payments platforms, coupled with high switching costs for clients, have created strong competitive advantages for incumbents. Disruptive winds that have been buffeting retail banking and consumer payments have been lighter in wholesale PCM.
But things are changing. Technological advances are reducing the cost of market entry and the cost of switching, as are regulations that require banks to make client data available to competitors.
The stakes are high. In 2017, wholesale PCM generated $250 billion of revenue and, unlike other areas of wholesale banking, they are growing fast. Revenues grew more than 10 percent in the first half of 2018 and we forecast growth of 5 percent per annum over the next five years, as growing volumes and rising interest rates more than offset margin compression.
With relatively low capital charges, returns on equity can be as high as 20-40 percent, making an important contribution to the overall economics of wholesale banking. It is also an anchor product in the corporate relationship, helping drive cross-sell of other products, such as foreign exchange.
To do so, they will need to take adopt a challenger mindset – developing immersive solutions that delight customers, building next generation technology from the ground up, and shaping the emerging industry structure. The path ahead is uncertain. But that is no cause for inaction.
The scale and pace of change that new entrants will bring to the industry is uncertain. Incumbents still have advantages. The depth of systems integration between a large corporation and its payments supplier mean that switching supplier remains costly and time-consuming. And the ability to package payments with other services is also potential source of advantage for the incumbents. Nevertheless, given what is at stake, and given the disruption caused elsewhere by tech players, incumbents will need to lift their game.
Start With The Customer
Technology firms have disrupted traditional businesses at a terrifying pace. Underpinning their success is a simple principle: start with the customer. Rather than designing products or features, they begin by understanding customer needs, pain-points, aspirations and feelings. Their products harness data and algorithms to sharpen the experience, or function, or both. The result is delighted customers, and immersive solutions that meet previously unknown needs.
Applying these techniques in a PCM context requires a profound change in approach and, often, new capabilities. Tech firms develop products through a virtuous circle of innovation and adoption. This means quickly building a minimal viable product (MVP) and offering it to clients. It may initially have narrow functionality but feedback from its initial use allows it to be modified to better serve clients.
The working style is agile and multi-disciplinary, bringing together customer experience, design, technology and financial engineering. By contrast, PCM businesses historically have delivered deliver a set of rigid and disjointed products that have not meaningfully changed in decades.
Making the change is difficult but necessary, if only because of the increasing demands on wholesale PCM customers. Treasurers face complex and inter-related challenges. Among other things, they must optimize the liquidity profile of the business, minimize working capital requirements, and control the complexity and cost of treasury operations. And their needs are evolving rapidly, as their own business models and operations are transformed by digital technology.
CHANGING NEEDS OF CORPORATE TREASURER CUSTOMERS
New platform businesses need to process very high volumes of micro payments and disbursements, and they need complex liquidity management structures to optimize their large (often offshore) cash reserves. The business models of firms in traditional industries are also being transformed in ways that will change their banking needs.
For example, automotive manufacturers face a future where customers no longer purchase or lease vehicles but instead pay for subscription and per-mile usage fees in driverless cars. They will require new capabilities to support real-time payments for car usage, in-car purchases, and payments triggered by sensory technology.
In short, treasurers need to squeeze more value out of traditional treasury operations, and they need to build new capabilities to deliver value as their business models change radically. Whoever can understand and solve those problems will be well placed to capture share and disrupt traditional PCM business models.
Future-Proofing Cash Management Infrastructure
PCM is essentially a technology business. This has been a source of advantage for incumbents, because the large fixed cost of building payments systems acts as a barrier to entry for potential competitors. Yet, in many cases, it has also become a source of disadvantage. The PCM businesses of many banks are built on a patchwork of legacy technology, the result of underinvestment and of mergers and acquisitions. Core banking systems often differ across markets, face volume constraints, and sometimes cause damaging high-profile downtime. Operating and constantly patching up such systems is expensive. The largest players spend $200-300 million annually – up to 15 percent of revenues – on simply maintaining existing legacy systems.
Retail banks face similar problems with inefficient legacy IT systems. Many have decided they will not be able to defend themselves against Big Tech and Fin Tech entrants by endlessly patching up and modifying their fundamentally flawed old systems. Instead, they have decided to build entirely new digital banks from scratch. Clients we have supported in this new venture have built new digital banks for less than $200 million, and in under a year.
Of course, wholesale payments is a different business. But the size of the prize is sufficiently large, and the cost of a targeted bet sufficiently small, that many challengers and more innovative incumbents are looking for ways to apply these techniques in the wholesale payments business.
Whether brand new or reconstructed, wholesale PCM businesses will need to invest in a number of aspects of their technology:
New regulations and customer demand will continue to require banks to expose APIs and connect to 3rd party distribution channels. Some banks are investing in building new frontends in the form of corporate banking portals or API marketplaces; others are integrating with online accounting platforms such as Xero.
Banks need to develop new product offerings that meet client needs. Some of these will be next-generation PCM products, such as virtual accounts, while others will be value-added tools that enrich the proposition, such as reconciliation tools or cashflow forecasting.
The underlying infrastructure must also be developed. Systems will need materially higher volume capacity to support an explosion in volumes of micro-payments. They will need to support real-time payments, and enriched payments messaging, in multiple markets. And they will need the flexibility to adapt to uncertain, but potentially transformational, market developments, such as distributed ledger technology and central bank digital currencies.
The Evolving Bank Ecosystem
No bank is an island. As important as sharpening your own customer proposition and technology stack, will be understanding how your offer fits into the wider ecosystem.
A range of industry outcomes are possible, with differing implications for the commercial attractiveness of various business models. Plans must continually be pressure-tested against a house view on how the landscape might evolve, considering a wide range of competitors and potential partners.
We have sketched four scenarios for the industry, with varying amounts of revenue at risk for banks. In the most disruptive scenario, we see up to 70 percent of industry revenues ($175 billion) at risk. These revenues could be captured by aggressive challengers and returned to customers as competition drives margins down.
With $250 billion of revenue at stake, wholesale payments and cash management is a battleground that banks need to defend. Lessons from big tech tell us that where there are unmet needs, or high margins, new and nimble challengers will find a way to provide compelling solutions. Challengers are presented with a large market, ripe for disruption.
Incumbents must rise to the challenge, and find ways to deliver a generational change in wholesale payments.
For more information on wholesale payments and cash management, download the full report or contact one of its authors.