Chapter 1
Risk vs. reward: driving innovation in a new landscape
Keeping pace with new payments products and services means rethinking the risk agenda.
Regardless of the country, the regulatory risk and compliance agenda is always playing catch-up with innovation and technology. As a result, early PayTech adopters need to pivot and re-evaluate their business models. In many cases, it also means keeping a large portion of potential adopters (mainly heavily regulated entities) on the sideline, taking a “wait-and-see” approach. This is often the case with BNPL, which are digital installment lending services, with different regions at different stages of maturity, from Australia (mature) to the EU (newly regulated) to the US (early stage).
Australia leads the way in regulating the BNPL market, with regulations that require players to conduct affordability checks before offering credit, allowing for a 14-day cooling-off period to customers to cancel agreements. Moreover, players must disclose all fees and charges associated with their services up front, along with late fees. The UK is in the final stages of consultation to introduce similar measures, several years after product introduction.
In 2021, the European Commission issued a proposal for a revised Consumer Credit Directive. It seeks to promote financial education and debt advice, while mandating stricter rules for assessing customer credit worthiness. Separately, the UK is proposing to extend the scope of regulation to capture BNPL firms that are not regulated, and the Financial Conduct Authority has warned BNPL firms about misleading advertisements.
Across the US, BNPL providers are subject to state-level regulation and must comply with Truth in Lending Act (TILA) disclosures. In 2022, the Consumer Financial Protection Bureau issued a report1 indicating that it plans to increase regulation of the BNPL industry. The report also found that BNPL customers may encounter products that do not offer the same protections that are otherwise standard across the consumer financial marketplace, such as cost-of-credit disclosures and a forced opt-in to autopay.
Other examples beyond BNPL include generative artificial intelligence (GenAI) in payments. There is a lot of promise in GenAI use cases — not only in the servicing of payments, but also in the marketing and promotion of payments. Given the newness of GenAI and its accessibility, regulators are taking notice but not action so far. This may create another wait-and-see aspect for regulated payments organizations. Not having a specific compliance playbook for a new product or service such as BNPL or a capability like GenAI can be paralyzing for some institutions and seemingly incents unregulated innovators to seize the opportunity to develop the market. However, there are ways to navigate this evolving risk and compliance landscape. Visionary leaders committed to innovation in payments, particularly in the consumer space, take four steps that make them particularly adept to navigating uncharted territory:
1) Designate a risk and compliance innovation team
Form a small team that is purely focused on new products and innovation in payments. This team should consistently evaluate new partnerships and capabilities, be deeply knowledgeable about payments as a domain, have consistent dialogue with regulators on innovation topics, and constantly evaluate lessons from other countries to incorporate them into a payments risk and compliance framework. This team should also be part of the journey from the beginning, continually evaluating performance from the launch through every change along the way. Additionally, in the UK we see these teams work with regulators and government to help shape the future of the payments landscape.
2) Instill a risk management-by-design mentality
Develop a fresh and customer-centric approach that embeds risk intelligence deeply into a range of critical interactions across the customer journey, rather than orienting around traditional risk management processes. This means breaking down the customer journey, identifying risks, installing controls across each part of the journey and evaluating risk acceptance on a continual basis to determine if additional controls need to be implemented.
3) Apply key risk principles to new innovations even without firm guidance
A good example of this would be applying anti-money laundering (AML) concepts in digital payments and investing in areas where recipient information is scored and shared. PayTechs can also go deep and focus on how to automate third-party risk management capabilities when embarking on embedded payments and ecosystem partnerships, anticipate fraud and cyber events and apply principles of fairness on fees. Even without exact written rules for new products, tried and tested principles from established regulatory frameworks can be excellent guides for innovation.
4) Prepare for the inevitable pivot
As the regulatory landscape changes and catches up to innovation, PayTechs need to be designed for flexibility. That preparation involves the ability to pivot terms and conditions, experiences, disclosures, business models and data to fit a new regulatory environment. The technology platform needs to be flexible enough to accommodate new guidance and more stringent expectations as the landscape matures. Smart, early adopters expect change and build that flexibility into their business model.
Chapter 2
Technology and the race to compete
Modernizing the technology stack is a must to enable growth.
Apart from uncertain risk and compliance guidelines, technology is a primary obstacle for many financial organizations that want to compete in the PayTech landscape. Whether they are pursuing real-time payments, open banking or distributed ledger technology, legacy technology infrastructure saddles innovators with infinite lines of decades-old, customized code that is daunting and “too tough to unwind.”
Legacy infrastructure, combined with the expected need to scale and respond in real-time, can make innovation seem insurmountable, particularly to incumbents or those with limited budgets to address fundamental legacy challenges. Whether it’s modernizing a card platform to enable product proliferation and launch in days versus months or migrating enterprise money movement functions to the cloud, the challenges associated with continuing to operate with legacy technology are complex. Addressing the modernization agenda for existing payments flows (wire, cross-border, electronic payments, card transactions) means the capacity to address new platforms is limited.
In countries like the US where adoption of new payments is not mandated, this is playing out in real-time payments, with over 60% of demand deposit accounts eligible to receive a real-time payment.2 Yet, only 10% of US banks are able to send a real-time payment, creating a challenge of ubiquity that becomes another hurdle of adoption. While the task of installing the capabilities to post and send real-time payments is relatively straightforward, legacy systems must adapt alongside and evolve to a real-time environment that tends to inhibit adoption, with issues such as fraud, AML tools and downstream operational processing leaving many organizations on the sidelines.
We see early adopters of PayTech technologies address these challenges, and we are working with our clients on a variety of fronts to move technology from an inhibitor to an enabler. There are a number of ways this can occur.
1) Pursue an ecosystem approach
Many organizations are seeking partnerships with third parties to leapfrog their internal technology deficiencies. Partnerships for payment innovations like connected commerce and digital wallets provide a lot of dexterity when it comes to adopting new capabilities. However, challenges exist, such as appropriate revenue models, data privacy and risk management, all of which feature on a partnership risk agenda. We advise clients to plan for success and enter into partnerships with a “best of breed” mentality, enabling integration with a variety of partners to provide ultimate flexibility — but knowing that the complexity of managing the partnership ecosystem from a cost and risk management perspective requires dedicated resources.
2) Invest in orchestration vs. a full core engine replacement
All payment processing services are, in principle, a commodity. However, some aspects of the payment lifecycle (e.g., payment initiation and routing) are more strategic and offer opportunity for differentiation compared to others (e.g., settlement and reconciliation). As organizations look to modernize their legacy payments infrastructure, building a modern orchestration engine that provides capabilities like API-based integrations with channels and enterprise systems, flexible business rules, configurable pricing and intelligent routing of payments allows for better control of customer experience, monetization opportunities and lower cost of processing. Leaving the commodity capabilities like clearing, settlement and reconciliation to a specialist partner or an existing core engine allows for an incremental modernization approach which not only de-risks the program but also helps lower the ongoing costs of managing regulatory payments schemes rule changes.
3) Invest in modernizing enterprise capabilities (fraud, monitoring, alerts) to support the entire business instead of supporting just the new service
In many cases, new services require investment in supporting systems that can scale and respond in a more agile fashion. Several clients have invested in small-scale servicing capabilities rather than addressing the entire enterprise function. For example, they may invest in real-time fraud monitoring for a particular payment method instead of expanding that capability to the enterprise. While this type of project is efficient in terms of up-front investment, it creates a disjointed enterprise roadmap and complexity in overall capabilities that service the organization and its customers. We suggest that each investment include a path to enterprise deployment to consider how a new capability such as real-time fraud management or AML functionality can be deployed across the enterprise to create a true shared services model that supports a variety of innovations.
Chapter 3
Data and analytics: the heartbeat of PayTech
Leveraging data and analytics can help decrease risk and improve the customer experience.
Data is the lifeblood of payments businesses, and monetizing data is the “holy grail” of PayTech business cases. All successful PayTechs have a relentless focus on data (whether it be their own or third-party data) to enable a superior customer experience, to reduce fraud and risk or to increase commerce activity. Handling data is also one of the major challenges in adopting new PayTech capabilities, such as open banking, real-time payments and embedded commerce experiences.
Over the past five years, payments as-a-service and open banking business models have accelerated and become regulated in some countries (like the UK) and are being explored in other territories. As-a-service business models enable payments providers to embed their rails and capabilities into digital experiences, and service providers can enhance the overall experience of the user (pay in session or checkout, manage your budget or cash flow, pay bills, etc.).
These enhancements provide exciting opportunities for overhauling legacy payments and for digital service providers with the ability to scale. However, a number of these new business models can fall short in terms of finance reconciliation, financial and regulatory reporting and integrated customer service. In many cases, the issue is a lack of integration of data into back-office functions like treasury management, servicing and operations.
These areas are vital aspects of open banking (or any new business model) and can considerably restrain growth and scale of PayTech early adopters, as data challenges often halt new business deals and new product development or restrict scalable growth until addressed.
Through our work with financial services clients and PayTechs, we recommend the following to enable better growth and success:
1) Manage robust data requirements
Many new PayTech relationships involve an ecosystem of partnerships. These partners all possess data that is critical in creating the service perform. However, robust requirements from partners tend to get overlooked during the initial partnership phase: information related to financial reconciliation and reporting and data required to fully perform customer support. Overlooking these will inevitably halt growth and expansion and require significant investment to address mid-stream. We highly recommend that treasury and customer operations become critical components of data requirements in launching any new service with a partner.
2) Empower the chief data office as an enabler
Globally, data ownership, portability and privacy are fundamental principles that must be addressed in any PayTech organization. Whether clearly regulated or not, customer ownership of data and a capability for data portability and control should be built into new payments products. Data localization is becoming a requirement in many countries; and mandated controls are eliminating the storage of data offshore, making the cloud strategy more complex. Finally, as more partnerships are required for PayTech plays, the questions of who owns what data, as well as how it can be used and monetized, can slow progress. The chief data officer or office is a crucial enabler of any PayTech strategy and their involvement in any endeavor pays dividends in a successful launch and scale of any new service or business model.
3) Create a foundation for interoperability
In order to launch, many programs think about the minimum viable product (MVP) model and rarely think about the long-term implications of success. Inevitably, innovative ideas and the growth of new business models are stunted due to interoperability obstacles. Payment industry standards like the International Organization for Standardization (ISO) 20022 will help create the foundation of interoperability. However, limited adoption and a focus on compliance through translation to downstream systems, rather than native capabilities, will continue to hamper the industry. Real time payment schemes, CBDCs, and even open banking efforts are rarely built with cross-border capabilities in mind. Five years since the launch of real-time payments in the US, there is still no plan for interoperability between two domestic schemes (Fed NOW and RTP) and there are only proof-of-concept efforts to see how Faster Payments in the UK can interoperate with other real-time payments schemes in the EU or US. There is some promise of interoperability in Asia, but progress is slow. Interoperability is difficult, but adopting ISO as the foundation and planning for the inevitability of interoperability is necessary for PayTech to scale.
Discover how to supercharge your payments business with ISO 20022.
Chapter 4
Deepening the customer experience
Digital payments have fundamentally altered how customers expect to carry out everyday transactions.
At the heart of every PayTech play — real-time payments, digital wallets or cross-border payments — a fundamental edge is to reimagine and offer an experience unmatched in the current landscape. In digital wallets, it’s about making the payment experience frictionless and invisible. In open banking, it’s about embedding banking experiences into a digital experience rather than requiring the user to go to the bank’s physical property. In digital currencies, it’s about taking the hassle out of foreign exchange. The experience is the business model. The customer experience is where incumbents are most vulnerable to PayTechs and where the historical cultural norm of having to own and operate the end-to-end experience is being challenged.
Many PayTech plays like digital wallets and open banking are of concern to traditional players due to a lack of full control over the experience and, frankly, the concern over the traditional bank brand becoming invisible. In the US this has been termed “fear of being the ‘dumb pipe’.” Early adopters are overcoming these traditional cultural barriers by embracing several of the following key principles and scaling to win in PayTech:
1) Think of risk management as an asset
Rather than renting out a bank license, incumbent financial institutions (FIs) with scale are producing fraud and security services as standalone products rather than embedding them into traditional payment products, thereby gaining not only additional revenue, but also premium margins. The decoupling of risk management services as standalone products that enhance traditional payment services enables FIs to charge premium pricing, as opposed to commodity payment processing rates.
2) Deepen relationships with as-a-service clients
Many as-a-service models struggle with single-service clients and the inability to deepen relationships acquired through this model. To enhance these relationships, the end client must be aware of the services banks are offering. Maintaining digital engagement with the end customer through apps, alerts or other mechanisms (besides a paper statement) are “must haves.” Without a strong customer retention strategy, these new clients and their deposits or volumes are transient, and incumbents will be challenged with rebuilding the book of clients on a cyclical basis. Payments offer a significant opportunity for value-add services to bolster the deepening strategy — from rewards and purchasing partnerships to real-time forecasting of cash flow, payments businesses offer significant avenues for deepening that are unparalleled in traditional banking.
3) Bring the bank: reimagine the operating model and end-to-end digitization
Incumbents are realizing they can take advantage of their consumer payments and lending products via their merchant relationships in the B2B2C model if they can bring together different business units as a cohesive “payments” business. Leveraging consumer data is a strategic imperative that can allow incumbents to personalize experiences, expand into adjacencies and identify cross-selling opportunities across the consumer and commercial bank. Mapping out these journeys and focusing on full digital experiences that integrate capabilities from the front, middle and back office make PayTechs stand out among peers.
4) Seek and build partnerships that introduce capabilities that enhance your client experience
There are numerous technology providers – either standalone or provided by large processors and networks that act as behind-the-scenes enablers. Examples include fraud and data analytics service providers that work behind the scenes to orchestrate a flawless digital front-end experience for merchant acquiring in small business enrollment or functionality that enables a customer to control their digital payments credentials (wallets, card usage, etc.) with a click of a button. These significant investments allow organizations to quickly address their customer experience challenges and compete in a very dynamic digital-first market.
Future considerations
Undoubtedly, the future of payments is exciting and will continue to significantly impact the financial world. For customers, the advantages of digital payments are clear. Frictionless, seamless payments have completely changed how merchants and consumers carry out millions of transactions every day. For FIs thinking of when to invest and how, careful consideration of the four pillars of risk, technology, data and customer experience is required. Inaction is not an option for those who wish to achieve smart growth. A new payments environment has already emerged — the question for those who wish to partake is: how fast can they follow?
Summary
Meaningful investment in risk and compliance, data and analytics, technology, and the customer experience will enable payments providers to outpace competitors in an increasingly crowded marketplace.
This article serves as a blueprint for how to harness new payments capabilities in a secure way, to achieve smarter, and ultimately faster, growth.
