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The Future Of Banking: Google-PayPal Partnership Challenges German Banks

Convenient mobile payment services in Germany look set to remain the home turf of international players such as PayPal. Mobile payments still only represent a fraction of transaction volumes in Germany, and the country lags peers in terms of mobile payment take-up (see chart 1). Now the banks face a new challenge: Google and PayPal have this month announced the expansion of their partnership into Germany to promote mobile payments. This will allow PayPal customers to use their PayPal accounts for point-of-sale (PoS) and web-based payments with their smartphones via Google's payment app Google Pay.

Chart 1


Customers can add their existing PayPal account to Google Pay as a payment method, where a digitized Debit Mastercard will be generated automatically. This virtual debit card is linked to the user's PayPal account and serves as a funding source for purchases via Google Pay. Payments are executed via the smartphone's near-field-communication (NFC) feature, which builds a contactless connection between the in-store terminal and the phone. The service is available at contactless-enabled Mastercard terminals, which currently applies to about 60% of all PoS terminals in Germany.

The new PayPal-Google partnership will affect German banks' revenue generation because it changes the traditional value chain in payment processing when using Google Pay. Under the current model, e-wallets are directly linked to debit or credit cards that were issued by a bank. As such, the bank earns interchange fees. Under the new model, however, PayPal takes the role of the card issuer and replaces the bank in the value chain (see chart 2). Although PayPal thereby now generates transaction fee income, the process nevertheless still requires a bank account from which PayPal draws the funds.

Chart 2


Tech titans such as Google, Apple, and Facebook, as well as e-wallet payment service providers like PayPal or Ant Financial in China have already established a strong presence in payments markets globally. The extent of their market presence, however, differs materially by region (see "The Future of Banking: How Much Of A Threat Are Tech Titans To Global Banks?," published Jan. 15, 2018, on RatingsDirect). In Germany, building on its global network with millions of users, Google has already introduced its own digital wallet and mobile payment device through smartphones using customers' credit or debit cards. ApplePay is also likely to officially launch in Germany before the end of this year following its introduction in several other European countries. We expect that the biggest value of this for companies such as Google comes from data-gathering related to customer spending patterns and financial information, and less from the fees they generate from payment transactions. From a fees perspective, German banks have therefore been largely indifferent as to whether transactions are processed through cards or mobile phones. PayPal, in the other hand, is effectively taking the role of card acquirer, card network, and issuing bank for transactions within its own ecosystems. The banks remain outside the value chain when funds are moved only between PayPal accounts.

Through the new partnership between Google and PayPal, German banks now risk being removed from the value chain in many PoS transactions, with a potentially material long-term impact on earnings from payment transaction fees. We nevertheless do not anticipate any meaningful short-term pressure on fee income for German banks resulting from the recently announced partnership, for two main reasons. First, in Germany, where cash remains the preferred payment method, the number of PoS transactions processed through mobile payment services remains very low compared to transactions processed through debit or credit cards. We believe card users find this method convenient enough to prevent them from moving quickly to mobile services. We therefore expect card usage to remain the preferred medium of payment for PoS in Germany next to cash payments.

Second, even if consumers were to make a material shift toward mobile payment services using Google and PayPal, German banks would currently remain part of the value chain when customers need to move funds into or out of their PayPal accounts using their bank accounts.

For mobile payments to have a material effect on German banks' transaction revenues, there would have to be a fundamental shift in consumer behavior, which we consider unlikely in the next five years. We have seen such a fundamental shift already in specific markets, such as China and some selected Nordic countries. We nevertheless expect the German population's focus on cash or debit/credit card transactions to protect domestic banks' fee generation in the short term.

Over a longer timeframe, however, we consider players such as Google and PayPal well placed to disrupt German and European banks' payment services, especially once the implementation of the European Commission's Payments Service Directive 2 (PSD2) is fully completed (see "The Future Of Banking: Is PSD2 Yet Another Threat To Revenues In Europe?" published May 16, 2017). We additionally continue to believe that tech titans might materially disrupt the banking landscape if they were to decide to more effectively utilize existing banking licenses.

This report does not constitute a rating action.

Primary Credit Analysts:Benjamin Heinrich, CFA, FRM, Frankfurt + 49 693 399 9167;
Markus W Schmaus, Frankfurt (49) 69-33-999-155;
Secondary Contact:Gabriel Zwicklhuber, Frankfurt + 49(0)6933999169;

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