Advances in financial technology (fintech) are rapidly changing the way businesses and consumers make and receive payments around the globe, creating opportunities for banks and payment companies that stay on the cutting edge and threatening those that don't. The volume of electronic payments is growing robustly globally, consumers are finding new and better ways to pay businesses and each other, and the system of business payments is gradually modernizing.
We believe it will be crucial for banks to maintain their market position in payments, because payments are often central to the client relationship, generating substantial revenues from credit and debit card fees, deposit account fees, cross-border transaction fees, and net interest income. It will probably be even more important for the card networks to fend off competing products given their concentration in payments.
Below, we present five expectations for fintech advancements in both business and consumer payments and how such trends are likely to affect the card networks, banks, and other payment companies we rate.
Central banks, commercial banks, the card networks, and fintechs are making significant improvements to how businesses send, receive, and track payments.
Size and growth rate
Industry participants have estimated the global business-to-business (B2B) volumes at well over $100 trillion, dwarfing the size of consumer-to-business and peer-to-peer payments (also known as consumer-to-consumer). B2B payments globally are growing at a mid-single-digit annual rate, according to industry estimates.
For instance, in the U.S., automated clearinghouse (ACH) payments, comprised largely of B2B payments, rose at a 5% annual compounded growth rate from 2012 to 2017, according to the National Automated Clearing House Association (NACHA). NACHA is a nonprofit association that sets the rules for the ACH system in the U.S.
Five fintech expectations for B2B payments:
1. ACH payments will remain the largest source of B2B payments, with the number of checks written likely to stagnate or decline. Since banks are central to ACH, this benefits them. B2B card payments may grow but should remain a small portion of overall payments. (See the Appendix for an explanation of the mechanics of how ACH and card payments work. Some countries use different names for systems equivalent to ACH.)
2. New versions of ACH systems will improve the speed of B2B payments. Governments, central banks, and private players are working to speed ACH payments by shortening the time it takes to settle transactions--which can be one to two business days if not longer in many countries. ACH payments often are only handled on weekdays during business hours. The aim is to also make them available at all hours 365 days a year. The U.K. already has a "fast ACH" system in place, allowing real-time transfers of payments of up to £250,000 at all times, and the Fed, the European Central Bank, and others are pushing to modernize their systems.
3. New versions of ACH systems will improve efficiency of B2B payments by transmitting data alongside payments. For instance, The Clearing House, one of the two U.S. ACH operators alongside the Fed, recently launched a new real-time payments system, its real-time transport protocol (RTP) Network. The system operates at all times and has the ability to carry not only a payment but also standardized data about that payment. For instance, it allows for confirmation of delivery, requests for payment, requests for information--such as customer account numbers or invoice numbers--or return of funds. Such data can make it easier for businesses to track and organize their accounts payable and receivable. Vocalink, which Mastercard Inc. acquired in 2017, designed this system for The Clearing House as well as the U.K.'s fast ACH system.
4. The card network companies and PayPal, which earn the great majority of their revenues from consumer-to-business payments, will push to use technologies other than ACH to move B2B payments. For instance, millions of businesses are already connected to the "rails" of Visa and Mastercard to receive payments. The card networks can use their rails to allow businesses to both send and receive payments. Such technologies also may include messaging. Mastercard has pursued B2B payments in multiple avenues including through its 2017 acquisition of Vocalink. Vocalink designed and operates the fast ACH system in the U.K. and also designed The Clearing House's RTP network in the U.S. Vocalink is a designer and operator of those systems, but it does not use the Mastercard network to carry the payments. We also expect business payment providers, such as FleetCor technologies and WEX Inc., to continue to expand their suite of B2B products through organic growth and acquisitions.
5. The technology behind cross-border payments will also improve. Ripple, a fintech competitor, has used blockchain technology to facilitate faster cross-border payments. That may have helped spur SWIFT, a member-owned cooperative that has dominated cross-border payments for decades, to launch its own product to improve the speed and efficiency of payments. JPMorgan Chase & Co. also has been developing a blockchain product it calls Quorum using technology from the fintech and cryptocurrency company Ethereum. Quorum could be used in part for cross-border payments. IBM, Mastercard, and Visa also have blockchain products that can facilitate cross-border payments. On top of that, Mastercard recently announced an acquisition of Earthport, another cross-border payments company that has partnered with other players, including Ripple.
Ratings implications: Banks unable to keep pace with advances in fintech for B2B could lose business; any growth in B2B payments that the card networks experience will help them improve diversification.
The improvements to the speed and efficiency of B2B payments should benefit businesses, helping them better manage their accounts receivable and payable and allowing the banks to offer their commercial customers the most cutting-edge payment capabilities. With commercial deposits accounting for more than half of the deposits of Federal Deposit Insurance Corp.-insured commercial banks in the U.S., and spread income and service charges on those deposits probably the source of more than 30% of their revenue, banks that depend on commercial customers will need to stay competitive in their offerings of treasury services and B2B payments.
Larger banks are probably better positioned than smaller peers to keep up with fintech advances in B2B payments given their scale and ability to develop their own products or purchase third-party products. This could allow them to win more deposits and business providing treasury services if small banks are too slow to adopt. Larger banks, for instance, may be quicker to connect into The Clearing House's RTP program and are more likely to form partnerships with fintechs that can assist with B2B payments.
To name a few examples of collaboration in the U.S., Fifth Third Bank in 2017 said it would begin offering products developed by Mastercard and AvidXchange, a fintech provider of accounts payable and payment solutions to midsize companies, to its commercial customers. Likewise, Citigroup Inc. entered a partnership in 2018 with fintech HighRadius to launch a product to help its commercial customers manage receivables, and Capital One Financial Corp. has partnered with a few fintechs on its treasury services offering. We expect other banks to sign similar partnerships in the next few years.
However, smaller banks that use externally developed systems, from companies like Jack Henry, Fiserv, or FIS, can still be competitive, especially with small and medium-size businesses. Small banks can still tap into The Clearing House's RTP system through a third-party service provider or through a bank that offers services to community banks. They can also specialize in providing treasury services to businesses in specific industries.
The challenge of keeping up with advances in fintech could be another factor that spurs consolidation among banks, particularly in the U.S., where there are still more than 5,000 banks. It could also lead to lower ratings on banks that are unable to keep pace with advances in fintech and lose business as a result.
We don't expect the card networks to win a material portion of B2B payments in the next few years, but any growth they find will add to their already-strong revenues. Our ratings on these companies do not factor an expectation of substantial growth in B2B payments. If they generated significant revenues in B2B, it would provide greater diversification and protection against any disruption in consumer payments.
Consumers are shifting more of their spending to electronic means while the card networks, other payment companies, and tech players compete for a size of the growing pie.
Size and growth rate
Industry participants have estimated global consumer-to-business (C2B) card volumes at more than $20 trillion. Card payments globally have been growing at a high-single- to low-double-digit pace over the last decade. We expect continued long-term expansion in card and digital payments on the back of economic growth, an incremental shift in consumer spending to electronic means, and more digital commerce. Consumers globally are paying more frequently through electronic channels rather than cash, given its convenience and ease of use, and ecommerce is expanding.
On top of C2B payments, industry participants have estimated peer-to-peer (P2P) payment volumes and remittances at more than $120 billion. Those volumes are growing rapidly, but are a fraction of the size of C2B and B2B volumes. (The below two charts, respectively published by the Federal Reserve and European Central Bank, demonstrate the strong ongoing growth in C2B payments, particularly in cards.)
Five fintech expectations for C2B payments:
1. Fintech advancements will continue to expand the number of businesses that accept card payments and improve the convenience of using cards, supporting continued growth for Visa Inc. and Mastercard as well as bank interchange fees. The growth of mobile card readers from companies like Square and iZettle have helped allow millions of more merchants and small businesses to accept card payments in a convenient way. Likewise, Quick Response (QR) codes--or two dimensional black and white barcodes--allow merchants to accept payments made with smartphones. Merchants, particularly in countries in the developing world, have made increasing use of QR codes. Because of these types of developments, Visa said that the number of business and merchant locations that accept cards rose 15% in its fiscal-year 2018. Furthermore, the rollout of contactless cards--which allow consumers to pay by simply tapping, rather than swiping or inserting--incrementally improves the convenience of paying with physical cards. Some countries, such as Australia, have already adopted contactless cards. We expect greater adoption in the U.S. beginning in 2019. We also expect the card networks in the coming years to implement a "common checkout" for ecommerce transactions, making it easier to pay online with a card. Currently, consumers must choose between numerous payment avenues, often by selecting their card network from a drop-down menu and entering their card number or by choosing PayPal and entering a log-in. The card networks also offer apps like Visa Checkout, Mastercard Pass, and Amex Express Checkout that allow a cardholder to enter a log-in, which automatically loads her or his card information. A common checkout button would simplify the process of paying with a card, essentially by rolling those apps into a single common button that works for Visa, Mastercard, American Express, and Discover cards. This would parallel how consumers pay in stores where the point-of-sale systems seamlessly allow payment by any card.
2. While cards remain dominant in consumer electronic payments, PayPal will likely continue to grow at a robust rate including in domestic P2P payments. PayPal relies notably on the rails of Visa and Mastercard as well as the banking system (for instance, consumers often fund their PayPal accounts through a card transaction). Still, when consumers pay with PayPal, Visa and Mastercard collect no or lower fees and banks collect no interchange fees. PayPal is also looking to expand further into in-store payments. For instance, in Germany, it has partnered with Google to allow users of Google Pay to pay in-store with PayPal, mostly removing banks from the value chain (see "The Future Of Banking: Google-PayPal Partnership Challenges German Banks," published Oct. 16, 2018). We expect PayPal's growth rate to remain high in C2B and P2P payments.
3. P2P payments will continue to grow rapidly from a small base, with banks and fintechs competing for volumes. Some players will look for ways to better monetize P2P volumes and to establish tight relationships with consumers that could allow them to win more of their overall payment and financial service needs. In the U.S. in the third quarter of 2018, PayPal, which facilitates P2P payments through its PayPal, Venmo, and Xoom apps, reported $36 billion in P2P volumes, up 50%. Zelle, the P2P network controlled by the banks, reported $32 billion in volumes, up 67% in the last year. In Europe and the U.K., a number of players are also competing, such as Lydia, Revolut, Monzo, and N26 (some of which are banks). Despite the growing volumes, we believe it has been difficult to generate significant revenues from P2P volumes. Many companies, such as PayPal's Venmo, only charge for certain P2P transactions, and it is unclear whether they will ultimately be able to generate large revenues from this activity--and do so on a cross-border basis. However, despite the limited revenues, expansion of P2P volumes over time could help competitors develop more extensive relationships with their customers. Perhaps consumers who become accustomed to using a given provider for P2P volumes will become more willing to use other financial services that the provider offers. Building an international P2P payments system will remain a major hurdle, however. Instead, we expect cross-border payments to remain dominated by global remittance firms Western Union, Moneygram, and Ria (a business by Euronet International) over the next two to three years. All three players are scaling up their electronic-interface capabilities in an effort to ward off fintech threats to their international market share. We believe cross-border payments entail additional operational complexity that warrants a cautious approach by new entrants such as Paypal. Both Western Union and Moneygram, for instance, have paid hefty monetary penalties and are operating under deferred prosecution agreements with the U.S. Department of Justice stemming from failures to comply with anti-fraud and anti-money laundering legislation.
4. While we don't expect the large tech companies to become major players in clearing and settling payments in the foreseeable future, they will likely look for additional ways to impact the payments ecosystem, perhaps helped by rules like Europe's Payment Service Directive 2 (PSD2). Tech companies like Apple, Google, Facebook, and Amazon currently mostly use technology to facilitate card payments rather than replace them. They are not involved in the process of authorization, clearing, and settlement--activities that still fall to the card networks, processors, and banks. Digital wallets simply make it easier for consumers to pay by card or PayPal. Also, their adoption in many countries has been far less than ubiquitous, and the rollout of contactless card and common checkout may make it less likely that more consumers choose to pay with digital wallets rather than directly through cards. That said, the extensive connections these tech companies have with consumers and businesses make it likely they could look for further ways to influence payments both in C2B and P2P. The Google-PayPal partnership in Germany is one example of that. Apple's ability to charge banks a small fee for each transaction on Apple Pay is another. Younger consumers in particular may also become more apt to use digital wallets. We cannot rule out that these companies will find some new ways to disrupt the current ecosystem. The implementation of the European Commission's PSD2 regulation and the U.K.'s Open Banking Standards--which aim to create a more open and competitive market for payments in Europe --may help facilitate that (see "The Future Of Banking: Is PSD2 Yet Another Threat To Revenues In Europe?," published May 16, 2017). Under PSD2, consumers can provide third-party companies permission to access their bank account information and initiate payments directly to merchants without the use of the rails of the card networks. Still, we believe those third parties will face significant hurdles to setting up and sufficiently monetizing such a process and to attracting large numbers of consumers and merchants to its use. Data security will be among those challenges, and it is unclear how comfortable consumers will be in providing permission to third parties to access their bank account information.
5. We don't expect Ant Financial and Tencent, which have become giants in consumer payments in China through their AliPay and WeChat mobile wallets, to eat greatly into the market share of the card networks and PayPal in many other countries. While AliPay and WeChat have become ubiquitous in China, we think it would be very difficult for them to gain widespread acceptance with consumer and merchants in other countries. Chinese travelers can pay with those mobile wallets outside of China but only at some merchants and mostly in major tourist areas like Paris, London, and New York. We wouldn't expect consumers to switch from their current payment preferences unless a new provider had not only superior convenience but ubiquity with merchants. We wouldn't expect merchants to quickly accept additional payment providers unless a large number of consumers had chosen to use the services of those providers. Still, the rise of these companies in China underscores how quickly industries can change with advances in fintech (see "The Future of Banking: How Much Of A Threat Are Tech Titans To Global Banks?," published Jan. 15, 2018). In 2017, Ant Financial attempted to acquire international money exchange provider MoneyGram International Inc. for $1.2 billion. The deal, however, was blocked earlier this year by the Committee On Foreign Investment in the United States (CFIUS), which we believe underscores the sensitive nature of cross-border payment providers.
Ratings implications: We expect the card networks--in conjunction with banks generally--to retain their very strong market positions globally for the foreseeable future, but some fintech advance may eventually eat into their market share.
We raised our ratings on Visa and Mastercard in November 2018 because of their continued and projected strong performance, low leverage, and our belief that they are unlikely to cede material market share because of fintech disruption--at least in the next few years.
Both companies have grown their revenues, EBITDA, and earnings at roughly a low-double-digit compounded pace for at least a decade. The convenience and services they offer to consumers, merchants, and banks (related to their ubiquity, ease of card use, timeliness of settlement, and guarantee of settlement) makes them very difficult to disrupt. We expect the closed-loop card companies--American Express and Discover--also to benefit from rising electronic payments.
At the same time, predicting how fintech will evolve and what implications that will have for the existing players is extremely difficult. While unlikely in the near term, we could lower our ratings on Visa and Mastercard if some development in fintech caused them to lose a material portion of their strong market positions.
PayPal has been a disruptor itself, and further sustainable gains in market share could benefit the rating. However, it also could be a victim of disruption over time. Perhaps that could come from the large tech companies or even the existing card networks via the advancements they have made to improve the ubiquity and convenience of card payments.
The fortunes of the banks in consumer payments are tied in large part to the success of the card networks. They collect interchange fees on card payments and can be deprived of those fees on PayPal transactions. While interchange fees make up a small portion of most banks' revenue, there is a high level of operating leverage associated with such fees. A drop in interchange revenues in dollar value essentially equates to an equal decrease in pretax income. It is also important for banks to maintain close relationships with their customers. For instance, consumers who use a given nonbank for P2P transactions may be more open to using that company for activities they may currently rely on a bank for, such as wealth management.
Appendix: The Mechanics Of ACH And Card Payments
Outside the U.S., other countries and regions often use different names for ACH payments, but the mechanics are often similar.
Automated clearinghouse (ACH)
ACH payments flow through networks that connect depository institutions (banks) in a given country. In the U.S., the Fed and The Clearing House, through its Electronic Payments Network (EPN), operate the two ACH networks. Since some depository institutions are not connected to both, the Fed and EPN rely on each other to process the transactions.
In an ACH transaction, a bank's customer originates a payment with its bank (the originating bank) with a request to send payment to a third party. The originating bank gathers that request with the requests of other customers and sends a "batch" to the ACH operator with all of those requests. Banks send batches at predetermined intervals during a given day. The ACH operators then edit and sort the batches and deliver them to the bank (the receiving bank) of the customer receiving payment. The ACH operator then settles payments by crediting or debiting the receiving bank.
Some ACH systems have the ability to settle payments in the same day. But often the batch request and settlement only occur during business days, with settlement often taking one to two business days and sometimes longer.
ACH facilitates direct deposit payroll, government benefits, mortgage and other bill payments, as well as P2P and B2B payments. NACHA, the nonprofit association that sets the rules for the ACH system in the U.S., estimates that ACH payments in 2017 totaled $46.8 trillion, with 21.5 billion transactions (25.7 billion transactions if you include payments within financial institutions). ACH is inexpensive. NACHA estimated that each transaction costs about $0.11 on average.
Visa and Mastercard, the two largest card networks, operate systems or "rails" that connect banks and those banks' clients (consumers and merchants). In this regard, they are similar to the automated clearinghouse network, in that they act as a clearinghouse for their respective card brands. These companies set the rules for the settlement of payments between banks, including default interchange fees--the fees a receiver of payment pays to the originating bank. They also guarantee settlement of payments on their networks.
While Visa and Mastercard operate their card networks, they do not issue the cards. Financial institutions, mainly banks, issue cards and also provide services to merchants to allow them to accept card payments. The bank that issues its customer a credit or debit card is called the "issuing bank." The financial institution that the merchant uses is called the "merchant acquirer." The banks together with the customer and the network become the standard four-party model (customer, network, customer bank, merchant acquirer).
In this model, Visa and Mastercard operate open-loop networks--those that virtually any bank can connect to. In contrast, American Express and Discover operate closed-loop networks. In the closed-loop, American Express or Discover acts as both the bank and the network operator, issuing their own cards and extending credit to their customers.
What happens when a cardholder swipes his card at a merchant in order to make a purchase:
1. The merchant acquirer determines over which network the transaction should be routed (e.g., Visa or Mastercard). Over that network, an authorization request is sent to the cardholder's bank (the issuing bank). If the issuing bank provides authorization (a decision made within seconds typically), the purchase can be made.
2. Following authorization, the merchant acquirer posts the transaction (clears it) to the merchant's account. The merchant acquirer, based on the type of transaction, calculates the interchange fee that will be deducted from the funds the merchant ultimately receives.
3. The merchant acquirer submits a request to Visa or Mastercard so the merchant can be paid by the issuing bank. Visa and Mastercard guarantee payment even if the issuing bank fails to ultimately make the payment.
4. Visa or Mastercard then request payment from the issuing bank, which they send to the merchant acquirer (and on to the merchant).
Visa and Mastercard set default interchange fees (known as discount fees in some markets), but merchants can negotiate specific interchange fees with issuers. In most markets, including the U.S., credit interchanges are far higher than debit card fees. The issuing bank typically earns the largest portion of the fees associated with card transactions with the acquirer and Visa or Mastercard getting a smaller portion.
- The Future Of Banking: The Growth Of Technology And Its Impact On The U.S. Banking Sector, Feb. 13, 2019
- Mastercard Inc. Long-Term Rating Raised To 'A+' On Continued Strong Performance; Outlook Stable, Nov. 20, 2018
- Visa Inc. Ratings Raised To 'AA-/A-1+' On Continued Strong Performance; Outlook Is Stable, Nov. 20, 2018
- The Future Of Banking: Google-PayPal Partnership Challenges German Banks, Oct. 16, 2018
- The Future of Banking: How Much Of A Threat Are Tech Titans To Global Banks?, Jan. 15, 2018
- The Future Of Banking: Is PSD2 Yet Another Threat To Revenues In Europe?, May 16, 2017
This report does not constitute a rating action.
|Primary Credit Analyst:||Brendan Browne, CFA, New York (1) 212-438-7399;|
|Secondary Contacts:||Thierry Grunspan, New York (1) 212-438-1441;|
|Stephen F Lynch, CFA, New York (1) 212-438-1494;|
|Sean C Tillman, CFA, New York + 1 (212) 438 0762;|
|Research Assistant:||Mira A Dalal, New York|
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