Consumers are getting tired of coins and notes, and COVID-19 catapulted them further toward convenient digital payments. It remains to be seen whether this pandemic-induced leap to digital from physical money is temporary or permanent. But in 2020, Mastercard reported about a 40% increase in contactless payment transactions globally. Even in Germany, known for its consumer conservatism, cash payments declined to about 60% compared with 74% three years ago. In the Nordics and in China, on the other hand, the use of cash is declining to the extent that authorities are getting worried about moving to a fully cashless state.
Despite some continued barriers to the wider adoption of digital money, tech developments in financial services are gradually closing the gap between developed economies and developing ones in terms of cash usage. In time, we expect central banks will play a pivotal role in further reducing this gap through the development of central bank digital currencies (CBDCs).
The role and scope of financial regulators is gradually evolving to meet the demands of emerging digital payments and consumer protection. We will closely monitor the role of this regulatory influence on our view of banking systems' institutional framework assessments. At this stage, we believe that the impact on bank ratings should be rather limited. However, we expect that it will benefit banks' operating structures and costs somewhat, and might present opportunities for those with clearly defined payment processing outsourcing strategies.
What Does It Take To Become A Cashless Society?
From Japan, where the majority of the population still uses cash, to Norway, Sweden, and China, where cash is almost nonexistent, it is clear that societies across the globe are moving at very different speeds away from notes and coins. We see four key factors that support the transition to a cashless society--an economy where payments are conducted digitally instead of through physical money. These are:
1. Technology penetration and security advancements. A solid digital infrastructure through mobile phone and smartphone adoption, broad and scalable use of e-commerce, a broad retail offering of point-of-sale (POS) devices, and a solid offering of online banking and financial services are all features that enable economies to move to digital payments. While internet penetration is already relatively high across the world, there are major differences between regions (see chart 1). Additionally, developed security systems to protect customers is key to providing continuity and trust in the non-cash payment system. For example, digital customer authentication through biometrics in recent years has provided a step forward because passwords have proved to be not secure enough.
2. Financial inclusion. Access to and use of financial services is far from equal across the globe. An estimated 31% of adults globally lack a bank account, and nearly 50% of the unbanked are concentrated in a few countries, namely India, Indonesia, rural parts of China, Mexico, Nigeria, and Pakistan (see chart 2). There nevertheless remain large unbanked populations in developed markets.
3. Financial literacy. There is ample room for improvement globally, not only in terms of education but also in financial planning, saving, and investing. Financial literacy improves the well-being not only of individuals but the economy as a whole. For example, on a scoring scale of 1-10, individuals across 26 countries scored 6.1 on average in terms of financial literacy, according to a 2020 survey conducted by the OECD (see chart 3). Some governments in the Nordic countries have strategies to achieve best-in-class financial literacy, with the Finnish government aiming to become the world's most financially literate country by 2030.
4. Data protection and other support mechanisms. A solid enabling regulatory environment, high data protection standards, as well as transparent and supportive financial institutions and payment processors usually all contribute to increased adoption of digital payments. For example, in Russia some banks incentivize the use of card payments by giving clients a percentage of cash back.
The Benefits Of Going Cashless Should Overcome The Risks; And Tech Disruption Will Likely Support It
Individuals and small businesses, as well as regulatory authorities and government bodies are gradually becoming comfortable with non-cash payment methods. We believe going cashless has some clear benefits that will eventually outweigh the risks. Table 1 summarizes our view of the main benefits and disadvantages of going cashless.
Among the barriers to a smoother adoption of digital money, we believe that economic inequality and financial inclusion and literacy are increasingly being tackled by technological advancements. Whether propelled by start-ups, big corporations, banks, or regulators, tech disruption is acting as an enabler in developing economies. The Indian government, for example, already a decade ago put in place a voluntary digital biometric identity system called "Aadhaar" that provides a universal identity to every Indian resident that has gradually facilitated an electronic "know-your-customer" process and encouraged the previously unbanked to open bank accounts. Today, around 90% of the Indian population is enrolled in the program. Moreover, about 424 million new bank accounts for unbanked people have been opened under the Indian government's financial inclusion program Pradhan Mantri Jan Dhan Yojana since its launch in 2014, according to the government.
We think that the increased use of biometric technology could eventually lead to wider use of face-recognition payment systems, both physically and through online shopping. We already see some examples for low-cost transactions, in grocery stores and small businesses in the U.S. and Singapore. However, we think that this technology is still in testing mode and will take some time to take off more broadly because there are still important privacy and security concerns regarding the accuracy of the identification software and how data is stored.
Recently developed wearable payment devices are another example of technological advances facilitating financial inclusion and convenience. These can take form of bands, rings, key chains, or smart watches and allow people to make contactless payments without having to own a smartphone. Wearable payment devices are expected to expand fastest in APAC over the next few years, with Chinese and Indian manufacturers making them affordable for customers.
We think fintechs, in particular, are contributing to narrowing the financial-inclusion gap between many developing and developed countries. Some of them simply offer traditional banking products but at a considerably lower cost than banks (through peer-to-peer lending, money transfers, or currency convertors such as Wise, Revolut, and Azimo). Others are addressing specific niche customer needs such as partial salary-taking or loan advances. For instance, M-PESA is a regulated service that was launched first in Kenya by Vodafone that allows the transfer money via SMS securely and instantly. The service doesn't require customers to have a bank account, and permits cash conversion into digital money, bill payments, money transfers, or receipt of salary. Other fintechs (such as Uulala, Lenddo, ZestFinance, and Alipay) are playing a role in expanding access to existing financial products to a larger part of the population, either by helping them to improve their credit scores or by providing specific credit facilities and small loans to users with little credit history. A further group of fintech educators (such as Finimize, Yolt, Plum, and Cash Coach) focus on improving financial literacy.
|Selected Fintechs Focusing On Financial Inclusion|
|Fintech||Region where they operate||Focus|
|Uulala||Based in California, operates mainly in Latin-America||Facilitating financial inclusion of unbanked population through money transfers, physical payments, and ecommerce.|
|Lenddo||Based in Singapore, operating in latin America, South Asia, and Southeast Asia||Facilitates financial inclusion by using non-traditional data (social media) to provide credit scoring and verification.|
|Zest AI||Based in California||Facilitating credit underwiting by provision of artifical intelligence (AI) software to banks and specialized lenders.|
|AliPay||Based in Shanghai, operates mainly in Asia||e-wallet app that facilitates online and mobile payments.|
|Finimize||Based in London||Empowering people to become their own financial advisor by providing information in easy-to-understand and concise manner.|
|Yolt||Based in London, operates primarily in the U.K., Italy, France, and The Netherlands||Born from ING Bank, this app facilitates savings by tracking information on all bank accounts in one place through open banking.|
|Plum||Based in London, operates in the U.K., Greece, and Spain.||Money managemnet app that facilitates savings through an algorithm.|
|Cash Coach||Based in London, operates mainly in the U.K.||Facilitates financial literacy and management of personal finance through gamification.|
|Source: S&P Global Ratings.|
Systemic concentration of most payments among a few large card and e-wallet processing company giants is another key risk, in our view, and one that is not easy to overcome in the short term. Payment processors continue to amass market and pricing power, even though their fees have been capped by regulators in some jurisdictions. For example, over 95% of mobile payment in China goes through Alipay or WeChat Pay. The relevance of such companies is such that their combined market capitalization is equivalent to that of the U.K. Italy, Canada, Russia, and The Netherlands combined GDP (see chart 4). Like any market oligopoly, it is a source of systemic and concentration risk. As a result, governments and regulators are exploring alternative routes, either by requiring payment firms to deposit 100% of client funds with a custodian, as is the case in China, or by setting up national lookalikes or embarking on digital currency projects. In the longer term, we think that payment processors face greater risks of being disrupted, while tech giants with an e-wallet business are more diversified by nature, having higher chances of disrupting the payment market, particularly if emerging technology leads to a reduction of alternative channels by which payments flow.
Many consumers still distrust the lack of anonymity linked to digital money, or a afraid of feeding their data to tech giants and other financial institutions that can profit at the expense of consumers. Others fear cyber attacks could expose their private information. But despite these concerns, we believe that increasing reliance on technology for non-cash payments is inevitable. However, that doesn't have to result in technological dependence or increased cyber risk if appropriate regulation, privacy settings, and risks controls are defined and imposed on market participants.
Central Banks' Digital Currency Plans May Speed Cashless Adoption In Developing Markets
Until now, the countries most advanced in digital-payment adoption have been developed economies such as Singapore, Sweden, Australia, the U.S, the U.K., and South Korea (see chart 5). We attribute this to a combination of their innovation capacity, digital infrastructure, and government effectiveness. However, equally important is the openness to digital solutions and adaptation among the population. For example, Sweden's largest banks created Swish in 2012, a payment method app allowing instant electronic payments via phone by using digital BankID. Spanish banks followed in 2016 with their own version, Bizum. Both platforms have expanded their customer base exponentially from initially younger parts of the population, to broader use by older people.
By contrast, most developing countries have lagged behind in cashless adoption, primarily because they have lower technology penetration and weaker financial inclusion and literacy. This situation, however, has led to a faster adoption of more innovative payment methods in place of traditional cards or cheques. Table 3 shows some examples of emerging payment solutions that allow physical and online merchants to easily become part of the acceptance network and are usually less expensive than card fees.
|Emerging Digital Payment Solutions|
|Quick Response (QR) code payments systems||These have gained momentum, particularly in China, India, Vietnam, Thailand, and Africa in recent years. We believe the higher adoption rate in these countries compared with developed economies is because QR codes facilitate financial inclusion, as they do not rely on point-of-sale systems for merchants or cards for consumers.|
|PromptPay e-payment method||In 2016, the Thai government unveiled the national e-payment master plan, aimed at turning Thailand into a cashless society by promoting the use of e-payment in all sectors. In the first phase, the government launched an electronic money transfer service (PromptPay) at all major banks, enabling customers to easily receive and send funds using their national ID or mobile phone number instead of a bank account number. In its second phase, the plan will allow electronic payments for goods and services, personal income tax returns, and welfare services.|
|Jan Dhan Yojna Platform||In 2014, the Indian government launched this platform to foster financial inclusion facilitating the opening of basic savings bank accounts for those without one. The government also uses the platform for direct benefit transfer for its welfare and subsidies schemes.|
|Swish||This cooperation between Swedish banks started offering a digital real-time payment service for P2P in 2012 followed by a solution for companies two years later. Over time, the offering has been expanded to QR codes, e- and m-commerce to address changing consumer behavior. Today, 80% of the Swedish population uses the application, which offers a real alternative for cash.|
|Source: S&P Global Ratings|
We nevertheless believe that the dual-speed evolution of the retail payment market between developed and emerging economies might be about to converge as CBDCs emerge. Over 60 central banks globally currently have ongoing projects to develop them, which in our view might improve payment infrastructure and processes, enhance financial inclusion, and spur innovation (see "The Future of Banking: Central Bank Digital Currency May Replace Cash, Not Banks," published Dec. 2, 2020, on RatingsDirect). While the majority of central banks are still at an early stage of development, a few are already preparing for launch. The Bahamas is the only country so far to have launched a retail CBDC, the sand dollar in 2020 (see chart 6).
Impact On Bank Ratings Remains Limited For Now
We expect that the role played by governments, financial regulators, and supervisory institutions as designers and enablers of digital payment policies and solutions could increasingly impact our view of a banking system's institutional framework assessment and competitive dynamics under our banking industry country risk assessment (BICRA) (see chart 7). Historically, we have assessed regulators' ability to preserve financial stability through business cycles. However, technological disruption requires regulators to enhance the scope and role of their supervision. Central banks will want to ensure that the dominance of a few international payment providers does not expose national payment systems to vulnerabilities as use of cash declines. The European Central Bank highlighted in October 2020 the excessive market power that global Big Tech firms could acquire by leveraging on their large customer bases by initially bundling them with their other products and gradually extending them to broader use cases online and in shops. With the transition toward cashless societies, banking regulators are playing a key role in the trade-off between being supportive in building a framework that encourages innovation and mitigates social costs of leaving unbanked or less educated people underserved versus being too prescriptive and blocking innovation. Finally, regulators should ensure public alternatives for private payment solutions to protect private integrity and customer data from commercialization.
The European regulator already took a stance a few years ago with the implementation of the PSD2 Directive, which opened the door to new payment providers and increased competition for banks' revenues in the payment segment (see "European Banks Face Risks In Race To Implement PSD2," published May 16, 2019). Over the next few years, as CBDC projects gradually move to full-implementation mode, we will increasingly monitor central banks' role in distribution and implications in terms of monetary policy and sovereignty.
Banks' capability to provide market infrastructure and convenient payment solutions in the form of virtual wallets will be key in avoiding tech disruption in the transition to a cashless society. The ability of the banking sector--either by individual large banks or through cooperation--to speed up technological advancement in payments will, in our view, protect it from the increasing competition from non-banks as non-cash payments become instant and invisible. As such, we believe that over time the transition to digital money and incumbent banks' ability to adjust, or conversely their lack of a response, could affect our view of banking industries' competitive dynamics as competition on revenue streams from payments intensifies. According to an estimate by the consulting company Accenture, for example, global revenues from payments will increase to U.S $2 trillion by 2025, of which up to 15% could be at risk for banks.
That said, we believe the gradual reduction of cash will have a limited impact on the credit quality of banks over the next two to five years. Overall, the physical decline of cash usage should save costs for commercial banks by reducing operating infrastructure, namely branches and automated teller machines (ATMs). It should also reduce operational risks such as bank robberies or human cash mismanagement errors, contributing to operating efficiency.
However, banks that are better positioned for digital payment adoption could see a positive impact on their business position assessments if it gives them a competitive advantage over peers. For example, a bank deploying data to achieve greater information on clients' spending habits should contribute to commercial banks' revenue streams through targeted customer value propositions. Likewise, banks offering transaction banking services to corporations should be able to use their instant payment propositions as a building block to a full range of digitalized international treasury solutions and value-added services to companies. This will, nevertheless, require hefty investments in rationalizing bank infrastructures and processes in order to be able to serve corporate clients through unified digital cash management platforms.
Along this journey, some banks might decide to focus on what they do best and outsource their payment ecosystem to third parties. Banks with focused cloud strategies might increasingly outsource payment platforms by using "Payments-as-a-Service" (PaaS) cloud-based solutions (see "The Future Of Banking: Bank Cloud Adoption Goes from Blue Sky Thinking To Economic Necessity," published Feb. 8, 2021). These "renting what you need" payment platform solutions permit banks to avoid capex investments while gaining flexibility and outsourcing services such as fraud protection, keeping up with cyber-security standards and regulatory compliance. We are already seeing increased collaboration between banks and specialized payment fintechs (so called PayTechs) and BigTechs. We think these relationships will continue to strengthen in years to come.
Digital Designer: Tom Lowenstein. Editor: Jennie Brookman.
- The Future Of Banking: Bank Cloud Adoption Goes from Blue Sky Thinking To Economic Necessity, Feb. 8, 2021
- The Future of Banking: Central Bank Digital Currency May Replace Cash, Not Banks, Dec. 2, 2020
- European Banks Face Risks In Race To Implement PSD2, May 16, 2019
This report does not constitute a rating action
|Primary Credit Analysts:||Miriam Fernandez, CFA, Madrid + 34917887232;|
|Salla von Steinaecker, Frankfurt + 49 693 399 9164;|
|Secondary Contacts:||Deepali V Seth Chhabria, Mumbai + 912233424186;|
|Markus W Schmaus, Frankfurt + 49 693 399 9155;|
|Research Contributor:||Harshleen K Sawhney, CRISIL Global Analytical Center, an S&P Global Ratings affiliate, Mumbai|
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