Historically, payments has been a core banking business, and it remains a vital function. Payment interactions are banks’ most frequent touchpoints with their customers and account for 40 percent of bank revenues on average. But in recent years, banks have encountered challenges to this long-held strength.
Increasing competition comes from incumbent payments specialists (such as global processors and card networks), fintechs with targeted tech-driven offers, and big tech players seeking to expand their customer relationship into payments and financial services. This competition exerts pressure on the margins of traditional transaction-based payments revenues. Perhaps more significantly, there is a threat of banks being disintermediated and losing a direct relationship with the customer.
These trends have influenced share market performance. On average over the past decade, payments companies’ return to shareholders has markedly exceeded that of banks and other financial institutions. And during the COVID-19 pandemic, growth in e-commerce and digital payments has allowed tech-enabled payments “attackers” to accelerate growth in customer base and revenues, thereby achieving further outperformance in the share market.
Leading payments specialists have been able to win over customers through a more focused approach emphasizing customer experience and innovation to serve unmet needs. As they have scaled, they have built global technology platforms with investment envelopes that dwarf those of most domestic banks. In general, payments specialists face lower regulatory and compliance obligations than banks, and recent entrants are not burdened by legacy technology issues. In Asia, payments specialists have been bolstered by rapid growth in digital payments and some markets’ adoption of new, more open real-time payments infrastructure.
That said, changes in the macroeconomic environment and investor expectations have brought about a sharp decline in the valuation of payments specialists—tech-enabled attackers in particular—over the past year. But while their rate of growth has slowed, payments specialists are still expected to achieve annual revenue growth exceeding 10 percent per year.
Despite these threats, banks retain key traditional advantages in the battle for value in payments. They have large existing bases of customers with high levels of engagement and trust. They can also combine payments with core banking products such as deposit accounts and lending, enhancing the customer proposition and offering a proven path to monetization.
Successful banks are developing a new playbook for winning in payments—one that leverages their traditional advantages with lessons learned from payments specialists, including a reinvigorated focus on the customer. These banks see payments as a holistic business, not just an enabler. But they also recognize that, in an increasingly competitive global landscape, they need to be thoughtful about where they craft unique solutions in-house and where they partner with others to meet customer needs.
Banks that can move quickly in response to the challenge posed by specialists have the potential to secure their relevance in the future payments landscape. Beyond that, they can create an opportunity to use the payments relationship with customers to unlock new and more lucrative value pools by moving into the broader payments ecosystem and offering services beyond traditional banking products.
With many payments specialists under pressure from investors to shift their strategic focus from “growth at all costs” toward achieving profitability, it’s time for banks to seize the moment and reset their approach to payments.
To understand more about how banks are rethinking their approach to payments, we talked to executives from three leading banks in Asia: Rakesh Jha of ICICI Bank, Sandeep Lal of DBS Bank, and Ethan Teas of the Commonwealth Bank of Australia (CBA) (see sidebar, “My path to payments: Leaders’ personal journeys”).
Individual interviews have been edited and combined to create “conversations” on common and pertinent themes.
New entrants winning in the payments space
McKinsey: In recent years, payments specialists have flourished. What’s the secret to their explosive growth?
Ethan Teas: Two main drivers have really accelerated change: digital business models and the opening up of the payments system. Around the world, the ecosystem is being blown open to allow third parties to participate in ways we haven’t seen before. These new players are seeking to serve clients’ broader needs in a more integrated way, setting new levels of experience and convenience.
A great thing that some of the payments specialists have done is create a community of people trying to exchange value. They have a good understanding that there are two sides to payments. How can we enhance both end points? That’s something I think the banks could get a lot smarter about.
Start-ups have actually started setting the standards in many areas. Banks have to reach or exceed these—and we’re positioned to do so, if we choose.
Rakesh Jha: People have also been getting more comfortable with digital. Governments have been doing a lot to encourage digital payments with initiatives like India’s Unified Payments Interface [UPI], and the availability of data has improved so much. And, of course, we’ve seen digital adoption accelerate during the pandemic. Overall—across retail, small and medium-size enterprises [SMEs], corporate—customers are evolving, the products are evolving, the economy is evolving. If you miss this bus and don’t keep pace with changes, you can get outdated very rapidly.
Sandeep Lal: The market is valuing some payments companies highly because they believe that’s where the growth and the margins are. And start-ups have actually started setting the standards in many areas. Banks have to reach or exceed these—and we’re positioned to do so, if we choose.
Payments remains a vital function for banks
McKinsey: Given the competitiveness of the sector, do you still view payments as a significant and profitable part of banking business?
Sandeep Lal: Payments continues to be very, very important. For banks, payments is core: we have to be efficient here. It’s all about having very good technology, good systems, and good capability. People say, “Hey, there’s a lot of disruption in the payments space.” But if you go to the banks and see their volumes, they’ve only increased. The banks have continued to play well in that high-value space where a lot of trust is required.
Rakesh Jha: The revenue model for pure payments is not well established; you don’t really make money off it. Many players see this as their core business while looking at getting into small-ticket lending. That’s not easy; not many are able to scale that. But as a bank—because customers do payments through you, do collections through you, do transactions through you, and maintain balances with you—there’s a clear revenue model that enables you to make money from payments.
Sandeep Lal: Banks have access to the clearing system; ultimately all the payments start-ups and fintechs are plugging into banking networks. We’re also direct participants in foreign-exchange markets. So our ability to do payments, the speed and value we offer, should at least equal those of the fintechs.
Rakesh Jha: There’s always a discussion about the flexibility or agility of a more traditional bank versus a fintech. If you can balance that, then you have all the benefits of a bank: you enjoy the trust of the customer, you’re a regulated entity, you have a large customer franchise […] any day, I would take that as a starting strength, versus being in the other shoes. But we have to be conscious that it’s not going to be as easy for us as it is for a fintech which has just come up, because their technology will be very different. They typically solve very precise customer problems in a focused manner—not like a bank, where we’re looking at the entire spectrum of products and services.
The banking advantage: Customer trust
McKinsey: You mentioned trust. Is that key to how banks retain the loyalty of payments customers?
Rakesh Jha: It’s no longer easy to differentiate yourself as a player in financial services. The two areas where you can differentiate, in my mind, are trust and service. Trust is a pillar that we focus on. Our core philosophy is being fair to the customer and fair to the bank.
Ethan Teas: We have over ten million customers engaged with us as a bank on the consumer side. And then on the business side, we have an incredible business franchise. The customers have deep trust in the bank to meet their needs and to do that in a really safe way—which is critical in payments, especially in an instant-payment environment, where risk can manifest very rapidly. Anyone standing up a new business centered on payments would have difficulty replicating that.
Sandeep Lal: When you deal with a bank as a consumer or as a corporate, you assume you’ll be dealing with someone who will do things safely. Particularly when you’re doing anything high value, you go to a bank, rather than to a company which isn’t that well known, even if their pricing is superior. Our risk management continues to be very strong, and I’d argue this is the core of our capability.
Ethan Teas: We can complain about legacy technology slowing us down, but the great thing about banks is, because we’re incredibly highly regulated, when you think about the technology stack that we’re running, it’s well proven to be safe and reliable. And we have the ability to keep that technology just as safe and reliable as it is today. Our ability to operate as a technology company in these high-stakes, highly regulated areas—that’s something many of these other players have not had to deal with and haven’t demonstrated 50-plus years of strength in doing.
Customer experience is key in the payments space
McKinsey: You have customer trust, but do you have their enthusiasm? How can banks outdo the experience that other payments players offer?
Sandeep Lal: As a bank, how do you make sure that the customer experience is state of the art and top quality? You can look to the fintechs and others around you and say, “What are they providing? Is my experience better in terms of speed, convenience, security, safety?” And if you can then define what you want to play on—whether it’s safety or the cheapest price—that’s your call. But you have to realize it must be competitive. The field is evolving, and you have to keep your eye on it.
Ethan Teas: We aim to meet our customers where they are and bring them the experiences they’re looking for. Buy now, pay later [BNPL] is an interesting example. It has exposed a need that has been there for a long time but never really was chased by either incumbents or start-ups. It has shown the power of explicitly bringing the two sides of a payment transaction together in a way that creates new sources of value. This meets the desire of a segment of consumers for a different type of credit and also helps merchants expand. We’ve worked to offer that same experience, but safely.
We need to go back to the really simple stuff. We’ve got to understand why our customers are using us for payments and why they’re not and then seek to close the gap.
Cross-border payments is another example. Digital players are now accelerating long-standing remittance models. I look at most banks, in terms of what making an international payment involves, and the customer experience could be better. We have to make that ground up.
Rakesh Jha: With remittances, we’ve tried to keep our thinking focused on simplifying the process for the customer. Initially, it was a separate application, then it was integrated into our internet banking platform, and then the mobile application. It has picked up very rapidly. We keep the customer at the core of all that we’re doing.
Ethan Teas: How do we play it? Number one, we need to think about our customer experience and this great advantage of being convenient to our customers. That convenience is starting to erode as the infrastructure is changing, so we need to go back to the really simple stuff. We’ve got to understand why our customers are using us for payments and why they’re not and then seek to close the gap. Recently, I’ve seen banks become much more open to looking beyond banking or even finance to understand what “great” looks like.
Moving into the broader payments ecosystem
McKinsey: There’s a growing array of digital services, like embedded finance, outside the remit of traditional banking. Does “meeting the customer where they are” for banks include stepping into new functions and ecosystems?
We try to reimagine the customer journey in a digitally enabled environment. It’s not limited to banking—we look across the entire space.
Rakesh Jha: It has become important to have offerings beyond your market banking products. We try to reimagine the customer journey in a digitally enabled environment. It’s not limited to banking; people are shopping daily on Amazon, they’re on social media, they’re on all the travel apps. So we look across the entire space. This has become even more relevant in the last two or three years, because everyone has gotten more exposed to doing things online.
Ethan Teas: At CBA, we’ve brought on a solution which moves us up the hospitality industry value chain—not just accepting payment, but helping customers run their business. The same with shopping: we’ve made investments which allow us to help consumers find offers that are valuable to them. At the same time, we can help merchants to introduce their business to new consumers—again, using our payments products to bring that two-sided marketplace together.
Rakesh Jha: We’ve also moved, in a very conscious manner, to offer financial and nonfinancial services to customers who don’t have bank accounts with us—with, for example, our mobile apps. Our objective is to get customers to experience the services of the bank. In the long run, that’s our focus with payments: to have another way of sourcing customers and to deepen relationships. As customers become active on these channels, the business they do through us increases, resulting in higher balances on the deposit side and much higher levels of data.
Keeping pace with global players
McKinsey: Some global payments specialists command massive resources. Can regional or national banks compete?
Ethan Teas: Any large bank can bring a lot of resources to bear. But if you look at the global payments companies that are working to enter financial services, some of them have almost unlimited development budgets. We’re creating customer experiences that have to stand up to what they produce. As banks, we do have to face reality. How do you move rapidly and at the same time really selectively, respecting the resource constraints that any individual incumbent is going to face?
Rakesh Jha: The kind of capital that some companies can commit is huge. But many of the big tech players entering payments are very clear that they don’t want to get into the shoes of a bank. As they come in on the payments side, we will partner with them and ensure that we’re part of the overall ecosystem.
Sandeep Lal: Different people will be good at delivering different pieces, so partnerships are going to be very important. Each is going to play to their strengths. Start-ups may play to the front-end or checkout piece, which they do very, very well; there may be people who are playing to the acquiring piece. DBS will play to the credit piece or the cross-border piece. Then you’ll have someone who will cobble a few of these things together and say, “OK, we’ll find a solution for you.” You’ve started to see this happen already.
Rakesh Jha: The banking landscape, the potential customer base, is so large, we can’t do it all on our own. Partnership is the way to go, and the partnerships we look at are across businesses, across customer segments, not just in the payments space or in fintech. And it has to be a win–win relationship; it’s not that we have to be the only gainers from this. We believe in long-term partnerships which are scalable and which can provide growth opportunities to both partners.
Sandeep Lal: It’s important to focus on where you can win. Decide where you want to play, where you have strength, and where you don’t. There was a lot of discussion, for example, in DBS when we chose to be a wallet player in Singapore but not in India. We felt that as a bank, we were not best suited for this in a large geography where we didn’t have a natural footprint or customer base. But in Singapore, where we did have a natural customer base, we said, “Let’s do it.” And now we have a good wallet product here in Singapore. You’ve got to be thoughtful about it.
Ethan Teas: Remember, too, that banks have built a network across the entire sector. While other payments players are seeking to create an all-encompassing ecosystem, the big problem they’re going to have is reach. But the banks have a reach that’s unmatched.
View payments as a business, not just an enabler
McKinsey: It seems a significant change in approach is required of banks in the new payments landscape. What can bank leadership do to ease the transformation?
Rakesh Jha: Things need to change, not just in terms of customer-facing platforms and solutions, but also in the core architecture of the bank. It must become much more modular for us to deliver changes at speed. For us, this is not something that’s owned by any individual or department; each team is responsible for enhancing innovation.
Sandeep Lal: One thing I would advocate is that, over time, banks should view payments more as a business rather than just a hygiene factor or an enabler. There needs to be a bankwide focus on ensuring the best set of capabilities. For banks that play in multiple markets, while payments can differ with geography, the nature of the disruption or competition is often similar, so there’s a real opportunity to share lessons from one country to the next.
Ethan Teas: You need a somewhat top-down approach to drive change. It’s incredibly important to bring the most senior leaders in the bank on the journey. When you look at many banks, the CEOs come from a variety of different backgrounds: some come from payments, others don’t. How do you ensure that the CEO and the entire senior-management team have visibility of payments and understand the landscape and what outcomes we’re seeking? My observation would be that the banks with senior leaders who really “get” payments are the ones that are going to be most successful in this world.
The future of payments: Where next for banks?
McKinsey: What’s your vision of the future role of banks in the payments space?
Sandeep Lal: It’s a fast-evolving space. The high valuations have attracted a lot of players, and it’s a challenge to keep up. The endgame is to ensure that banks evolve along with the marketplace and that we have top-notch infrastructure that allows us to deliver to our consumers and to our corporates.
Rakesh Jha: We actually see new players coming into the payments space as something that will widen and develop the market. It will increase the bankable population and accordingly increase the opportunity pool for banks like us. With payments, our focus is not so much on reducing costs; for us, the focus is how we can meet customer needs in a seamless manner and create opportunities to do more business in the future.
Ethan Teas: We are focused on reimagining our products and services for the digital age—ensuring that we’re as modern and dynamic as possible while building core capabilities. We need to think about the future and understand how we get there, organically or through a step change. The thing I’m most excited about is working across the seams—creating these two-sided experiences that are positive and bring value for both business customers and consumers. Basically, payments are a means to an end. And the end is delighting our customers, right? We have this opportunity to move beyond banking and serve our customers more completely.