The world of paper money, cheques and settlement networks has been good to the banks. In Frictionless money, a report on the likely future of payments in the electronic age, Logica Consulting cites the Boston Group’s estimate that the world’s banks make some $200bn from running domestic payments systems and a further $28bn from the payment networks for cross-border transactions.
This is a lot of money for a slow service. What makes it even more annoying is the fact that the banks make revenue out of the delay by charging interest on the outstanding funds. The banks’ happiness with the status quo is plain to see: I am a bank; you give me money to give to B, whose account I also hold; I don’t give it to B for, say, five days and I charge B interest on his/her overdraft for those five days; also, I have free use of that money for those five days, as well as very low-cost use of it until B empties his/her account; I also charge both you and B for the privilege.
Of course, if B’s account is with another bank, it shares in the profit from the delay, so there is next to no incentive to speed things up.
This system is nice for the banks, but every dollar charged and every second of delay represents a cost to businesses and consumers. However, it may be about to change. Jerry Norton, Logica’s director of strategic development, explains that there is now an unstoppable trend towards instant transfer of value. This will eliminate paper and all the delays associated with processing paper, and is fundamental to the revolution in both payments and money that Logica anticipates.
With today’s technology, when company A receives a crate of widgets from company B, it is already theoretically possible for the receiving agent to authorise the instantaneous movement of funds from A’s account to B’s.
The system could be set up so the receiving agent’s mobile device sends a signal to A’s bank, which can then send confirmation of the transfer to B’s mobile device. The driver of B’s goods could depart A’s premises happy in the knowledge that he had just enriched his company by the value of that crate.
From B’s perspective, two major benefits follow. Firstly, it would begin to earn interest on A’s funds instantly. One notable feature and benefit of the instantaneous settlement process Logica envisages is that banks would be pressured into calculating interest on a per-minute or per-second basis, rather than daily. Secondly, B would be able to eliminate a whole tranche of administrative processes, since it would not have to extend credit to A, with all that means in terms of credit control, aged debt analysis and debt chasing.
In a funny way, the elimination of credit would also open an opportunity and revenue stream for banks, since companies would have to fund their working capital from their own resources and from their bank, rather than by taking liberties with their suppliers.
In this example, if we strip out the issue of whether A and B really would deal with each other on a “settlement on receipt of goods” basis, and instead look more closely at what is really going on in the instantaneous transfer of funds between A and B, some very interesting issues emerge.
One model of how this exchange could happen simply layers the electronic transfer of funds on top of the existing banking structure. The major difference here is simply the addition of wireless technology and PDAs, supported by a banking payments network that can remit funds electronically and near instantly between A’s bank and B’s.
A second model, however, could equally well see both A and B, or at least one of the parties not “banking” with a conventional bank at all. In this model, B’s account could be held by a telco, or a consortium, comprising a global network of retailers. The settlement mechanism here would be the internet, pure and simple. A third, and even more radical model, would see the transaction taking place not in some government approved currency, such as sterling or the euro, but in some form of e-money, issued by the consortium.
There may even be a “foreign currency” conversion element if A, say, holds its account in sterling, while B, although headquartered in Watford, prefers e-money, issued by the mega-consortium, Global Utilities and Storage, headquartered in Korea. The Logica report does not actually envisage governments having much trouble containing the challenge posed by e-currencies. Nor, ultimately, does it see any necessity in the banks losing their struggle with new age wanna-be banks of whatever stripe, telcos, giant retailers or anything else. However, banks will have to wake up to the challenge if they are going to survive.
Tim Willey, strategy consultant for Andersen Business Consulting, agrees that banks and the major card issuers have a real lead in the business of assessing and managing credit and settlement risks. However, as a specialist in mobile wireless e-payment technologies and the various plays being made in this sector, he reckons that the potential power of e-money to transform the nature of the banking game should not be under-estimated.
“Singapore has already announced that it is going to be an e-cash society by 2008. It is the first country to take such a bullish stance on e-cash, but others will follow,” Willey says. And he points out that a company called Fundamo is already looking to transform the African market by deploying a network aimed at facilitating micro payments from mobile phones.
One of the major barriers to progression is the embryonic nature of standard setting in e-money. Another is the poor reputation telcos have, by comparison with banks, when it comes to customer service. This can be a tricky point to make for anyone who remembers the way banks panicked and closed up relatively healthy businesses during the Thatcher-era recession. But things have moved on, and telcos, with their habit of making their customers queue for ages to get through to what they laughingly term their service centres, probably have even less goodwill to trade on than banks. They certainly can’t match the banks or the card companies in terms of mind-share when it comes to managing money.
Rather than taking over banking from the banks, Willey predicts that telcos and the traditional credit and payment players will find their best short-term game will lie in partnering with each other. “For example, Visa has already set up working relationships with all the major GSM wireless operators. It is developing an e-cash payment chip in partnership with Nokia, which will be placed inside Nokia mobile phones. This chip will authenticate payments and handle the encryption,” he says.
In Willey’s view, telcos already have enough problems right now, without expanding into a field they know nothing about. However, he warns that there is no room for complacency among the banks. “Instant e-cash and e-settlements call into question the whole point of banking. They put a real question mark over the banks’ current business model,” he says.
Logica’s Norton argues that the biggest pressure on banks comes from corporate clients and the EC. “Right now, the friction costs (costs associated with shoving paper between physical systems) are far too high. This is already exercising the European Commission, which wants to drive margins on intra-eurozone deals down close to zero,” he says.
A second force driving the banks to act is the issue of customer ownership. “The banks today are not worried about the telcos and others eating their lunch,” says Norton. “The thing that really concerns them is the prospect of mobile phone operators with millions of customers coming to them and saying: ‘Hey, my customers all want mobile banking. I’m going to charge you 8% on every deal to get access to them, OK?'” Already, Japan’s DoCoMo collects a charge from the customer for every deal done through its network – it passes only 92% of payment to the retailer.
Frictionless money is published by Logica. For information call Jules Wright 020 7446 4655.
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