How can we make substantial cost reductions to Europe’s payments? – An agenda for Banks, Outsourcers and the European Commission
Should be read in conjunction with The Outsourcer’s View – An Interview with Unisys.
The prize is great!! Across Europe there are hundreds of banks that collectively knit together to make up the European payment system. In its totality the European payments system is fundamentally inefficient. There is a very high degree of fragmentation of solutions and operation of what are commodity services, namely payments. The cost is difficult to assess but probably runs to billions of euros per annum. Much of this cost is caused by having to maintain and upgrade thousands of different software systems (hundreds of banks times tens of payment types).
We are not just talking about cross border payments, that is a payment from a person in one country to someone in another. We mean the provision of a small number of payments infrastructures to many banks in many countries. Even within a country cost savings can be made, however really major progress to cost eradication will require international economies of scale.
From the banks’ point of view there is a real opportunity to create extra profits from cost savings. From the European Commission’s point of view, market forces in banking services, combined with the cost savings would drive down transaction costs of European businesses and consumers. This would be a powerful catalyst for economic growth.
How can Cost Savings be Achieved?
The diagram below shows an abstract representation of a payment system. Click here for a more detailed explanation and how it relates to the UK payment systems (we do not talk about cash and cheque clearing systems in this article as the physical constraints of paper and cash movement limit the scope for cost reduction).
The main ways to see how to make inroads into the costs of the payment system are driven out of the following ideas:
- For a given payment type, Routing and Sorting functions can be rationalised from a country to international level (i.e. going from 20-30 such hubs in Europe to one or two).
- Bank functions that are specific to payment processing (e.g. payments error correction, authorising payments) can be rationalised within countries.
- Bank functions that are specific to payment processing can be rationalised across borders.
The mechanisms for reducing the duplication (and hence reducing the inefficiencies) of functions would be either:
- More common software components and platforms
- Greater outsourcing and joint ventures so as to share the human resources and software platform costs.
We present two examples of how this might work in practice; click on the headings of interest below.
The main message is that cost savings are achievable and that the approach and speed will depend on payment type.
The Need for Standards
What also becomes clear in the examples is a need for standards development and adoption. Standards would allow banks more freedom to “unplug” software and operations from their current setup and outsource them or replace them with more industry standard software applications. (The cost savings are not wholly dependent on standards but are hugely accelerated because an outsourcer can generate economies of scale much more easily from use of shared platforms.)
The crucial standards appear to be:
- A standard, at least at a national level, preferably at an international level, on a payment instruction produced by a Payment Interface point. Right now these vary between banks in one country and across countries (and frequently within a bank).
- A standard at an international level between banks for interbank payments. Every country has such a standard but for most payment types they are different from one country to the next.
- A standard for legal rights associated with payment types.
The Role of the European Commission
Banks will naturally, over very long periods of time evolve the payments systems to adopt standards so as to facilitate cost savings. The problem with this natural evolution is that it is desperately slow, because:
- Within countries, most payment types are regulated by a banking industry body that usually goes at the speed of the slowest member bank. Since at any moment in time one or more banks have a more urgent priority (e.g. a merger) than collective schemes to save money, they tend to move very slowly.
- International vehicles for interbank payments standard setting are generally even weaker.
There is a clear role for the EC to provide some leadership and drive here. The banks would probably be grateful for some unilateral standard setting in this area, given the inherent difficulties of multilateral agreements of standards by banks and/or country based banking associations. This is particularly true for the payments infrastructures which are underpinned by different legal rights and responsibilities in different countries, for example the legal rights of payment cancellation and their periods of effectiveness are different in different countries. Indeed, the legal implications probably mean it is impossible to achieve European scale payment efficiencies without legal standards produced by the EC.