HSBC Corporate Insights

Breaking the Payments Dam:

External Forces Transforming the
Payments Ecosystem
HSBC View
Welcome!
The payments ecosystem is facing changes like never before, It’s those who
with opportunities – and challenges – for all. What better time to are most
launch this new initiative to help ensure you make the most of
these changes. adaptable to
We’ve teamed up with Celent to provide the industry with a regular
change that
stream of reports, exploring the key issues that the industry faces. survive.
They’re not just more reading for you – we’re supporting each report
with live webinars, video interviews and in-person events. We want
these insights to be valuable for all of us, as these changes are
The question
impacting banks as much as they are impacting corporates. Hearing is then--
from you is important, so please do engage in the conversation. just how
The reports are written independently by Celent, a leading research and adaptable are
advisory firm specialising in the Financial Services industry. In you?
partnership with Celent, we hope to bring you insight into the rapid
changes we are experiencing in our industry.
This first report highlights just some of the major external impacts we all
face today that are likely to be a catalyst for major change in payments
over the next few years, with a focus particularly on technology. FinTechs
The conclusion may surprise you. Celent makes a compelling case that will become
corporates shouldn’t want FinTechs to continue to rise and banks to fall
out of favour. Furthermore, they assert that the FinTechs will become
reliant on
reliant on banks, rather than compete with them, for their own long term banks, rather
survival. than compete
Our observation is that it’s an ecosystem we operate in, not a vacuum. with them,
There will always be an evolution in how the ecosystem functions– but for their own
it’s rare that there is revolution that leads to extinction. It’s those who are
most adaptable to change that survive. The question is then-- just how long term
adaptable are you? survival.

Diane Reyes
Group General Manager and
Global Head of Payments and
Cash Management, HSBC

Published: November 2015

HSBC Bank plc. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct
Authority and the Prudential Regulation Authority.
Registered in England No. 14259
Registered Office: 8 Canada Square, London, E14 5HQ, United Kingdom
Member HSBC Group
BREAKING THE PAYMENTS
DAM
EXTERNAL FORCES TRANSFORMING THE PAYMENTS
ECOSYSTEM

Gareth Lodge
November 2015

This report was commissioned by HSBC Bank Plc. ("HSBC") at

whose request Celent developed this research. The analysis,
conclusions and opinions are Celent's alone, and HSBC had no
editorial control over the report contents.
CONTENTS

The Payments Dam Bursts ................................................................................................. 1

Key Research Questions ................................................................................................. 2
Today Is Different ................................................................................................................ 3
Forces Shaping the Future.................................................................................................. 5
Technology ...................................................................................................................... 6
Competition ..................................................................................................................... 8
Regulatory ....................................................................................................................... 9
Economic ......................................................................................................................... 9
Customer ......................................................................................................................... 9
The Path Forward ............................................................................................................. 11
The Banks...................................................................................................................... 12
The Corporates .............................................................................................................. 13
The FinTechs ................................................................................................................. 13
All in This Together ........................................................................................................ 14
About our Research .......................................................................................................... 15
Using Seasoned Professionals ..................................................................................... 15
An Unparalleled Network ............................................................................................... 15
Robust Research Methodology and Independence ...................................................... 15
Leveraging Celent’s Expertise .......................................................................................... 16
Support for Financial Institutions ................................................................................... 16
Support for Vendors ...................................................................................................... 16
Related Celent Research .................................................................................................. 17
THE PAYMENTS DAM BURSTS

Most people can think of industries that started out as exciting but became commoditized.
Rarely, though, has a commoditized utility emerged to become sexy and take centre
stage. Payments are perhaps that so-called overnight success that has taken decades to
happen! Pent-up demand for modernization has built to the point where the dam holding
back change is under enormous pressure; new entrants and new ways to pay have
moved payments from being a dull (but necessary) backwater to a space that has more
start-ups and more investment than almost all other areas of banking put together.

The visibility of payments to the end user has been transformed with mechanisms like
PayPal, Square, and Apple Pay widely known about, if not always understood. Querying
“payments” on the startups funding site AngelList returns more than 3,200 results.

And it’s not just large, existing payment companies attracting interest. Payment
processors used to be infrastructure owned and used by banks. Today large investors
have spent billions acquiring processors and continue to offer eye-watering sums for the
other players in the market. Established businesses such as Worldpay and First Data are
filing for some of the largest IPOs ever seen, and large technology firms are buying
smaller rivals for large sums, such as the $1.1 billion D+H paid for Fundtech.

Considering electronic payment types have existed for many decades, why now? Or,
perhaps even more pertinently, why at all?

Several factors, not least technology, are driving this dramatic shift. Thirty years ago,
banks were at the leading edge. Networks such as SWIFT pushed the boundaries of
what was possible. Even until the early days of the dot com era, banks were still on a par
technologically with their customers. The last decade, however, has seen banks’ IT
remain static, whilst customers have accelerated away. In effect, there has been a
technological seesaw.

This has manifested itself in a number of ways. On the demand side, corporates seek
more sophisticated solutions that align with their processes. They’re not looking for the
proprietary one-size fits all software that they feel banks now provide. The largest banks
broadly offer the same package of products and services across delivery channels, with
little differentiation. On the supply side a new breed of suppliers – FinTechs – is entering
the market. They have a number of distinct advantages:

• They’re built using modern technology, often unencumbered by legacy systems – or

thinking
• They’re cherry picking specific functions or services, rather than trying to provide
everything
• They’re less regulated (and in some cases unregulated – at least for now) and so
escape the cost and complexity that many banks face.

The net result is that these FinTechs are starting to make inroads into what has
traditionally been a bank-only market, making the corporate payments ecosystem a
rapidly evolving space. Yet it’s not clear quite how the forces will affect this complex and
finely-tuned ecosystem, and how it might evolve in response. This report highlights those
external forces, with the prime focus on technology, by exploring three key research
questions.
 KEY RESEARCH QUESTIONS

What are the main How must key

How will the

1 forces transforming
the payments
ecosystem?
2 payments
ecosystem change? 3 players evolve their
processes and
relationships?

Some commentators have suggested that banking is facing its “Kodak moment,” that if it
doesn’t evolve quickly enough that it is going to be replaced by FinTech firms.

Celent’s conclusion is somewhat different. Our assertion is that Banking will change, but
banks themselves will not disappear, at least not all banks. Whilst in many markets there
are new challenger banks entering, overall Celent believes there will ultimately be fewer
banks. Furthermore, we believe FinTechs and customers should hope that banks don’t
disappear as it would be potentially disastrous for both.

FinTechs will seek stickier, less volatile routes to market; the most obvious is the banks
themselves. Banks have customers but need modern technology; FinTechs have modern
technology but need customers. Ultimately the customer benefits more than either the
banks or FinTechs going it alone.

There will undoubtedly be tension between the three because their starting points,
strategies, and goals differ. Ultimately, because banks have the most to change, the
financial institutions able to adapt most quickly and completely will be those that reap the
greatest rewards. Make no mistake, however: as the payment dam bursts, every player in
the payments ecosystem will need a set of robust strategies and partners to navigate the
ensuing rapids.

Chapter: The Payments Dam Bursts

2
TODAY IS DIFFERENT

The payments world is facing unprecedented change for reasons internal and external.
On the internal side, payments have historically been an overlooked area, but
technological and competitive forces are intensifying. Externally, a confluence of factors
driven by economics, regulation, and customer demands is reshaping the payments
ecosystem in fundamental and profound ways.

Key What are the key forces transforming the payments

Research ecosystem?
Question

1 Technology is spurring new competition,

compounded by regulatory and economic pressures
and changing customer demands. With the greater
levels of pressure banks are under, change is
inevitable.

Making a payment looks deceptively simple. Yet the many steps needed to initiate and
settle a payment require intricate technology and orchestrated standards, coupled with
trust and co-operation; together they make payments almost a dark art. When the SWIFT
network was built, it was at the leading edge of technology across any industry, anywhere
in the world. Today, no new entrant into the market would build a similar infrastructure,
but would instead harness the cloud and use the infrastructure of others.

And whilst some aspects of banking, particularly capital markets and trading, have
continued to push the boundaries of technology, particularly around latency, significant
other areas, like payments, haven’t fundamentally changed. There are three good
reasons for this.

First, payments are a two-sided process that has to work for everybody, in the same way,
every time. Every change has to be either backwardly compatible, or every single party in
the value chain has to change at the same time. Simply stated, it’s big and it’s
complicated to do anything.

Second, payments have traditionally been seen as a cost of doing business, rather than a
business themselves. As a result, banks with limited funds for discretionary investment
have had to focus on cost, rather than revenue, and have kept many of the payment
developments to the bare minimum required. That's partly why many banks still have old
technology. It may be old, but it’s paid for and does just what is required, and nothing
more. That used to be sufficient for banks.

The third and final factor is that payments growth has surpassed anyone’s expectations.
Chapter: Today Is Different

In truth, no-one really ever thought about how many transactions might happen
electronically, and how quickly.

One of the realities that the credit crisis highlighted was that the world kept turning –
people kept making payments, and indeed, volumes even grew during the period.
They’ve kept growing, as Figure 1 shows, with growth in some developing countries
increasing at even greater rates. Each transaction has a fee attached to it, meaning that
as volumes rise, with costs being relatively fixed, payments has become more and more
attractive.

3
Figure 1: Payment volumes globally continue to grow

Source: Celent Global Payments Database

As a result, attention has turned to payments like never before. The question has shifted
from will payments evolve, to how they’ll evolve; the variety of potential paths is
staggering.

Chapter: Today Is Different

4
FORCES SHAPING THE FUTURE

How will the payments ecosystem change?

Key
Research
Question
Corporates will have more choice and leverage as

2 new competitors enter and the dynamics of power

change.

Each bank is a complex system, and those systems differ dramatically across banks. We
therefore find it helpful to draw some lines around broad areas of concern, understanding
that each bank’s journey will depend on where it is today, where it wants to go, and the
constraints it faces.

Banks operate within the context of a much broader ecosystem, one which includes
customers, vendors, regulators, counterparties, and competitors. Many institutions have
historically preferred to do as much as possible on their own, and it might even be said,
unkindly, that banks didn’t play well with others. But the number and intensity of
interactions with other members of the ecosystem is increasing. Driven by necessity,
banks will have to improve their partnering skills if they are to continue to offer a
compelling set of products and services. Going it alone is no longer an option.

Figure 2 illustrates this flow of influences and impacts, and forms the basis of how to
explore the changing face of payments and cash management.

Figure 2: Institutions must adjust their business models to adapt to a changed banking ecosystem

Chapter: Forces Shaping the Future

Source: Celent

5
While coping with these external forces, of course, banks must contend with the difficult
internal realties of today’s operating environment: a complex set of legacy systems and
culture, a budget-constrained operating environment, and regulatory demands for data
that has to be extracted in ways that architects never contemplated when first designing
the technology. Acknowledging that, five key external focuses warrant further
examination.

TECHNOLOGY
Banks have many, many pieces of disparate payments technology, with some parts older
than the people maintaining them in. Cutting-edge when first installed, they have
accreted over time into inflexible behemoths, further complicated by M&A activity and
geographic expansion. A tier one bank might easily have over 100 payment systems.
Typically taking a fast-follower approach, banks are striving to bring their payments
systems up to date to keep pace with the ongoing and significant advances occurring
elsewhere in the industry.

Payment Services Hubs are a good example of this modern technology, architected in a
different way than existing platforms and engines. In a little over 10 years, payment
services hubs have gone mainstream. Celent estimates that 80% of the top 40 largest
banks in the world by assets have at least one payment services hub. Java and J2EE are
another example. When VocaLink, the UK ACH, proposed to build its new platform using
these technologies, there was a great deal of debate and skepticism. Yet within five years
of initial implementation, most in the industry employ them.

And yet, even for big banks, five to ten years for significant industry adoption is the norm.
That many smaller banks have yet to implement some of the payments technology
already serving the majority of their larger counterparts highlights the challenge they’ll
face with upcoming innovations. Four inter-related areas of technology – cloud,
openness, real-time, and analytics – will have profound impacts on payments. Each has
the potential to dramatically change a bank, but because of the complex and inter-related
nature of banks’ systems, implementing these technologies at production level is taking
longer than an observer from outside the industry might expect.

Cloud Delivery Models

The changing nature of payment execution and servicing brings together a number of
ideas. Whether it’s called cloud or SaaS, or something else, the paradigm shift is
enormous. The U.S. National Institute of Standards and Technology says cloud
computing “…enables ubiquitous, convenient, on-demand network access to a shared
pool of computing resources that can be rapidly provisioned and released with minimal
management effort or service provider interaction.” [Celent emphasis]

As banks test the waters, there have been a few modest cloud projects (typically avoiding
external cloud) focused around either a fairly basic proposition – cheap storage for
Chapter: Forces Shaping the Future

example – or as simple cost reduction measures. Neither is bad, and banks must
certainly become comfortable with cloud before implementing it at scale, but they
perhaps miss the bigger opportunity.

FinTech players have the technological advantage of having started with a blank sheet of
paper. Almost every single one builds in the cloud, to operate in the cloud. Some
payment services hub vendors with cloud-based delivery options suggest that the cost to
deliver their solutions is approximately 10% of a bank’s; this is before calculating
additional benefits like agility and the ability to process large volumes of data more
quickly, a prerequisite for big data analytics.

While banks are understandably concerned about security, the potential benefits of cloud
are significant enough, and the threat of new entrants formidable enough, that banks
should accelerate their efforts in this area.
6
Openness
Bankers and their customers are changing the ways they work and play. Indeed, as
institutional customers experience sharing-based innovations in their personal, non-bank
life, they expect banks to begin to do the same. Yet many commonly used practices have
yet to be widely adopted in banking.

A keystone of easier information sharing is open standards. Banks have traditionally

used their own proprietary software or industry-specific pieces of technology. Any change
to any part of the process requires significant effort; even if the change is relatively
simple, it still requires weeks, if not months, of testing. The industry recognizes this is a
problem, and is gradually moving towards creating common standards – the Open Bank
Project and BIAN are just two examples – though adoption is slow and patchy. From the
customer’s perspective, it looks much worse. They don’t even get the same levels of
service and functionality across channels and countries with one bank, let alone the
same functionality and technology across several. Whilst standards adoption such as
ISO20022 perhaps provides some level of bridging, even with these protocols, wholly
consistent adoption is rare.

APIs are a specific instance of openness. And yet there is much consternation in Europe
about the use of APIs to provide access to account level information, and much
handwringing about whether banks should do it, let alone how they can do it. Yet other
organizations – PayPal, Visa, Apple and Google – have put APIs at the heart of their
business. They start from the default position that sharing data allows greater
collaboration and better innovation.

Embracing an open mind-set is a difficult cultural shift for banks, yet it’s at the foundation
of their nimble competitors’ philosophies.

Real Time
Most in the payments industry think reflexively of real-time payments. But there is a
growing expectation of everything being instant, and on demand, from reporting to
decisions. That implies that everything within a bank has to be real-time, and not just the
obvious parts of the value chain. Furthermore, real-time encompasses 24/7, on demand
and single message. Few banks have this kind of capability, with most still relying on
batch systems and regular maintenance windows.

Moving to real time will improve customer experience, improve agility, and reduce costs
(after initial investment).

Analytics
This leads to a related area that banks seem to struggle with: analytics. Here perhaps
the case is slightly different – banks are well aware of the benefits but are challenged by
their previous engineering. Bank systems were designed to secure and store data, rather
than share and use it. Control of the data is still required but banks need to find better
Chapter: Forces Shaping the Future

ways to work with it. If done after the fact, analytics are simply historical enquiry. But
executed in real-time, they can positively affect a transaction as it happens.

Improving analytics will broaden the range of services banks can offer their customers
and increase revenue opportunities.

On the Horizon
Other technologies developing fast will undoubtedly have an impact, yet no one can quite
predict what and when. Blockchain is a good example. The underlying distributed ledger
offers many dramatic possibilities. A consortium of nine of the world’s largest banks is
exploring its uses and the Bank of England’s’ Chief Economist has suggested that
replacing cash with a virtual currency may have some very real benefits. Corporate banks
are abuzz with Blockchain’s potential and innumerable experiments are underway. The

7
speed with which banks have taken notice has been breathtaking: six months ago the
topic was just beginning to be seriously discussed. This willingness to embrace the new
is extraordinarily encouraging.

While various aspects of technology are important for banks, they’re also the driving force
behind new competitors.

COMPETITION
Competition is a fact of life. What is changing in payments, though, is the nature of that
competition. Banks have typically and rightly looked at other banks as their rivals. Until
recently, banks only had to be as good as their local competitors. Regulation and
globalization have somewhat changed that. “Somewhat” because to date, despite the
best efforts of regulators, customers have begun somewhat slowly to use services
provided by non-banks, many of whom are either unregulated or subject to low levels of
regulation.

These non-bank services are often delivered by technology firms that not only have
adopted the four technologies outlined above, but which have been designed from the
ground up with those forces in mind. Whilst banks talk about their clients increasingly
being “digitally native” and their need to become “digital,” it is striking that these new
entrants don’t use the term at all; they’ve simply never known anything else.

Take SWIFT Service Bureaus. Since SWIFT finally opened up direct corporate access,
the majority of corporates now accessing SWIFT directly – over 80% – have chosen to do
so by using a SWIFT Service Bureau, rather than using their bank’s connectivity solution.
The bureau solution is often not even local to them. Their RFP lists have often been
global in nature, with bureaus many of the banks haven’t even heard of previously.

The corporates who access SWIFT are multi-banked. They’re discovering that a bureau
can act as a multi-bank aggregator. Instead of having to rely on each bank’s proprietary
software, the corporate can use a bureau as a single aggregation pipe. Whilst the
bureaus are at pains to say that they’re not disintermediating the banks, they are
increasingly at least providing the corporates with choice and flexibility that the banks
cannot. Whilst corporates have more control using a bureau, their use has yet to
significantly impact the corporate-bank relationship (although it is easy to see how it
could).

On a broader scale, there are an increasing number of solution providers who are
targeting corporates with new technology and with solutions designed around specific
corporate processes. For them, payments are just one part of a larger offer of value.

Look at GT Nexus, a cloud-based supply chain management company. 25,000

businesses managed $100 billion of revenue in 2014, including $20 billion of payments.
Chapter: Forces Shaping the Future

Those payments obviously require a bank at some point, yet only 30 banks are involved,
and as suppliers to the network. Whilst banks often speak about supply chain
management, few offer the complete value chain – nor do they partner or participate with
those who do.

At the same time, the landscape for provider networks is changing and consolidating. The
large procure-to-pay networks are being acquired and complemented with other services
– Ariba, with Crossgate, being rolled into SAPs’ Financial Services Network. Or they are
being developed with even grander plans. For example, OB10, the e-invoicing supplier,
has been acquired, then merged with an analytics company and a bank authorized in the
UK. The new entity, Tungsten, can now offer financing around invoices. Whilst it is
technically a financial institution, this is very much an example of a FinTech company
encroaching on banks’ traditional territory.

8
So where the massive scale and expertise in technology required to execute payments
used to be a formidable barrier, the landscape has effectively flipped. What was once an
advantage for the bank is now a constraint. Coupled with clients’ comfort in snacking and
assembling (that is, decomposing and recoupling value chain processes), more agile
non-bank firms are competing in two different ways. The first approach is to specialize to
cherry pick some of the more profitable parts of the value chain, such as providing foreign
exchange services. The second strategy is to offer far more than the banks’ value chain,
particularly in the procure-to-pay space.

Banks find themselves potentially neither fish nor fowl, unable today to offer much more
upstream in the value chain, yet unable to offer more granular services either.

REGULATORY
Entire reports are written on the regulatory requirements that banks face. Yet it’s still
worth noting that much of the regulation, particularly in Europe, is designed to enable
new entrants to come into the market, and specifically dismantle some of the barriers that
the regulators perceive that banks have put up. This includes access to payment
systems. These changes are increasingly technology-focused (e.g., access to account
provision in the Payment Services Directive II). Whilst ostensibly about giving greater
access to funds, and information about those funds, the regulation also mandates the use
of APIs by banks. There are many other similar examples across the world.

While regulation is opening the door to FinTechs, it will add additional requirements as
they grow and mature. If they are to enter more lines of business in a more
comprehensive way, they’ll be subject to additional oversight, a factor that will only
increase their costs and level the playing field with banks. Building systems that will
easily and cheaply accommodate regulatory requirements can only help a FinTech in its
effort to scale its business.

While regulation can be a burden to banks, it has a silver lining: it actually further
entrenches them into the payments value chain by requiring the presence of a bank. The
trick for banks is turning that burden into a benefit.

ECONOMIC
Payments emerged from the credit crisis as being one of the most valuable parts of the
banks’ franchise. They’re used by every customer and are vital to all. When the economy
is fragile, customers make smaller value payments, but more frequently; in a growing
market, payment volumes grow in parallel to GDP growth.

At first glance, all is well. In most, though certainly not all, economies, stability has
returned, with many countries growing in GDP terms. However, interest rates remain low,
making bank margins difficult to maintain. There are then the unknowns. The foreign
exchange market has traditionally been a source of revenue for banks. However, swings
Chapter: Forces Shaping the Future

in several currencies recently (the Yuan and the Euro for example) show that volatility
provides opportunity but also risk.

Regardless of the stage of the economic cycle, economic entities still need to make
payments. Banks providing that service at the lowest possible marginal cost will benefit.

CUSTOMER
Every bank customer has always made and received payments. The character of
payments today has changed, however. They’re initiated and settled more quickly, and
executed more cheaply. While in some instances they’ve become more prominent
because of the information associated with them and their place in the supply chain, in
other instances they’ve become nearly invisible (think of leaving an Uber with only a
goodbye; new startups are offering the same kind of experience at restaurants).

9
Clients continue to adopt new technology, and even as corporates lag consumers in their
willingness to try new methods, many institutions are nevertheless experimenting, often
with new entrants. Banks are perhaps on the back foot.

The challenge is that many banks are limited by what they can build with legacy
payments technology, rather than being able to start with the questions: what is that
clients want, and why? For many corporates, payments are just one step in a much larger
value chain. They’re seeking solutions that enhance the entire supply chain and that may
mean more granular products to address specific issues, or much broader solutions to
improve the overall process. In either case, banks are challenged to broaden their
traditionally narrow focus.

New entrants start with the customer in mind, and often attack a specific corporate issue.
Banks, on the other hand, are trying to optimize an inherited series of different and
complicated offerings. Many incumbents also continue to see payments as a commodity,
often discounted to win cash management contracts. Unbundling is the death knell of this
practice, and payments will have to stand on its own.

As every day passes, payments technology ages and becomes more costly. The average
cost per transaction may look to be falling, but the reality is far different. Because many
payment systems were optimized for a different world and have had all the excess costs
stripped away, doing anything – from upgrading to adding new features or channels – is
slow, complicated, and adds yet more cost.

New entrants see economic value in payments and have designed systems to participate
in the ecosystem at a substantially lower cost using state of the art technology. Banks
need to re-assess payments to see the business in the same way the new entrants do,
and then figure out how to make the economics work. That is likely to require re-tooling
their payments architecture, as many simply don’t know their cost per transaction. And
without cost data, how can a bank ever be sure it’s pricing effectively?

The world has changed. Bank payment systems are no longer tuned for optimal
performance, corporations want more services faster and cheaper, while many new
entrants lack heft and reputation. What, then, should each player do to navigate the swift
and uncertain waters of this complicated and rapidly evolving ecosystem?

Chapter: Forces Shaping the Future

10
THE PATH FORWARD

Much of our focus has been on the banks, not least because they have the most to do,
and the most to lose. That would imply opportunities for corporates and FinTechs. But it’s
critical to understand that this is not a zero-sum game. Whilst the ecosystem is evolving,
all three parties need to co-exist and work cooperatively.

How must key players evolve their processes and

relationships?
Key
Research
Question
There is an imperative to change – doing nothing is

3 not an answer; but for long-term evolution, all

parties working together will create a far more
efficient and effective ecosystem.

A dynamic tension binds banks, corporates, and FinTechs together. Managing that
tension properly will ultimately benefit all; bungling will deliver mutual losses (Figure 3).

Figure 3: Banking Ecosystem’s Dynamic Tensions Mean Each Party Has a Role to Play

Chapter: The Path Forward

Source: Celent

Urban myth has it that the phrase “May you live in interesting times” is an ancient
Chinese curse. Whether true or not, the phrase holds as true today as ever before. This

11
final section looks at the impact on each of the three constituents, and suggests how
interesting the future might be.

THE BANKS
Our commentary on banks may be seen as damning or frightening. It’s neither; rather, we
paint a picture of the challenging reality that banks face as the ecosystem evolves at an
unprecedented pace. What shouldn’t be in doubt is that the nature of competition has
changed, and for a bank, that’s worrying. Previously banks competed with other banks
who pretty much offered the same palette of products and services. Competition was
relatively stable, incremental and predictable.

Technology has allowed non-banks to enter the market, and they change the game.
Competition is now multifaceted: broader, narrower, upstream, downstream, etc. Despite
these challenges, banks are still masters of their own fate, but much depends on the
actions they take now.

In one scenario, banks suffer death by a thousand cuts, and find that the most profitable
pieces of their franchise are gradually eroded, leaving them with the burden of regulation
and the cost of the commoditized pieces that are left. In another scenario, banks use this
opportunity to re-imagine themselves, and focus on the pieces of the value chain that
they are best suited for and generate the most value for them (and their customers).

Our assertion is that Banking will change, but banks themselves will not disappear. That
latter statement however, will not apply to all banks. Whilst in many markets there are
new challenger banks entering, overall Celent believes that there will ultimately be fewer
banks.

Smart banks will therefore need to figure out a way to stay relevant for their customers.
This might be leveraging the trust they have, where regulation may actually become an
advantage; it may be launching new services which banks are well placed to deliver (e.g.
identity/ KYC as-a-service, instant financial advice, etc.); or it could be actually working
with, while also competing against, FinTech.

Whichever direction the banks choose to go in, there are a couple of basic truths.

Firstly, survival is likely to be by those banks most able to change, not necessarily those
that are the biggest today. They are not mutually exclusive – that is, there is an argument
that big banks have potentially the biggest changes to make; equally the biggest banks
have the deepest pockets to make it happen. Secondly, those most able to change are
likely to be those who have embraced the technology drivers outlined here. After all,
willingness doesn’t equal ability when it comes to change. The banks most agile and
open are those most likely to both respond and embrace the changes.

Transformation will take several forms, but will all involve technology at its heart. The
question for banks then is how to achieve this technology switch. There are three basic
methods.
Chapter: The Path Forward

The first is making acquisitions. BBVA buying Simple is perhaps one example, but not
the only one. The second is talent-spotting. The explosion of FinTech incubators that
banks are involved in is not only about what they produce – but also about finding those
who are producing it. Whilst there is undoubted talent within the banks, it’s very difficult
for many of them to think outside the proverbial box if they’ve never been outside the box
themselves! The third route is perhaps the hardest – collaborating with others. By taking
an API approach, banks give others the tools to build products and services than many
banks wouldn’t even think of – and in a much more agile way.

12
Ultimately every bank is starting from a different place, with varying abilities to execute
each of these three broad strategies – buy, build, partner – to different degrees. Banks
must determine their capabilities and culture, then design a strategy using tactics that
they can realistically execute.

THE CORPORATES
Corporate customers will always need to make and receive payments. Whilst they are
managing their budgets carefully, they have continued to invest in technology. Where
customers were technologically ahead of the banks at the start of the credit crisis, they
now find themselves significantly more advanced than most banks.

At the same time, customers’ perceptions of the banks have shifted. Some saw their
banks raise their cost of lending fourfold overnight – that is, if they would lend at all. Trust
in both in the banking sector as a whole, and in existing relationship banks specifically,
has fallen as banks have sought to reduce costs (including service and relationship
management). Many corporates feel less close to banks than they’ve ever done, and
increasingly less well served.

As a result, corporates have been become more and more open to sourcing from
anyone, from anywhere in the world, as they seek the best fit and value for money.
Corporates aren’t explicitly rejecting their banks; rather there is an assumption that most
banks are similar, and that they don’t offer sets of solutions as comprehensive as those
of new competitors. SWIFT Service Bureaus and supply chain networks are two
examples of new entrants that offer services that banks simply aren’t structurally capable
of providing today.

As corporates begin to adopt solutions that erode bank services, partly because they
don’t believe that a bank can necessarily help them, they find that they don’t miss the
banks. Tired of having banks dictate terms, they’ve used their newfound control to gladly
seize on alternative providers.

THE FINTECHS
It would be easy to assume that FinTechs are gleefully rubbing their hands, having
successfully stolen business from banks. Yet Celent believes this to be a very short term
view, one that may prove to actually be a barrier for them.

FinTechs face two major issues. Firstly, the larger and more successful they become, the
greater the chance that they will become regulated. Staying unregulated will limit the
services they can provide, but many will nevertheless avoid regulation because of the
cost and complexity. They will be fated to nibble away at the edges as they simply cannot
enter deeper into bank domains.

Many would seem to have overlooked a second and obvious issue: while it’s easier today
for newcomers to enter the market, the opportunity is often less about the technology
than the identification of the market gap and how to address it.
Chapter: The Path Forward

Square is a good example in the card acquiring space. The Square dongle is actually far
less functionally rich than an ordinary POS device. And yet Square have surfaced a
number of key insights that are instructive on both the retail and commercial side:

• How to reduce the cost of a POS device

• How to identify both a new segment (small volume/occasional merchants) and a
trend (rapid growth in smartphone and tablets), then harness them as an opportunity
• How to get scale rapidly. This has been achieved by giving away the dongle for free
at a wide range of merchants

13
The result is interesting. Since its launch, Square has been unprofitable, with widening
losses. However, it is now ranked by volume amongst the ten largest acquirers in the US,
and is the brand that everyone knows. With optimum distribution of dongles almost
complete, the costs dramatically fall away, and with revenue growing at an estimated
50% year-on-year, Square has the potential to be a highly profitable business in a very
short period of time, setting the stage for its highly anticipated IPO expected in Q4 2015.

But what of the rest of the market? Technology has made it simpler than ever for “me too”
products. Whilst Square was first, there are now over 300 other vendors in the market
globally, and over 100 in the US. Given that the differentiating elements of a POS device
have been stripped out, most now compete on price. The resulting industry-wide price
drop has led to the exit of a several companies, many of whom stated that the market
was commoditized and unsustainable (VeriFone’s’ SAIL product is the most obvious
example). The speed of this cycle has been breathtaking.

FinTechs need to be far more forward thinking with respect to banks, who both provide
vital parts of the overall value chain, but also have one killer advantage – their customers.
The reality is that whilst bank margins may be under threat by these FinTechs, all
customers remain banked, and few switch banks other than during the usual cash
management contract cycle. Rather than trying to fight with banks and other competitors,
FinTechs could partner with banks to provide a far better way to market; indeed, the pivot
toward this model has already begun. Working together provides value for both parties,
although the alliance will likely be uneasy.

ALL IN THIS TOGETHER

These alliances, done right, offer value to customers as well. Corporates will be able to
use the individual advantages offered by bank and FinTech to address needs across the
value chain while mitigating the risks posed by an unproven and perhaps unregulated
company.

The payments ecosystem is undergoing profound changes. As these changes reach a

critical level and break the payments dam, Celent believes that those firms – banks,
corporates, and FinTechs – attuned to the needs of the others and willing to adapt will be
best positioned to provide value and be fairly compensated for it. Those cooperating in a
large raft will successfully navigate the roiling waters; those going it alone will be
overwhelmed.

Chapter: The Path Forward

Was this report useful to you? Please send any comments, questions, or suggestions for
upcoming research topics to info@celent.com.

14
ABOUT OUR RESEARCH

Celent is a research and advisory firm which focusses on delivering technology-related

insight to the Financial Services industry, to enable our clients to make the right
decisions, at the right time.

To deliver these insights, Celent harnesses three core principles.

USING SEASONED PROFESSIONALS

Our analysts come from a wide range of backgrounds, but they all bring wide ranges of
experience with them. Often the source of an insight that an analyst brings is from their
previous life of having dealt with an identical situation. Celent analysts have often walked
in the shoes of their clients, rather than studied it in an academic way at arm’s length,
and so they understand what matters, and the nuances of the situation.

AN UNPARALLELED NETWORK
Celent's research clients include financial institutions, vendors, and consulting firms, from
around the world. In addition, we interact with the broader community, from industry
bodies to regulators to journalists. Every day brings new questions, giving Celent a
unique insight into the pulse of the industry, and how each party in the co-system
perceives often the same issue. Equally, this network is a powerful tool for Celent to tap
into as it seeks answers or validation to questions.

ROBUST RESEARCH METHODOLOGY AND INDEPENDENCE

Celent uses a variety of methodologies in its reports. For this type of report, we start with
posing three key research questions. Based on our interactions with our clients, these are
the questions that our clients are seeking answers to, or, using our experience and
insights from previous questions, the questions that they now ought to be considering.

The research is carried to address these questions, through primary and secondary
methods. We are careful to separate fact and opinion, and will always seek to validate or
corroborate those facts. Information furnished by others, upon which all or portions of this
report are based, is believed to be reliable but has not been independently verified,
unless otherwise expressly indicated. Public information and industry and statistical data
are from sources we deem to be reliable; however, we make no representation as to the
accuracy or completeness of such information.

As a consequence, the findings contained in this report may contain predictions based on
current data and historical trends. Any such predictions are subject to inherent risks and
uncertainties.
Chapter: About our Research

15
LEVERAGING CELENT’S EXPERTISE

If you found this report valuable, you might consider engaging with Celent for custom
analysis and research. Our collective experience and the knowledge we gained while
working on this report can help you streamline the creation, refinement, or execution of
your strategies.

SUPPORT FOR FINANCIAL INSTITUTIONS

Typical projects we support related to payments include:

Vendor short listing and selection. We perform discovery specific to you and your
business to better understand your unique needs. We then create and administer a
custom RFI to selected vendors to assist you in making rapid and accurate vendor
choices.

Business practice evaluations. We spend time evaluating your business processes,

particularly in payments. Based on our knowledge of the market, we identify potential
process or technology constraints and provide clear insights that will help you implement
industry best practices.

IT and business strategy creation. We collect perspectives from your executive team,
your front line business and IT staff, and your customers. We then analyze your current
position, institutional capabilities, and technology against your goals. If necessary, we
help you reformulate your technology and business plans to address short-term and long-
term needs.

SUPPORT FOR VENDORS

We provide services that help you refine your product and service offerings.
Examples include:

Product and service strategy evaluation. We help you assess your market position in
terms of functionality, technology, and services. Our strategy workshops will help you
target the right customers and map your offerings to their needs.

Market messaging and collateral review. Based on our extensive experience with your
potential clients, we assess your marketing and sales materials—including your website
and any collateral.
Chapter: Leveraging Celent’s Expertise

16
RELATED CELENT RESEARCH

Corporate Banking: Driving Growth in the Face of Increasing Headwinds

October 2015

RegTech — Not Reg Plus Tech, But Reg to the Power of Tech
July 2015

Delivering Better Treasury Services Through Digital Transformation

July 2015

Top Trends in Corporate Banking 2015: The Business of Managing Uncertainty

April 2015

Celent Model Bank 2015, Part 5: Case Studies of Payments Innovation in Banking
March 2015

IT Spending in Banking: A Global Perspective

February 2015

Noncash Payments: Global Trends and Forecasts, 2014 Edition

December 2015

Chapter: Related Celent Research

17
 Chapter: Related Celent Research

18
Copyright Notice
Prepared by

Celent, a division of Oliver Wyman, Inc.

Copyright © 2015 Celent, a division of Oliver Wyman, Inc. All rights reserved. This report may not
be reproduced, copied or redistributed, in whole or in part, in any form or by any means, without the
written permission of Celent, a division of Oliver Wyman (“Celent”) and Celent accepts no liability
whatsoever for the actions of third parties in this respect. Celent and any third party content
providers whose content is included in this report are the sole copyright owners of the content in
this report. Any third party content in this report has been included by Celent with the permission of
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This report is not a substitute for tailored professional advice on how a specific financial institution
should execute its strategy. This report is not investment advice and should not be relied on for
such advice or as a substitute for consultation with professional accountants, tax, legal or financial
advisers. Celent has made every effort to use reliable, up-to-date and comprehensive information
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Information furnished by others, upon which all or portions of this report are based, is believed to
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Celent disclaims any responsibility to update the information or conclusions in this report. Celent
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No responsibility or liability is accepted by HSBC for the contents of this report (including
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