Should banks outsource payments?
At a recent webinar hosted by InstaPay on payments transformation, a question was posed to the speakers (from HSBC, Nordea and Icon Solutions); “Given the challenges involved in payments transformation and the need to reduce costs, should banks consider outsourcing payments to a payments factory rather than incurring the development/migration/support costs?” With the growing (but not new or revolutionary) trend towards outsourcing payments capability, I thought it deserved deeper exploration.
The drivers for outsourcing
Across the global banking industry, the payments landscape is being transformed by rapid advances in technology, profound shifts in consumer demand, and increasing regulation. Banks are also facing significant profit margin pressure – banks’ return on equity (RoE) has shrunk from double digits to low single digits (especially across Europe), and recent research from Aite and Icon Solutions highlighted that only 18% of global Tier 1 banks can charge enough for payments to meet expected returns. At the same time, competition is dramatically intensifying with a recent Accenture report predicting that banks could lose up to $280 billion in payments revenue by 2025.
In response, many banks are reviewing how they manage payments and are contemplating outsourcing as a ‘quick fix’ to the problem. There is no shortage of options with more and more providers running ‘cloud solutions’ to reduce costs and increase flexibility, but are these really that different to the age old ‘payment bureau’ of years gone by?
The reasons for outsourcing are well documented: it can enable organisations to improve operational performance, share the growing cost of compliance, reduce operational risk, and potentially reduce financial cost. Over the past couple of decades many banks have shed their payments capability, only to find that as the function has risen back to prominence, the lack of expertise has left them with gaps to fill. Afterall, payments are of strategic importance. They are a key point of customer interaction, providing the opportunity to capture data and intelligence, and are also the potential starting point for product sales – be that a Point of Sale consumer loan or the Corporate need for a significant FX transaction and appropriate hedging. Today’s payment infrastructure forms the backbone of any bank’s functional model, and the customer data that comes with it is the lifeblood of a bank for the years to come.
Size (and volumes) matter
When it comes to the outsourcing of payments processing to a ‘payments factory’, the size of a bank plays an important role. On the webinar, Mark Evans, Global Head of Payments Advisory, HSBC, shared that because of the size and reach of HSBC, their payments processing is already handled like a payments factory. They have created a common capability that is shared across the HSBC group, that not only supports payments processing internally but also on behalf of some of their corporate customers. Their size means that they can leverage economies of scale to deliver more efficiencies, including cost efficiencies. This was echoed by Marta Stensheim Haugen, Head of Payments, Nordea, who said while efficiency was always a key focus, Nordea’s payments volumes and reach meant that outsourcing was not needed.
That’s fine for the big players but does that mean smaller players should head down the ‘outsource’ route? For that there are two key considerations:
For Simon Wilson, Director, Global Payment Solutions, Icon Solutions, thinking needs to begin with agreement on what is strategic for the bank, what will lie at the heart of a bank’s long-term objectives and differentiators. Outsourcing payments is not a simple yes or no response; it necessitates strategic decisions on which processes within the payments value chain are key to your business and which are not. Can you afford to rely on a third party for something at the heart of your customer experience? Are you able to tailor your end to end payment flow in support of wider product offerings? How will you manage the increasingly complex approach to managing the payment initiation and pre-execution activities to deliver value added services that need to wrap around the payment?
Banks need to identify the components of the payments value chain which enable them to deliver added value to their customers and differentiate themselves in the marketplace. The combination of PSD2, Open Banking and ISO 20022 has given banks the opportunity to leverage data generated by payments to deliver innovative new products and services. Relinquishing control of payments could mean missed opportunities for the future.
Secondly, cost and risk…
Here technology plays a key role. With the advent of cloud computing ‘scale efficiencies’ need not only be the domain of the top tier banks. Google, Amazon, Microsoft all have greater expertise than any bank in scaling infrastructure securely, and can offer it to all payers at a flexible price point much lower than could be achieved by a bank alone. By leveraging the cloud cost reduction gains can be achieved without having to give away the business functionality to someone else. Combine this with open source software and the total cost of ownership around payments processing drops significantly compared to traditional vendor solutions that in themselves are expensive and run on costly legacy infrastructure.
It is also important to fully appreciate the process and scale of change. Cost reduction can only be fulfilled once legacy infrastructures are turned off and ongoing risk only reduced when you have clear control of the integration challenges within the rest of the bank environment – an area that can heighten complexity in an outsource environment.
Look before you leap
In making the leap to outsource take care not to jump from the frying pan into the fire. It may well be a smart move, but only when done with careful consideration and an eye on long term strategy. Payments… the life blood of a bank… are to be handled with care!