Gain Insights into Current Trends and Challenges Impacting the Financial Services Industry

Alternative Payments - Transforming the Payments Landscape

In 2012 there were 333.4 billion non cash transactions and this number is expected to rise rapidly in the coming years with the average transaction size reducing drastically. Two other trends waiting in the wings are mobile payments and global transactions.  M-payments are expected to grow by 60.8% and global transactions are expected to rise driven by electronic shopping, global sourcing, companies purchasing inventory from other countries, international money transfer, and so on.

Can traditional payment models support the needs of future transactions? The problem with traditional payment rails is the value transfer between the payer and payee may involve several institutions especially in cases where sending and recipient banks do not hold reciprocal accounts so

  • The actual transfer is not instantaneous and funds may take several hours or even days to be transferred.
  • Customers are likely to suffer a backlash of currency fluctuations due to delay in transactions
  • Customers may also incur additional costs depending on the number of intermediaries involved.

How are alternative payment systems more effective than traditional players?

Considering deficiencies in the current payment systems and the need to provide modern financial services to the unbanked which is about 2 billion according to World Bank's 2014 Global Finder report several alternative payment systems – Crypto currency, mobile money and peer to peer transfers - have emerged and some such as Bitcoin, Ripple, PayPal, mPesa, and TransferWise have gained widespread acceptance already.

Introducing Crypto currencies

Crypto currency such as Bitcoin and Ripple use cryptography to perform payment transactions or creation of digital currency units. Transactions are verified by network nodes and recorded in a public distributed database or ledger. The advantages of such as a system are:
  • The payment infrastructure uses distributed network and there is no single point of failure, ensuring the transactions are secure
  • There are no brokers or a third party exchanges and no one controls or owns the protocol so transfer fees remain low
  • Absence of intermediate institutions means transaction settlement can happen in (near) real-time

Mobile money transfer systems' reach exceeds that of financial institutions

Mobile money is payment schemes run by mobile network operators as in the case of mPesa or Airtel Money or in the case of online retailers (PayPal).  Mobile money especially has been very effective in unbanked countries of Africa. For instance the number of person to person transactions in Kenya using mPesa was 288,780,000 in 2012. As in the case of crypto currencies mobile money is fast and transactions can be of really small value and the reach of its service may exceed that of financial institutions especially in developing countries.

Peer to Peer payments systems transfer money at mid-market currency with an exceedingly low transaction fee

Startups like Transferwise, Currency Fair and WeSwap.com have come about an innovative way to transfer money across borders that saves considerable amounts in transaction fee. Furthermore, since transfer of money is done at mid-market currency rate customers will not lose money in unfair rates quoted by banks or exchange services.  Processes deployed by these companies are very simple. They match you with someone sending in the other direction and the converted money is sent to the account you specified in most cases within a day, a pace that is not matched by traditional banks today.

What is the impact on traditional payment schemes?

Wider acceptance of nontraditional payment rails has already lead many non-bank financial providers to leverage these alternative payments schemes and develop further innovative products and services.  Some of the non-bank financial providers -Epiphyte, Coinbase, and TransferWise - are already making waves.

In order to compete with these non-bank financial institutions, banks can start providing products and services around these payment rails to capture the customer base of these institutions.  Also since crypto currencies cannot be regulated by a central authority and mobile money also has its regulatory challenges in cross border transactions, banks can collaborate with traditional payment network providers and develop innovative payment protocols and systems with the characteristics outlined below to gain a competitive edge:

Fast: Faster systems that undertakes broad variety of business and personal payments and transfer funds instantaneously and not takes hours or days. The underlying payment infrastructure should either support real-time payments or should be an emerging infrastructure such as telecom or distributed networks.  

Secure: Payment system that is robust and keeps pace with the rapidly evolving and expanding threat environment.

International: Global transactions are increasingly on the rise so the system should help in timely and effective cross border payments.

Cost-effective: Only a payment system with low transaction cost would be accepted for frequent low value transactions which is the need of the customer going forward.

Unbanked: The payment system should be have the widest possible reach and should satisfy the financial needs of the population with no bank accounts.

Tushar Chitra is the Senior Director for Product Marketing at Oracle Financial Services. He can be reached at Tushar.chitra AT oracle.com. 

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