[Dave Birch] Well, Consult Hyperion have done their bit to help the banking system get back on its feet: we sponsored dinner for a group of bankers and some of their suppliers — through the good offices of Financial Sector Technology magazine — at Level 42 (the NatWest Tower, for older readers). The dinner, which was chaired by Forum friend Paul Smee from the Payments Council, was an opportunity to share a range of views about the world of payments and exchange ideas about trends in the European payments sector.

A report on the roundtable discussion will appear in a future issue of Financial Sector Technology, and I don’t want to steal its thunder, but I did want to mention one of the topics that came up. One of the subjects that interests me — by which I mean, interests our customers to the point that they are prepared to pay for us to think about it — is the impact of the PSD. For banks, the PSD represents cost with little benefit. But for some non-banks, the PSD represents an opportunity to get into the payment business.

I wonder if banks are little too sanguine about the potential impact. A couple of times at the round table when M-PESA came up in conversation, people said things like “Vodafone aren’t a threat because Vodafone don’t want to be a bank”. I’ve no idea whether Vodafone want to be a bank or not, but that’s not the reason that banks should be worried about M-PESA. If customers hold balances in mobile operator payment accounts instead of in bank accounts, that has a significant impact on the bank bottom line (bottomless line?).

To see why this is you need to understand the real dynamics of the payments business today. Transactions account for most of the costs of payments but for only about a third of revenue (in Europe), with the natural consequence that transactions lose money in most European countries. As I have frequently pointed out, it only makes sense for banks to engage in that business because of the customer balances that they hold to fund the transactions. Take the example of debit cards: the bank loses money on every debit card transaction, but debit cards still contribute to profitability because customers hold higher current account balances (to fund the debit transactions) than they otherwise would, and the bank can earn a good return on this money. Therefore, overall, the picture is rosy, if

A detailed study by McKinsey (discussed in a paper called “The Hidden Side of Payments”) confirms this analysis. It caught my eye because it also included a surprising result. I’d never really thought about why customers keep higher or lower balances to fund payments, and I’d certainly assumed that with savings rates falling, the amount of money left in current accounts would go up. But McKinsey found that

Differences between countries are not related to the interest rates paid on current accounts,the penalty fees or interest rates charged on overdrafts, the level of internet banking penetration, or the availability of credit. On the other hand, there is a positive correlation between the share of income left on current accounts and the ATM penetration in a given country.

What an interesting observation! If I’ve understood it correctly, then, the more ATMs there are in a country then the more money that consumers will leave in their current accounts, presumably because they believe it will be easy to get the cash they want when they need it. So if banks reduce the ATM penetration to save money, they are shooting themselves in the foot by reducing balances on which they can earn income therefore making payments less profitable, irrespective of the cost of the ATM estate. I’ll ask Charlie Nunn of McKinsey about this at the CSFI round table in London tomorrow.

Now, looking forward, suppose that a small part of the costs but a larger part of the payment revenues are obtained (via PSD) by non-bank competitors? Then how long are these current structures sustainable? The non-bank competitor (which would have a much lower cost base than the bank) does not have to obtain all of the payment revenues for the bank to reach a tipping point, which leads me to think that this tipping point may not be off in the indefinite future.

These opinions are my own (I think) and presented solely in my capacity as an interested member of the general public [posted with ecto]

One comment

  1. > If I’ve understood it correctly,
    > then, the more ATMs there are in
    > a country then the more money that
    > consumers will leave in their current
    > accounts, presumably because they
    > believe it will be easy to get the
    > cash they want when they need it!
    Hey Dave,
    This is a *direct result* of something called the Baumol-Tobin model. This originally modelled the cost of “going to the bank” so as to predict how much cash the old Lady needed to print. It is good to see that McKinsey concurs!
    The model can be used for all sorts of observations. Back in 1996 or so I used it to predict that digital cash would not impact monetary policy one dime, see URL above. Also, with digital cash of the Internet variety, because the cost of going to the bank is effectively (or should be) zero, all money will be left at the bank.

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