The Future of Payments
The payments landscape has gone through a significant transformation in recent years. Technological advancements have led to step changes in innovation, with payments becoming faster, on both a local and global scale, more comfortable and more convenient. As business and customer needs evolve, it is clear that the global payments ecosystem must be agile and open to innovation without sacrificing the financial stability the infrastructure is built on.
Payments companies continue to be some of the most highly valued businesses in FinTech. They had notable exits in 2019, including Visa’s pending $5.3 billion acquisition of Plaid and the IPO of Bill.com, a $4 billion (market value) business-to-business payment processor that has doubled in value since it went public in December 2019. Last year, payments startups attracted a gusher of funding, taking in $15 billion globally, a 20% jump over 2018, and more than one-quarter of all FinTech funding, according to Accenture. Nine payments companies made Fintech 50 list this year. They range from a San Francisco startup that lets businesses keep a more significant share of the processing fees that merchants pay to a Boston venture that provides restaurants with credit card readers, reservation software, and loans of up to $250,000.
Technology is transforming payment systems. The pace of change and potential for disruption to incumbent service providers have propelled payment systems to the top of policymakers’ agenda. Digital innovation is disrupting the instruments and institutions that have historically dominated payments. New players are developing innovative payment solutions that compete with traditional means of payment provided by banks. Incumbents are also redesigning payment systems to make them faster, cheaper, and easier to use. Customer behavior and expectations have radically changed the way we produce and receive payments, and consumers have come to expect continuous improvements in the convenience and safety of payment services.
Payment systems are vital to the functioning of the economy. A payment system is a set of instruments, procedures, and rules for the transfer of funds between participants. Safe and efficient transfers underpin the purchase and sale of goods, services, and financial instruments. Indeed, a pre-condition for engaging in transactions is a trust that payments will be executed. Established payment systems have evolved to become safer, faster, and cheaper. Wholesale payment systems – for large-value transfers, mainly between banks – have experienced successive waves of innovation over the past few decades. Retail payment systems – for low-value but high-volume transfers between consumers and businesses – initially lagged but are now changing rapidly. Changes to payment systems require coordination among many participants. Wholesale systems typically have a small number of participants and include the central bank in a leading role, which helps to align incentives to change. As a result, innovations are simpler to develop and implement wholesale systems. Retail payment systems are becoming increasingly convenient, instantaneous, and available 24/7.
Nevertheless, payment systems still suffer from shortcomings in two areas: access and cross-border payments. Large numbers of people have limited or no access to a bank or other type of account for making payments, especially in emerging markets and developing economies. Obstacles to opening a payment account include high costs and a lack of documentation or trust. Furthermore, cross-border payments remain slow, expensive, and cumbersome.
FinTech and big tech companies are increasingly offering cross-border payment services. Other initiatives aim to improve the infrastructure that links payment service providers in different countries. The most transformative option for improving payments is a peer-to-peer arrangement that connects payers and payees directly and minimizes the number of intermediaries. Many peer-to-peer mechanisms use distributed ledger technology (DLT). Whereas account-based systems record transactions in a central ledger, DLT systems record transactions in multiple places at the same time, resulting in a decentralized, synchronized ledger. Examples that have garnered attention in recent years include Bitcoin and so-called “stablecoin” initiatives like Libra.
Central banks in Asia and Europe are in the final stages of launching digital currencies for future payment systems and cross-border transactions, according to a new report from accounting firm KPMG. And governments around the world see the launch of these blockchain-based central bank digital currencies (CBDC) as something that could one day give them a competitive advantage in global trade. Among other banking entities, the International Monetary Fund (IMF) has shown support for fiat-backed cryptocurrencies, saying they can reduce the reliance on government-issued money. Unlike bank transfers, crypto-asset transactions can be cleared and settled quickly without an intermediary. The advantages are especially apparent in cross-border payments, which are costly, cumbersome, and opaque. Other countries are already looking to innovate in ways that given them an advantage. China is reportedly close to releasing a national cryptocurrency that, because of greater efficiencies, could challenge the U.S. dollar as the de facto currency for international trade. Other smaller countries such as Sweden are planning their state-sponsored cryptocurrency. Sweden’s would be called the e-Krona. And the Bank of England has been researching cryptocurrency since 2015. Even though it does not currently plan to issue a cryptocurrency linked to the Pound sterling, it has published extensive research on the monetary policy and financial system implications of issuing CDBCs.
Innovation in domestic payments continues to occur. Wholesale systems are opening up access to non-banks, extending operating hours, and improving the interoperability of systems. Fast or instant retail payment systems have been or are being developed in many jurisdictions. However, shortcomings in access and crossborder payments remain. Access issues can be addressed through targeted interventions in individual domains. Quantification of the extent and relative importance of the various drivers facilitates such responses. FinTech is also likely to improve universal access to and frequent usage of transaction accounts. The way to address the problems surrounding cross-border payments is less clear. First, more data are needed to help understand the extent and the drivers of the issues. Initiatives to improve cross-border payments would benefit from being able to quantify both the relative importance and the costs and benefits of the various types of back-end arrangements. Second, coordinating efforts to address the issues besetting cross-border payments is more challenging. There are more stakeholders involved and no organization with a clear leadership role. In 2020, the G20 took on a leadership role when it decided to give priority to enhancing cross-border payments.