The disruptive threat that fintech innovators pose to traditional banking institutions has been an ongoing source of debate and analysis. In the US, some of the most significant recent developments are unfolding in the peer-to-peer (P2P) payments space. The success of mobile solutions including Venmo (acquired by PayPal in 2013) and Square Cash has validated consumer interest in digital transfer capabilities, particularly among millennials—a segment in which US banks have until recently shown only nominal interest. The recent retooling of the bank-owned clearXchange network following its purchase by Early Warning Systems signals renewed focus on a financial institution–led collaborative initiative that will compete head-to-head with non-bank solutions that have demonstrated exponential growth.
Many observers ask which model will prevail; however, this question presumes a battle between banks and non-banks with a single winner. McKinsey expects the two models will continue to coexist, either addressing different aspects of the P2P ecosystem, or collaborating to integrate existing solutions or build new ones.
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As with some other payments technologies (for example, the implementation of EMV card protocols) the US has lagged behind other countries in P2P capabilities, largely because of the adequacy of legacy solutions and the lack of a clear path to monetization (Exhibit 1). For instance, M-Pesa’s well-documented success in Kenya was in part born of necessity, given the country’s high unbanked rate and lack of branch access. In North America’s present network-building stage, P2P functions as an engagement tool rather than a profit generator—analogous to the launch of remote deposit capture for which some banks briefly assessed a fee before reversing course in favor of its benefits of cost reduction, balance gathering, and customer satisfaction.
Conditions are favorable in the US for banks and fintechs to reboot their P2P initiatives and close the gap with other geographies in this persistent pocket of high-friction payments transactions, delivering customer satisfaction in the process. Leveraging examples from other markets of ubiquity, branding, collaboration, and pricing will greatly enhance the probability of success for all parties.
New environment, new rules of engagement
Digital P2P’s reach has gradually expanded to appeal to ever larger groups (PayPal first found traction as a means for settling eBay transactions). The Venmo app enjoys prime position on the smartphones of a high percentage of US college students in particular. Its volume now exceeds $1 billion per month, having roughly tripled in the past year. Meanwhile digital currencies, led by bitcoin, have launched a new paradigm for exchange of value. Although these virtual currencies have yet to gain mainstream acceptance, the underlying blockchain technology has attracted billions of dollars in bank investment and the interest of central banks, promising to alter the landscape further.
The checking—or demand deposit—account remains the fundamental building block of most consumer banking relationships. Consequently, any new provider or product that diminishes banks’ perceived value in providing such services has been regarded as a significant threat. As younger consumers increasingly view banking as a service performed both virtually and across multiple platforms, financial institutions must maintain their position as go-to providers of such services; otherwise, incumbent status for other products (lending, investments) could soon be similarly jeopardized.
Globally, electronic payments are moving toward a 24/7/365 model, with funds available to the payee in seconds. Successful rollouts of “faster payments” in other geographies have led the US to pursue upgrades to its own legacy payments infrastructure (for example, Same-Day ACH, the Federal Reserve’s Payments Improvement initiative), despite concerns from industry observers about a perceived lack of valuable use cases.
With handset manufacturers like Apple and Samsung contemplating proprietary P2P solutions in their branded wallets, and messaging services (Facebook, Snapchat) launching money transfer in their apps, banks are under pressure to defend their core assets (Exhibit 2).
Enter clearXchange, a bank-owned venture launched in 2011 with the objective to streamline US P2P payments through the use of mobile apps and email address tokens. Despite the ownership stakes and market reach of several US banking market leaders, adoption was slow and critical mass proved elusive in the initial rollout. Limited bank participation undermined the promise of “paying anyone with an email address,” and the enrollment and authentication process—designed to address regulatory requirements and manage risk—fell short of expectations established by mainstream mobile apps like PayPal. The institution of a fee for many transactions further impeded uptake. A similar offering from Fiserv–branded Popmoney encountered many of the same challenges.
Non-bank fintech providers are not subject to the same regulatory requirements as financial institutions. This lack of regulatory oversight creates opportunities for innovative approaches and customer experiences. Fintechs are often focused on a single product, and may not face the same challenges as banks in the introduction of new products and services (for example, concerns about brand equity, competition with established profit centers for IT resources). On the downside, fintechs cannot access payments infrastructure and bank accounts directly. The lack of visibility into account balances presents risk management challenges, leading to fintech solutions consisting of prefunded P2P accounts funded through an existing banking relationship or payments made within the solution.
Collaboration as a key to ubiquity and success
Given the recent momentum in P2P adoption, there are a proliferation of solutions, partnerships, and players entering the space. Large banks have redoubled their efforts, as evidenced by the acquisition of clearXchange by Early Warning Systems, a consortium with broader bank participation. This purchase allows for repositioning of the clearXchange offering with an emphasis on security and real-time execution.
In the US and elsewhere, financial services stalwarts have teamed up with fintech start-ups to explore mutually beneficial solutions:
- BBVA and Dwolla collaborated to deliver the bank’s US P2P offering, leveraging Dwolla’s “real-time” model (essentially a book entry transfer). This move is notable because although BBVA conceptually possessed the capabilities to move forward independently, it opted to leverage a fintech’s consumer experience knowledge to move forward more rapidly.
- Kakaotalk, Korea’s leading messaging service, launched its Kakao Pay digital wallet as part of a consortium with the 16 largest Korean banks along with South Korea’s Financial Telecommunications and Clearing Institute.
- Western Union and WeChat (see sidebar, “WeChat’s Red Envelope rollout”) forged a partnership that allows WeChat’s US customers to send money to other users via Western Union’s transfer network.
The same challenges remain, however—delivering a compelling user experience and endpoint ubiquity. This is a daunting task in an ecosystem with over 10,000 depository institutions.
With the precedent set by no-fee solutions in the market today, it will be difficult for banks to charge for low-value P2P payments and also develop a sufficiently robust user network (see sidebar, “Interac’s success in a bank-led Canadian model”). Once critical mass is established, however, there are value-added use cases for which a fee is plausible: cross-border payments, escrow-like services, B2B, and B2C. Additionally, P2P has been successfully extended to broader use cases in other countries, for example Barclay’s Pingit app in the UK.
Beyond pure P2P
One natural approach to segmentation divides payments use cases into low/high value and low/high frequency (Exhibit 3). The four resulting quadrants imply different use cases and opportunities to eliminate friction or design a compelling user experience. This construct also illustrates that many consumers do not regard P2P and consumer-to-business (C2B) as distinct activities. For instance, the average transaction value through a bank-offered P2P solution is over $300, confirming that many consumers are using these services for use cases beyond “textbook” P2P.
Checks account for 10 percent of P2P payments in the US, and the opportunity exists to digitize these transactions as well. According to research by the Federal Reserve Bank of San Francisco, the average value of a P2P check payment is $128, four times larger than the average P2P cash transaction ($32). Checks are costly for banks to process, and savings can be realized from bank-based P2P solutions displacing these paper items. Bank-offered P2P solutions often have higher per transaction and daily/weekly limits than fintech solutions, with the added benefit of real-time funds access because banks can confirm availability. The structure of many P2P offerings lends itself to smaller, frequent payments. The average transaction value on fintech P2P products in the US is around $35, in the range of a P2P cash transaction. Meanwhile, the daily and weekly limits imposed by fintech P2P solutions are substantially lower than the limits on bank-offered solutions (for example, $3,000 per week versus $3,000 per transaction). Fintech providers do not have visibility into the DDA account balance and cannot confirm good funds payments from the account. To limit credit risk and to provide real-time availability of funds, many P2P solutions offer a dedicated prepaid account.
The most widely adopted fintech P2P solutions to date are available to customers regardless of banking relationship. They focus on delivering a differentiated experience that transcends the payment itself, whereas bank-offered solutions have emphasized the transaction over the social/interactive aspect of a payment. Since cash satisfies most perceived consumer needs for low-value exchange and ubiquitous acceptance, the key to expanded digital acceptance may be in the non-financial social aspects of the experience. Smartphone-based payments apps can include support for messages (including emoticons) and pictures, and can even support group chat as part of the payments process—a very different experience than a cash transaction. Fintechs have gamified the P2P transaction and have created a social component to the payment (Venmo), spurring adoption. Other social media heavyweights are now striving to integrate P2P payments into their messaging platforms.
Cash remains the most common form of P2P payment in nearly every country. Cash transactions remain relevant in the retail environment also, representing 40 percent of retail payments in the US in 2014. The digitization of retail cash payments represents a very attractive opportunity for banks, payments networks, and fintechs alike. In jurisdictions where P2P solutions are more entrenched, bank-offered P2P options have made the jump to retail payments. MobilePay in Denmark, Swish in Sweden, and Zapp in the UK have extended their capabilities to support direct transfers between bank accounts to support C2B payments. Canada’s Interac has focused on extending its account-to-account solution to support the replacement of business-to-consumer (B2C) check payments through the introduction of bulk payments capability. These approaches may come to the US from offerings like clearXchange and Popmoney. Fintech solutions in the US have thus far focused on P2P payments only and have not ventured into the C2B or B2C space.
Room for multiple winners
P2P offerings from banks and fintechs currently deliver different value propositions, with consumers using the products differently. P2P is not an area that necessarily lends itself to a single clear winner. Banks can leverage risk and fraud management expertise to enhance and expand their real-time, account-to-account payments offerings; fintechs can continue to engage customers with features and functionality that create a unique payments experience. Interac and WeChat provide examples of successful P2P products established by banks and fintechs, respectively.
Over time, technology and regulation will continue to evolve and existing sources of differentiation may be challenging to maintain. The US launch of Same Day ACH payments will allow fintech providers to provide faster funds availability directly from a bank account for customers, closing the value proposition gap with bank solutions. Banks are learning from and partnering with fintech providers to engage customers more effectively, and are leveraging their fraud and risk management experience to simplify the end user payments experience. Although there may be some convergence between the products offered by banks and fintechs, these providers will continue to focus on different business objectives. A broad range of solution providers will ensure current and future customer needs are met, and the evolution of the market overall.