Right around the corner is a world with neither cash nor payment cards. Contactless payments mechanisms—built into cell phones or even jewelry—are helping create this world, and the result will help change banking, thinks Theodore Iacobuzio, managing director of Tower Group’s executive research office.
The reality is that companies that once fed the banks’ payment networks—merchants, for instance—will be future competitors. But banks shouldn’t panic about this, any more than when, not so long ago, the Internet was supposed to be extinguishing banks. And banks won’t be disappearing now, either, thinks Iacobuzio: the anxiety over banking’s future, so prevalent in boardrooms around the country, is overdone.
“Banks are really bad at a lot of things, but they’re really good at one thing—processing transactions,” says Iacobuzio. “Until somebody invests in building the networks, and creating the expertise you need to process transactions, no one is going to replace the banks.”
The real issue, then, is how banks can deal with and manage a payments environment in which the usual branding vehicles plastered on payment cards, checks, and computer screens are at a minimum less of a commonplace than they are today.
“Whether I authorize a payment with the mechanism of a mag-stripe card or a chip or a key fob—or a paper check—ought to be an indifference to banks,” Iacobuzio says, “but behind that, the configuration of the payment networks is changing.”
He says the key is recognizing that what appears to be a transformation is really just what he calls “much of a muchness,” without missing that real change is taking place underneath a surface that’s only apparently being transformed. “This is a form-factor issue,” he says. “But if some banks don’t want to play the form-factor game, then they’re going to cede the business to large vertical institutions and processors who are willing to [do so], but that’s been the story in credit cards for 15 years.”
Some banks, of course, will refuse that choice, and Iacobuzio expects another shakeout in the credit card business in the next three-to-five years, probably the final one. For him, it’s hardly impossible that American Express or Morgan Stanley’s Discover Financial Co. will either buy a big issuing bank, or be bought. “They’re both definitely in play,” he says. “Discover owns a payment network, and American Express is issuing cards through banks. A bank could buy American Express or Discover—there are some very big banks out there.”
There are still major issues that need to be addressed before the full promise of a cashless society appears, looming large among them is the matter of finding a practical fee structure for micropayments. That solution, packaged in a card or a ring, a necklace or a wristwatch-cellphone, will open the door to the world Iacobuzio envisions.
Some are warning that this event will also open Pandora’s Box. Once the payment vehicle has no bank logo on it, they say, a wedge is driven between the bank and its customers, possibly vaporizing much of a bank’s market leverage and maybe much of its market cap.
This doesn’t impress Iacobuzio either. “Let’s be frank about this,” he says. “Brand in credit cards was sold down the river 12 years ago, and if the banks are worried about their brand now, the horse has left the barn. That’s one reason there’s going to be another round of mergers and acquisitions [among banks]; unless you’ve got a brand as good as American Express’ you’re going to lose to American Express in a lot of this,” even though Amex or Discover could as easily be bought, as be the buyers.
If this seems to suggest that Iacobuzio means banks are doomed to becoming payment utilities, and the sooner they embrace that destiny, the better, think again. It may happen, he says, but it’s not pre-ordained. “Depending on what a bank is good at, it may become a payment utility. You could see U.S. Bank going in that direction; it depends on what a bank wants or is capable of doing.” U.S. Bank earned more than 50 percent of its 2005 revenues from payments-related activities.
And choosing this path isn’t a one-way ticket to Palookaville in any event. State Street Bank decided years ago that it was best at global custody, and it’s preeminent today, not to mention very profitable. Bank of New York made a similar decision about global securities operations. Nobody is claiming that these institutions are headed for the ash heap of history.
Iacobuzio doubts that 10 years hence the payments landscape will look very familiar. Bank of America may be constrained from acquiring more banks by the so-called 10 percent rule—no bank can account for more than 10 percent of the nation’s deposits, and BofA is just under that figure now—but that wouldn’t apply to, for instance, Citigroup, which mainly takes deposits only in New York City. Citi has made clear it has no immediate plans to expand.
But other financial institutions could. And the eventual scale created would be a real benefit since, as Iacobuzio points out, the idea for really big institutions is to clear and settle payments on themselves—so-called native payments. This sort of institution could be created starting today, if a bank that identified payments as its future began assembling a payments-oriented bank. The same is true for, perhaps, a group financed by some of the private equity groups; those firms as a sector have identified payments as a potential investment area.
The main point, says Iacobuzio, is that the successful bank of the future will be a unique company, built around its own native abilities. It can choose payments as that vehicle if it chooses, and not disappear by any means: “What they’re going to look like is themselves, and not like each other,” he says. “Each one of these banks has to play to its own strengths.”
The idea isn’t to copy a successful model, it’s to embrace change, and exercise an institution’s little gray cells. (Contact: TowerGroup, Theodore Iacobuzio, 781-292-5265)