Counting the cost of payment fragmentation

As a user of financial services myself, the issue of payments is one that is close to my heart – and my wallet. I have often been surprised by the fact that, no matter where I am in the world, I can make a phone call to my family at home in Ireland at a reasonable cost. But it is a lot more difficult to send them money at reasonable cost and in real time or even a guaranteed time. Why is it that these ‘old-fashioned’ state telecom monopolies can develop such modern and efficient services, but banks with all their financial resources cannot? It is not simply a question of competition. It is also due to the fact that payments markets have developed along national lines for a variety of legal and economic reasons. The situation we see today is simply not satisfactory for the users of payment services, be they large corporates or private individuals. The technology exists to change the situation. The political will is there. The business case is there. Huge savings can be made. Now it is up to the banks to play their part.

Let us be clear. When we talk about payment markets, we are talking about big money. Some 56 billion non-cash transactions are made in the EU every year to purchase goods and services. Roughly, €52tr changes hands in the EU every year – and not all of that is at racetrack!

However, we should recognize that payments are not for free. I was surprised to learn from studies that the cost for the current fragmented nationally based payment systems is around 2–3 per cent of GDP. Banks themselves also bear a large share of this cost. At present, banks are spending a third of their operating costs on payments. So they stand, as do other payment service providers, to be major beneficiaries of a more competitive market. In the end, the users of financial services bear the cost of inefficient and uncompetitive payment services.

Fragmented System

Consumers are complaining about the effects the fragmented payment system has on them. As a result of this situation, they have limited access to pan-European products. Worse still, they do not have access to those providers from other EU countries that might provide them with a cheaper and swifter service. To illustrate the point, customers in Italy pay an average of €252 a year for basic banking services, which includes payments, while Dutch customers pay only €34 a year on average. The lack of competition in the market is also hurting retailers. In some EU Member States, payment service providers may exercise a de facto monopoly and charge retailers up to 5 per cent of their total card sales. For retailers, accepting payment cards can therefore be an expensive privilege. It is one that would certainly be cheaper if there were a real internal market for payment card services. The EU Commission is already investigating the market for debit and credit cards in the EU. I am working closely with Commissioner Kroes on this issue. Corporates also suffer from this fragmentation. They are unable to integrate their invoicing with their payments. They tell us that the extra workload involved in running two systems in manual reconciliation and the cost of carrying late payments runs to €50bn a year.

Personal Vision

I have a different vision for the future of the payments market in the EU:

• We can create a real EU market for payments. Payment systems will then operate to the benefit of all users in the payment chain without regard to their nationality.
• We can take steps to encourage more competition in the market, both nationally and on a crossborder basis. That will mean that the most innovative new products and services will be available to all users.
• We can encourage greater efficiency in the payment system. There will be a process of learning from the most efficient systems and sharing best practice on an EU-wide basis.
• We can make a technological leap forward. We already have some of the world’s most advanced payment technology. Re-engineering our payment system should lead to much wider adoption of this technology. That should result in real added value for providers, businesses and consumers.
• We can create a genuine single payment market, which will deliver real benefits for citizens, and reduce price divergence.

Cost & Benefits

These are my political objectives. But what are the costs and benefits of such a single payment market? Creating a single payment market is certainly a challenge. And integrating fragmented national payment systems will involve significant investment from the participants. Around 8000 banks will have to adapt their operating systems to handle new products and services, while two million enterprises will have to prepare themselves to interact with these new payment systems. But I believe, from the figures I have seen, that significant savings and efficiency gains could be realised. A recent study from McKinsey suggests that the integration of the European payments market and infrastructures will strengthen the competitiveness of the financial sector. It will offer a unique opportunity for banks to reduce their operating costs. For example, McKinsey states that if unit cost levels were to decrease to 20 per cent above the current lowest level in Europe, this would generate €10bn in additional profits for EU banks. Banks should therefore not be afraid of change. Let me also point to the wider benefits for the EU economy and consumers, be they businesses or citizens. A modern, technologybased economy needs an efficient and modern payment system. This will have a positive impact on the competitiveness of the financial sector and improve the competitiveness of the entire economy. As such, it forms an integral part of the Lisbon agenda. A single payment market will offer improved economies of scale and competition. I believe this is the best way to reduce the total cost of the payment system to society and make it more efficient. Over the long term, common European payment standards would provide the basis  for consolidation and rationalisation, eliminating the duplication of investments for maintaining different systems and reducing operating costs. The overall cost of payment services could also be reduced, if the share of electronic payments increases and the use of cash decreases, as banks and businesses would benefit from the lower cost of electronic payments.

If banks could offer standardized and faster end-to-end automated payments, businesses would have access to quicker and more reliable settlement and improved cash flow. This is crucial for cross-border trade and in generating projected savings of €50–100bn a year. And there is one additional point of political relevance here too. A modern electronic payment system leads to increased traceability of payments. I do not need to remind you of the growing importance of this issue for those involved in combating money laundering and terrorist financing.

Taking Action

So how can we implement this vision for a single European payments market? Let us take a closer look at what needs to be done and who should do it. I believe the banking industry has the primary role to play in delivering integrated payment infrastructures. It must get its act together and create the schemes, services, infrastructures and standards to underpin a single European payment market. Existing fragmented national payment systems should be replaced by a European payment system by 2010. I know this is not a simple task. I don’t want to downplay the investment cost involved. This is a complex project requiring an enormous amount of cooperation between different industry actors. But it has to be done urgently.