2016 PAYMENTS OUTLOOK

January 2016

2016

P

AYMENTS

O

UTLOOK

In payments, every day is a new “election night.”

In payments, the term “disruption” has become a cliché;

every day seems to bring developments that change the

operating environment. At least political outcomes are

usually resolved on election night. This Research Note

summarizes the 2016 Outlook Notes published by

Mercator Advisory Group’s research practices,

highlighting the sweep of changes we anticipate for the

volatile year ahead.

by Ken Paterson, VP, Research Operations

Introduction

How perfect; 2016 is a Presidential election year. In addition to the usual dramatics, it is the perfect showcase for prediction and punditry. My alter egos, the Monty Python troupe, had a particular knack for putting political pundits in their places:

LINKMAN: Well, there’s the first result and the Silly Party have held Leister. What do you make of that, Norman?

NORMAN: Well, this is largely as I predicted except that the Silly Party won. I think this is mainly due to the number of votes cast. Gerold?

GEROLD: Well, there’s a big swing there for the Silly Party…but how big a swing I’m not going to tell you.

GEORGE (standing by a swingometer): Well if I may…I think the interesting thing here is the big swing to the Silly Party and of course the very large swing back to the Sensible Party…

–from “Election Night Special,” Monty Python’s Flying Circus, Show #19

Coming on the heels of 2015’s big events—Samsung/Android/Walmart/Target/Chase Pay announcements, the EMV liability shift, and awakening real-time payments just to name a few—prediction in the payments industry is not for the faint of heart. And there are wild cards to be considered as always, just to add more excitement. But as Norman, the pundit quoted above, sagely notes about actual outcomes, “I think this is mainly due to the number of votes cast.” We try not to lose sight of the countervailing forces of embedded infrastructure, customer inertia, and the law of large numbers. Forces of change play out on a well-established field in payments, and our analyst team tries to map out the most realistic outcomes.

The summary below draws on the Mercator Advisory Group’s practice directors’ predictions contained in their respective 2016 Outlook Notes, which are available for viewing or download on the Mercator Advisory Group website. Readers with focused interest in these market verticals are highly encouraged to read these individual documents, which offer more detail on the topics summarized here.

If my summary fails to hit the mark, I can perhaps paraphrase Norman’s other comment quoted above: This is largely as I predicted except that my colleagues were correct.

Cards: Different in the Same Ways

Credit, debit, and prepaid cards are of course very different animals from a business standpoint. Yet three broad trends will affect them all in 2016: consumer mobile preferences, the continuing EMV rollout, and potential for regulatory change.

Credit Cards

Against a backdrop of mostly positive macro growth indicators (accounts, cards, purchase volumes, outstandings), coupled with rising delinquency and charge-off rates coming off their historic lows, the general outlook for the still-reviving credit card business is healthy (see Alex Johnson’s 2016 Outlook: U.S. Credit Cards for specific growth metrics). In the 2016 time frame, most cardholder mobile payments developments appear to be accretive to credit cards. In particular, card-on-file services such as Uber, Lyft, Airbnb, and a class of new transaction

aggregators/platforms are driving new credit card spending at sometimes substantial average ticket sizes that disproportionately benefit credit cards and are worth issuers’ attention to secure default card status in these platforms. Consumers focused on credit card rewards and/or Reg Z consumer protections will continue to be motivated to choose credit cards as their card on file of choice. The rollout of mobile wallet programs (Apple Pay, Samsung Pay, etc.) will likewise favor credit cards over debit (cards or ACH), although our expectations for

significant volumes via mobile wallets are modest for 2016. These lower near-term volumes do not absolve issuers of a need to compete for top-of-mobile-wallet position in these new programs; default cards may prove to be very sticky in mobile wallets in the long run.

Credit card issuers won the slow-motion EMV deployment race in the United States in 2015, and we expect EMV-compliant credit card transaction volumes to triple in 2016 thanks to continued credit card reissuance and a spike in installation of merchant terminals equipped to accept EMV cards following the liability shift. We will be continuing to monitor EMV card issuance and terminal deployment trends throughout the year and will issue updated estimates midyear.

Despite the relatively rosy macro outlook for credit cards, issuers face a range of new competitive challenges, ranging from the competition for default card position in mobile wallets to alternative and marketplace lenders (Lending Club, Prosper, etc.) to online advertising and account opening. The alternative/marketplace lenders are a universe of small competitors today, but their appealing user experience and broad underwriting capabilities position them for growth as credit card alternatives or refinance vehicles. These lenders appear to be competing rather successfully for digital acquisition channels (Google AdWords, Facebook, etc.), and we predict they are likely to bid up digital advertising costs for all lenders using these preferred channels.

From a regulatory standpoint, credit cards are perhaps the card type least likely to be affected in this election year (but see our Wild Cards caution later).

Debit Cards

The introductory heading of Sarah Grotta’s 2016 Outlook: U.S. Debit Cards says it all: “2016, the Year Debit EMV Happens (No. really.)” The delay in finalizing the U.S. common debit application identifier (AID) caused by post-Durbin Amendment litigation, which was compounded by plastics capacity constraints and prolonged

implementation timelines, delayed EMV debit card issuance for most banks, which lagged far behind EMV credit card issuance. With the corresponding slow pace of EMV updating of merchant terminals in the U.S., the risk of missing the liability shift date seemed reasonable to many issuers (other than the PR risk should a major breach

occur). But 2016 will be different, and issuers must ramp up in the face of the proliferation of EMV terminals in the U.S, ensuring that their resources will again be tied up in reissuing plastics as well as in the all-important

reeducation of cardholders. And in 2016, as merchants are increasingly able to recognize the application identifier, they will increasingly steer transactions to the card or EFT network of choice, potentially reducing net interchange revenues that have briefly increased to issuers as merchants’ ability to route to EFT networks was delayed. EMV is truly a challenge that keeps on giving to debit issuers (and payments analysts too).

In today’s regulated interchange era, more large issuers are expected to move away from their pre-Durbin Amendment product management structures, which ran debit as a separate P&L from the DDA. With reduced revenue potential, plus a host of other pay-now options such as mobile payments, person-to-person (P2P) payment services, e-checks, and of course paper checks, large banks are shifting to a more holistic DDA management approach. Five years post interchange regulation, it is surely time to realign org structures. The awakening of real-time payments in 2015 is driving higher expectations for progress in 2016, thanks to the Federal Reserve’s Faster Payments Task Force and the ownership convergence of The Clearinghouse, Early Warning, and clearXchange. The course of action is unpredictable at this point, but stakeholders are clearly aligning to influence the process. The Clearinghouse and partner VocaLink intend to deliver some faster payments network capabilities in 2016. Interested parties also include the Consumer Financial Protection Bureau (CFPB), which has already set forth a high-level outline of how real-time payments platforms should be regulated. Speed of development is also hard to predict, but multiwindow processing of ACH seems a surprisingly near-term prospect.

Prepaid Cards

As Ben Jackson comments in his 2016 Outlook: U.S. Prepaid Cards: “The coming year will be one when prepaid providers of all types will need to devote time to learning the new rules of their respective games.” Some of those may literally be new rules, as the CFPB is expected to release potentially sweeping new prepaid rules in the spring of 2016. Expected areas of focus include disclosures to potential cardholders, compliance with Reg E for functions like those of checking accounts, and Reg Z compliance should the product include overdraft protection (a status that might extend to products based on any fees charged while an account is in an overdraft position). Disclosure side-effects could encompass seemingly unrelated products such P2P services that store funds at some point in their transaction life cycles.

On the EMV front, prepaid issuers will increasingly be forced to consider chip card issuance as more merchants install EMV terminals in 2016 and thus increase the liability risk to issuers. Playing into the fraud worries of prepaid issuers will be the possibility that fraud risk will move to non-EMV prepaid cards via card-not-present (CNP) transactions in spite of prepaid’s typically lower balances. 2016 will be a high stakes waiting game for prepaid issuers waiting to read the tea leaves on fraud trends.

With the proliferation of mobile payment services, consumers will come to expect the same convenience and functionality of prepaid cards, especially open loop cards. Issuers of these products have some important decisions

to make regarding the wallet programs they wish to support, and the costs and benefits of doing so or not doing so. Closed loop gift cards will engender the same cardholder expectations for mobile convenience.

Commercial and Enterprise Payments: Not Immune to Change

Change is typically slow to come to commercial payments, a speed often well justified given the complex systems and org structures of corporate payments providers and their customers. But with so much change occurring across payments, pressure is building across four key areas:

1.

collaboration across multiple supplier networks, incented by some of the new momentum generated by Faster Payments initiatives. Mobile technologies are likewise increasing the priority of developing “commercial wallets” for use by corporate cardholders. Virtual cards, not exactly a new technology, have strong expansion potential to move beyond T&E and procurement functions.

2.

accessing and customizing the information for corporates is no small task. Issuers are beginning to recognize the differentiating value of these capabilities in winning new corporate card programs.

3.

improved relationship management structures and addressing corporate needs is providing improved results. Moving beyond a narrow focus on sales goals toward real visibility into the corporation’s needs is hardly a new-tech concept, but it is one that is often sorely needed.

4.

(FIs) can be a competitive advantage. It may include enterprise resource planning (ERP) and treasury systems, online banking, portal gateways, and methods of communicating financial transactions and information. Improving integration between an FI and its corporate clients can serve to improve communications, understanding of corporate needs, and customer loyalty.

Banking Channels: Omnichannel Strategy Moves Off the Drawing Board

We are finally seeing evidence that FIs are operationalizing the omnichannel concept. In 2016, expect to see more evidence of the omnichannel influence as branches and call centers are increasingly equipped with common characteristics and capabilities, enabling benefits such as extended operating hours for sales, service, and problem resolution. With pressure to right-size and to optimize branch networks, further developing self-service across channels (e.g., digital banking, ATMs) and assisted self-service in-branch are critical capabilities. 2016 will also mark the ascendency of “lean banking,” focusing on process improvements that add value to customers while at the same time reducing costs on less critical elements. In this sense, the omnichannel vision and lean banking objectives can be seen as reinforcing rather than competing with each other.

ATMs and self-service kiosks are critical components of both the omnichannel and lean banking trends. Enhanced ATMS with video call center capabilities or possibly mobile banking interfaces (e.g., transaction prestaging) are literally becoming the face of the banking institution for customers preferring this channel. Digital banking—the seamless integration of mobile, tablet, and online interfaces via adaptive and responsive design—will become a more pervasive strategic approach, recognizing that in 2016 most customers use more than one of these channels and therefore hold the same expectations for experience and functionality across all the channels they use. Successfully managing and analyzing data across multiple banking channels has long been a barrier to achieving the omnichannel vision. These solutions arguably take longer to deploy, and of course they continue to evolve as channels are added. We see analytic customer experience (ACE) solutions making their way into production— especially as FIs try to obtain a better return on their channel investments through improved sales and reduced attrition.

Disruption as a Global Payments Theme

Lest we forget, electronic payments in their multiple forms are themselves a disruptive factor globally, as they continue to displace cash and checks. But beyond this core attribute, global disruption themes mirror those in the United States, with some important differences.

Regulation is a recurring theme in payments globally. Regulators are placing a great deal of the focus on removing perceived competitive barriers, ranging from the licensing of financial institutions to pricing controls (e.g., interchange regulation). 2016 will show the first full effects of interchange controls in Europe as debit and credit interchange caps there take hold. First glimpses on FIs’ willingness to invest in this environment may become apparent.

Contactless card-based payments have built a strong issuer and cardholder base in Europe and other markets but had been somewhat forgotten in the U.S. until the last year when interest in payments via Near Field

Communication (NFC) technology peaked thanks to mobile payments, also reliant on NFC. 2016 is likely to see continued global growth in contactless-enabled point-of-sale terminals globally in support of either or both contactless cards or mobile payments. This NFC-accepting terminal base likely sets the stage for future mobile payments growth globally, and perhaps a resurgence of contactless card issuance in some markets.

With at least 16 real-time payments systems in operation globally, and a growing base of solution providers, we expect 2016 to be an active year of announcements for new systems and enhanced capabilities. At least seven countries are in a planning or design phase for real-time systems outside the U.S., and expectations for progress are building within the U.S. Depending on capabilities, these systems have the potential to displace many methods of payment, in part due to their typically lower price points and newly enhanced performance characteristics.

Emerging Tech: You Thought You Only Had 2016 to Worry About…

In his 2016 Payments Outlook: Emerging Technologies, Tim Sloane, Mercator’s VP, Payments Innovation, highlights eight technologies that will have the largest payment-related impact on financial institutions over the next five years. These technologies, along with their near-term 2016 adoptions focus, are as follows:

• Biometrics of various types to manage the authentication of users across multiple access channels. Look for 2016 applications in mobile apps and call centers.

• Wearables for distributing financial information, guidance, and payments to consumers. Look for applications in mobile payments in 2016.

• Bluetooth low energy (BLE) used both as a method of two-way communications with local users and to communicate payment information. Look for more in-store pilots and experiments in 2016.

• Machine learning within bank operations to improve customer service at reduced cost and as a means of predicting customer behavior. Large FIs and ISVs are likely to be early experimenters in 2016.

• Mobile operating systems adopted more broadly in multiple consumer-facing applications (including automated teller machines as device manufacturers improve the ATM security environment and the mobile OS becomes the core technique for establishing identity). Midsized merchants and large FIs are likely to be main adopters in 2016.

• Platforms and payment APIs, which continue to grow robustly within current platforms and drive

development of new context-based services to capitalize on consumer interest and expectations. Platforms like Uber and Apple grow strongly via APIs in 2016, setting the stage for future growth and innovation. • Tokenization to payment-enable existing bank apps, mimicking Capital One’s approach, and tokens deployed

into browsers to secure e-commerce. In 2016, use of host card emulaton (HCE) and Android bank apps will expand, and browser pilots will be tested.

• Blockchain technology as a private implementation within banks for internal audit and perhaps to lower the cost of regulatory reporting. Large FIs are expected to pilot applications in 2016 via R3 and Azure.

That is just the tip of the iceberg in terms of Tim’s predictions in his 2016 Outlook: Emerging Technologies. To see Tim’s outlook beyond 2016 and full details underpinning his predictions and forecasts, read his Mercator Advisory Group research report titled Eight Technologies That Will Impact Payments and Banking Going Forward, released in late December 2015.

Wild Cards

In the mobile payments era, the term “wild card” no longer has the double entendre value it once did. Nevertheless, this year’s wild cards include the following:

• The next “Pay.” Apple Pay was a well-kept secret until launched in 2014. Chase Pay made a dramatic entry in 2015 and promises to shape industry developments more in 2016. And of course Android Pay, Samsung Pay, Walmart Pay, and Target Pay also arrived in 2015. It’s hard to imagine what the next “Pay” might bring, but then again they have all brought surprises. The biggest surprise would be a service introduction that simplified competitive dynamics or user experience across apps.

• Legal/regulatory risks. Specific risks were highlighted above with regard to the 2016 outlook for prepaid, where they can be anticipated for 2016. In an election year, conventional wisdom suggests that regulation takes a back seat. But what year did the Durbin Amendment arise? 2010, a Congressional election year. • Economic contagion, 2016 edition. January’s experience with the Chinese economy and sliding oil prices

once again reminds us how interconnected world economies are today and how quickly cross-border events can be magnified. In the case of China, its outsized influence could drive economic volatility throughout the year. And of course there is also the newly awakened Fed Funds rate, which will have newfound influence whether it increases, decreases, or stays the same.

• And then there is the real election night. On the eve of primary season, it looks like even political pundits are going to have a challenging year for prediction. As election results are interpreted for potential effects on the economy and regulation, year-end 2016 looks like it will be particularly exciting. We will have a lot to write about in our 2017 Outlook documents—that is a safe prediction!

Where Mercator Advisory Group Will Look in 2016

As we kick off the 2016 Mercator Advisory Group research calendar, we will be focusing on five macro themes across our practices that examine key elements of our 2016 outlook as well as interests of our clients:

• Finding and Acquiring Profitable Customers: Cross-selling and Onboarding in a Multichannel World • Managing Fraud in a Post-EMV World: CNP and Authentication Take Center Stage

• The Evolution of Loyalty Versus Steering in Payments: Merchants and Issuers Collide and Cooperate • Financial Inclusion: Products and Tools for Profitable Relationships

As always, we seek and appreciate the input of our clients and industry contacts as we explore these emerging topics throughout 2016.

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Copyright 2016, Mercator Advisory Group, Inc. Reproduction without written permission is completely forbidden.

For more information about this report, please contact: Ken Paterson, V.P. Research Operations

[email protected]

781-419-1715

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