The $1.2 trillion global payments industry is in a state of flux, with everything from headline grabbing Bitcoins to rarely discussed regulations favoring more innovation. The interplay between four mega-trends – new technology, regulations, demographics, and international reach – are the key to understanding the future of the payments industry, argue Goldman Sachs analysts James Schneider and S.K. Prasad Borra in the latest Future of Finance report.
“The way we pay is changing. The plumbing connecting banks, merchants, networks and consumers is being reconsidered. From Square and Stripe to Apple and Alipay, innovators are creating new ways to transact,” they write.
Emerging markets have a great need for alternative payment methods
The clearest way that these trends intersect is in the way that emerging markets adopt new technology. Bitcoin got a lot of press in 2013 when its value exploded, briefly crossing $1000 per Bitcoin. Since then its value has steadily dropped so you would be forgiven for thinking that the cryptocurrency had fallen off the map, but it’s more accurate to say that the focus has shifted away from the US. At this point 80% of volumes are Bitcoin-yuan exchanges.
Similarly, Kenya has 13 million mobile payment users, more than any other country in the world – not just EM. The growth of alternative payment systems in emerging markets is uneven as you would expect, but the need is enormous. Half the world’s population is either unbanked or underbanked (has a bank account but still leans heavily on other non-traditional services like payday loans), and the credit cards that are so prevalent in the US hardly exist outside of Western markets. This is similar, and connected, to the way cell phones became popular in many emerging markets where the infrastructure necessary for a landline in every house never took hold.
Even in the US, 28% of the population fall into the unbanked/underbanked category because they don’t have enough cash to maintain a normal bank account. If wage growth keeps picking up there should be a boost in US demand as well as people re-enter traditional banking.
Payments industry: Debit cards and cash squeeze out credit cards among young people
On the other hand, regulations and demographic trends in the US seem to be pushing against each other. Cash and debit account for 91% of all payments for Americans aged 18 – 24, with credit card payments taking up just 7% of the total (as you would expect, checks are basically unused by anyone under 45).
The reason that’s surprising is that debit volumes fell during the financial crisis and then again after the Durbin amendment to Dodd-Frank restricted debt interchange fees, making debit cards much less lucrative for banks. So just as people in the youngest demographic were becoming adults, banks were given a powerful reason to push credit cards instead of debit cards. The Goldman Sachs report says there is a good chance that credit card interchange fees will also be regulated in the future (both are likely to be capped by the European Union this year).
Anti-money laundering regulations could boost innovation
The focus on combatting terrorism and drug trafficking has led to stronger anti-money laundering regulations in the last decade, pushing up costs for the world’s largest money transmitters.
“We estimate this burden is as high as 4% of sales for Western Union, and below 1% for some emerging money transfer players. As a result, we believe small-scale money transmitters may be able to price more aggressively in the market,” write Schneider and Borra.
That gives smaller upstarts a 300bp pricing advantage that, ironically, disappears as soon as they become successful enough that the same regulatory requirements apply to them as well. This regulatory anti-moat should encourage entrepreneurs to enter what is otherwise a tough market, driving innovation in the years ahead.