Four Trends Redefining the Payments System in 2022
Fintechs seek to carve up payments into profitable parts, while banks seek to 'rebundle' payments in new ways. Even as this tug of war is contested, the payments marketplace is embracing embedded finance, contextualized authorization, programmable money and more.
The payments business is changing so fast that in a year or two it will not be recognizable.
More technologies keep coming on the scene, more types of players are grabbing for a piece of payments, what “payments” means is broadening and evolving. As real-time forms of payment become the norm, this may in turn drive acceptance of payments types that today are right on the leading edge. And the device-to-device initiative launched by Apple in late 2021 for its iPhones is a wild card.
Who succeeds and who becomes less relevant as this picture develops? Jacob Morgan, Principal Analyst at Forrester, led a team that produced the report, “The Future of Payments.” It’s main theme is that the fabric of the payments business will increasingly be determined by those players that can make payments simpler.
Simplicity in some cases may lead to “invisible” payments. Consumers as well as businesses face a myriad of expenses in everyday life, such as buying gas for the car, that could just as easily occur in the background. Note the longstanding popularity of toll payment systems that rely on transponders or license plate capture.
For providers and for businesses as well, making the payment part of transactions painless or even nearly invisible represents a competitive advantage. Uber is a good example of this.
For payments providers, the reward is volume. For businesses, investing to maintain or enable the smoothest path to purchase for consumers creates an edge over competitors. At the same time, Morgan says in an interview with The Financial Brand, payments technology has improved to the point where businesses will also want to invest in it as a means of saving costs.
However, while Morgan believes the momentum built among consumers for digital payments during the pandemic will continue to have some influence, he says the companies that handle those transactions is going to change. In addition, while the emphasis on innovation in payments has been heavily on the consumer side, Morgan believes much of the emphasis will be shifting to business payments.
Shakeout Coming Among Traditional Payments Providers
Historically banks thought of the payments system as “theirs.” But increasingly the combination of new channels that blend bank and nonbank “rails” — often facilitated by and banks giving access to the payments system via banking as a service — has changed that. Parallel systems, such as PayPal’s and Intuit’s, operate both with industry rails and with funds that are contained within their own systems as “deposits” that can be used to transact.
Increasingly, Morgan explains, offering payments requires a level of investment that demands scale, obtained through market share. “You need scale and volume because margins are so small,” he says. Offering real-time and near-real-time payment networks with 24/7 availability will not be cheap, he adds.
This will be chiefly the realm of larger banks that already have significant market share, because they can consolidate the volume of others who can no longer justify their payment operations. Morgan believes this will apply both to traditional payments as well as platforms that offer payments as a service. He sees this trend driving mergers among those institutions that choose to stay in payments, to bolster capacity and volume, and sees those who decide to “double down” buying or licensing payment solutions to incorporate into their own offerings.
“The smaller banks that likely don’t have enough scale may well choose to divest payments and to look instead at building value on top of the underlying payment rails,” says Morgan.
Morgan expects to see fintechs continuing their efforts to unbundle payments, building value in specific services in their chosen segment of the payments process. “We’ve seen more than a decade of unbundling, which leads to complexity,” says Morgan.
As a result, some banks and other players will seek to rebundle payments services in new ways to bring about functionality and, most importantly, simplicity.
Trend 1: The Advent of ‘Encapsulated Payments’
Embedded payments entail the weaving of payments into other processes so that buying something automatically includes the payment and, potentially, the financing for that purchase.
Morgan says “encapsulated payments” represents the next iteration. This concept will take the embedding of payments a step further, with the inclusion of data and other functionality along with the payment.
In business payments, wrapping data around the payment would permit functions like automatic reconciliation on the payer’s end. This data could also support payment authorization and approval processes, according to Morgan.
Technologically, encapsulated payments would enable users to tap such functionalities as 5G connectivity; “edge computing” — where processing takes place close to where the data is produced; and connected devices — devices joined to other devices via the internet.
In a sense, consumer payments have already seen a form of this, the “chip and PIN” payment card, with the embedded microchip.
“Most people think of embedded payments as a means of originating a payment from inside some other platform by using an application programming interface (API),” says Morgan. However, he explains, “the chip on the card is actually hosting and running a micro program from Visa or Mastercard or American Express that lives on the card and decides whether or not to make the payment. In a sense, that is an encapsulated payment.”
As more such programming goes along with the payment, “we’re almost going back to the future,” says Morgan. Ultimately, he says, the change is not about payments by itself, but the improvement possible for the entire process.
Trend 2: Contextualized Verification, Authorization and Payments
A selection of technologies is coming together to help deliver payment authorization in forms that will require little or no human interaction. The blend will include biometrics, geolocation, device fingerprinting (data that identifies a remote computer or other machine), and localized artificial intelligence. Forrester predicts that payments providers will set up packages of payments services wrapped up with authorization and data elements to enable painless transactions.
One application on the business side is payments for fleet vehicles such as delivery trucks. Morgan pointed to Car IQ as a company offering this already.
“Such services would allow fleet owners to control the payments rules for their drivers and their drivers would no longer have to carry around means of payment,” says Morgan. The vehicle actually becomes the payments device. Car IQ’s service permits payment for fuel, parking, tolls and maintenance and repairs.
The foundation for such services for consumers is already taking shape, with manufacturers like Mercedes Benz and Jaguar Land Rover add features like voice, facial and touch biometrics to their vehicles. From there those features can be used to permit the car to handle payments.
Trend 3: Democratization of Payments
“Digital payments will not supplant prior form factors unless they support all customers and can be translated to low-tech environments,” the report states. Morgan believes that regulators will insist on technology that permits the interoperability of payment methods, in part to encourage financial inclusion.
One means of accomplishing this would be central bank digital currencies, according to Morgan. The Wall Street Journal posted a video during the Beijing Olympics Games showing one of its reporters participating in the CBDC pilot that China opened to foreigners in its Olympic “bubble” during the games. Senior Correspondent Jing Yang demonstrated how it was unnecessary to have a device to convert other currency to China’s digital yuan (e-CNY). She inserted $20 into a specialized ATM and received an e-CNY card with the equivalent in Chinese CBDC.
Morgan says that it is the view of Forrester’s digital currency specialists that the majority of countries looking at CBDCs will move on them within five years.
“CBDC’s provide one of the more interesting opportunities that’s come out of the whole cryptocurrency and decentralized finance environment,” says Morgan. He adds that the firm also sees stablecoins as a viable result of the digital asset movement.
Trend 4: Money that Knows What to Do with Itself
In the future payments will be more than a fungible quantity of value. Forrester’s report states that programmable money will “set the conditions of operation, restricting service to a merchant, a value, a location, or a time…”
This technology has both business and consumer applications. On the business side, one use could be company-funded payments for employee travel and entertainment that would be controlled so it wouldn’t be abused and would be accounted for automatically.
A consumer application would be pocket money for children. This could be programmed regarding when the money would be available for spending and what it could be spent on, says Morgan.
Morgan points out that the gig economy has already created a limited form of programmable money. Shoppers picking up groceries for delivery service customers have pre-authorized power to purchase on the client’s account, but the money can only be used at the store selected. As part of the process the gig worker is paid for their service.
More complex uses could also be set up. Morgan sees the home-buying process becoming simpler yet more controlled through the use of payments programmed to become available when certain conditions of the home sale have been met, with the payment logging in satisfaction of all requirements.
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By Steve Cocheo, Executive Editor at The Financial Brand