MGT415: Fintech

Payment Innovation

Topic:

Why Payment Innovation?

payments is a profitable line of business

payments data is very valuable

payments $=$ clunky and full of frictions

payments is the entry level drug to all things FinTech

Legacy institutions are most likely attacked where the greatest sources of customer friction meet the largest profit pools

Giancarlo Bruno, Senior Director, Head of Financial Services Industry, World Economic Forum

payments matter a lot more to people than we might think

$16B for transactions costs?

fritctionless

fast

open & expandable

cheap

secure

How would a perfect payment system look like?

Source: How can payments modernization benefit Canadian businesses? Evaluating the cost of payments processing; EY and Payments Canada, 2018

From Wendy Rotenberg: 734 Million Cheques for $4 Trillion

Are people well serviced?

In 2015, underserved consumers spent $140.7 billion on fees and interest across five financial product categories that serve the "under-banked"
Slow payments drives individuals to use
- high cost check cashers $2 billion
- small dollar ‘pay day’ lenders $7 billion
- bank overdraft fees $24 billion
Not all but some of this stems from slow payments - why?
- Get paid on the 30th by cheque
- rent is due on the 1st
- cheque clears on the 2nd or 3rd

Source: Schmall & Wolkowitz (2016), Center for Financial Services Innovation (2016) "Financially Underserved Market Size Study"

Are people served well? Some data from the U.S. on slow payments

International remittances: $600B (U.S.) p.a.

all in: 10% fees

International Remittances

to be fair: remittances to date don't even work for internationally operating banks

Undue Risk Aversion:
Financial institutions often won't offer payment solutions to small business, due to their credit risk profile.

B2B payments:
most financial institutions charge base fee + transaction fees

Payroll:
Need for payroll solutions for SME that are integrated with accounting systems.

Credit cards:
SMEs need to use owner's personal card which affects their personal credit score

Accounting/corporate finance
Small businesses have to integrate payment activities to accounting platforms themselves.

:$1 per transaction

Small Business Grievances: Anecdotal Evidence

Business: Better Data and Faster Processes?

Manual/Excel-based, stand-alone cash need forecasts

$\Rightarrow$ inadequate cash management

Source: How can payments modernization benefit Canadian businesses? Evaluating the cost of payments processing; EY and Payments Canada, 2018

So we aren't there yet!

Summary: sub-optimal payment processing costs Canadian businesses $2.9 to $6.5 billion annually

Source: How can payments modernization benefit Canadian businesses? Evaluating the cost of payments processing; EY and Payments Canada, 2018

Innovations in Non-physical Payments around the world

Scandinavian Digital Payments

Mobile
Money

Mobile Apps in Emerging Economies

Danish Mobile Pay

4+ million users (population 5.7M)

235+ million transactions, 8.6Bn EUR value

launched by Danske Bank, but bank-neutral

instant payments based on mobile phone numbers

Critical component: "digital" ID

Critical PreReq for Danish Mobile Pay

government issued digital ID

available to anyone with a SIN

common login for:

civic services

banking

taxes

other businesses, e.g. telcos

Components of Danish Mobile Pay

a mobile app

links to existing bank account

uses trusted infrastructure and authentication

cleverly leverages what you have

adoption rate shows the value of form factor/frictionless experience

Mobile Money in the Developing World

bank account

access to saving vehicles and safe storage & transfers

better economic future

Mobile Money in the Developing World

Mobile Money: M-Pesa

https://www.youtube.com/embed/g1IqjY88YuM?enablejsapi=1

Mobile Money

Cash-In
agent

Cash-Out
agent

Mobile Payment

Mobile Apps in Emerging Economies

Where accepted?

and almost every other 905 tourist mall

900M WeChat Pay Users
84% market penetration

Component of : digital identity + Unified Payments Interface

"To empower residents of India with a unique identity and a digital platform to authenticate anytime, anywhere."

"[PayTM] want[s] to become the universal payments layer on every bank account"
"something that was going to take 3-6 years now takes 3-6 months"

UPI puts multiple bank accounts into a single mobile application (of any participating bank), merging several banking features, seamless fund routing & merchant payments under one hood.

some stats for India

300 million users
5 million transactions per day
over 7 million merchants
over $4 billion per month

These apps offer more financial services than payment

Why is WeChat etc already relevant for Canada?

Will new students ...

get a bank account?
or just choose merchants by whether they can use WeChat pay?

How about new immigrants?

At what point will they simply stop using Canadian banks?

and almost every other 905 tourist mall
>150K WeChat Pay users @GTA

Is PayTech a thing in Canada?

Yes!
42+ PayTechs in the GTA

Source: Seizing The Opportunity: Building The Toronto Region Into A Global Fintech Leader; TFI/Deloitte/McMillian 2019

Yes!
42+ PayTechs in the GTA

Source: Seizing The Opportunity: Building The Toronto Region Into A Global Fintech Leader; TFI/Deloitte/McMillian 2019

Is PayTech a thing in Canada?

Remittances

Consumer PayTech

loyalty

Payment financing

mobile payment integration

mobile payments + rewards

connect advertising directly with immediate mobile purchasing option

personal payment management app

Payment financing + loyalty

PayTech & Accounting Platforms

Overall idea: increase visibility of payments across the supply chain and across internal business operations

Specialized SME Products

property management and rent payments

B2B & inter-company real time payments

gig economy instant pay

fast vendor payment

Services to Cater to Chinese Customers

North American merchants connect to Chinese consumers who use WeChat & Alipay

Why do PayTech solutions emerge?

people want mobile, frictionless, and immediate

Reduced payment
risks

new customer-business relationships (data collection)

Business integration and accounting simplification

expansion of merchant and user base

Examples of PayTechs

credit card issuer
easy reward point redemption
in-app loan application

Pitch: $16 billion of rewards left unredeemed each year by Canadians.
Why? Cumbersome, not relevant or have been devalued.
With Brim, points accrue at market fare because user purchase first and then redeem rewards. No redeeming at a marked-up value. The platform makes earning and redeeming simple.

Examples of PayTechs

enable businesses to make deposits in real-time directly to an account in seconds, not days

payments usually take 4-5 days
Companies such as Borrowell provide on-demand loans for businesses and consumers. Without Pungle, businesses that need cash instantly, whether to settle up with a supplier or pay for an unexpected expense, must wait several days to receive the money.
Gig economy: employees expect to be paid instantaneously or at shift-end. We’ve found that the more frequent payment of wages has had a direct correlation with lower turnover.

Innovations by BigTech

BigTechs operating as FinTechs in Canada

New frontier: revenue-based lending

14.5% interest - over what horizon?

1. Visit Agent

2. Deposit Cash by phone or bar code

3. Use online

Customers use Amazon login ...

... to pay at other merchants sites!

Why we should be skeptical of untethered AI

The most controversial entrant of them all ...

Partnerships

Will people use Libra?

Source: Will Libra Succeed? Results of a Global Randomized Survey Experiment; by Danielle Goldfarb and yours truly

Why does BigTech enter the finance game?

They have ZERO interest in becoming a financial institution/bank

$\rightarrow$ no expertise

$\rightarrow$ competitive market

$\rightarrow$ one of the most regulated business environments

My take

They are trying to deal with frictions that impede their business

They aim to collect data which will vastly improve their business

Meanwhile, in the traditional world of finance

Business as usual?

PayTech

banking and payments activity require a banking license

need approval of the Finance Minister and the Office of the Superintendent of Financial Institutions (OSFI)

Hurdle #1: Current Law

Pain Points & Adoption Hurdles

providing any financial service

acting as a financial agent

providing investment counselling or portfolio management services

issuing payment, credit, or charge cards,

operating a payment, credit, or charge card plan in co-operation with others (including other financial institutions)

Wide Reach of the Law

Hurdle 1: Current Law

Existing banks protected from (too much) competition

granting of bank license has extensive list of regulatory criteria (subject to political interpretation)

takes 2 to 5 years to successfully acquire a banking license in Canada

Rogers applied in 2011 and was granted a Schedule I bank license in 2013

most FinTechs and PayTechs do not have the time or money to acquire a banking license

High Regulatory Adoption Hurdle

Hurdle 1: Current Law

PayTech demonstrated use and purpose of prepaid card to regulator
OSFI rep had never seen one, not had any experience in dealing with the regulatory implications of this product.
OSFI and others do not have Fintechs and PayTechs in scope (not yet threat to the safety and soundness of the financial system).

Lack of Knowledge by Regulators

EXAMPLE #1

Hurdle 1: Current Law

regulatory compliance = lawyers
lawyers = second line of defence teams at FI
$\Rightarrow$ decision makers have very little access to clients and the frontline.

EXAMPLE #2

good at general service and infrastructure

banks have very rigid ways of engaging with their clients, “they push information, they don’t take it”

$\Rightarrow$ poor at customization and customer service

Banks & the Last Mile Problem

Banks' Modus Operandi

Premise of FinTech

start with customer needs and then build platforms

Hurdle 1: Current Law

Current Development

New Framework To Regulate Canadian Retail Payment Ecosystem was in the 2019 budget

foundation for broader, risk-based access to Canada’s retail payments ecosystem

Payments Canada: "level the playing field"

Mentioned safeguards:

safeguarding end-user funds
implementing operational risk-management standards
minimum disclosure requirements
dispute resolution mechanisms
liability rules.

Why is payments data valuable?

How much money is coming into and out of the account each month

If you had a full view of payments, what would you learn?

Spending habits: what you spend money on and where you spend it

Payment habits: Are you paying bills way ahead of deadline or tardy?

Useful services

Assess how much a customer spends on products of competitor and undermine competition

Pepper consumer with ads tailored to spending habits

Play on impulses and behavioral biases

Prying on the weak (payday loans)

Manipulation

create a comprehensive overview of balances for customer

keep tabs on expenses and income

show how much one can spend freely until next income

reminders or automated retirement savings when income arrives

Open Discussion: Other ideas?

Breakout Discussion

Which small firms and entrepreneurs can benefit?

How would they benefit?

What payment related data can they collect?

How might they use the data?

Some Examples of (Past) Industry Leaders

Why worry about the distant future?

Nokia's market shares for devices:

2007: 49.4%
2012: 3%

What happened and can it happen to banks?

Examples: Blackberry and a generic bank

Paid-for vs. valued

Keyboard
Security
Being businessy
Cool and cutting edge
Being Canadian
Independence from desk

What did they pay for?

What do people value?

Mobile email

Brand name
Easy access to branch
Great product range
Fair prices
Great advice
Latest tech
Friendly tellers

Safe-keeping of assets
moving money around

If banks move all data into "the cloud," why do we need banks?

What took the place of Blackberry?

Major Lesson: Platforms provide value

What took the place of Blackberry? The App-Phone

Past, Present, and Future

Who will provide the next gen banking platform?

Siloed banks

Cloud computing and cloud storage

Open banking and open data

The past (and the present?)

The present and near future

3-5 years in the future

5-10 years in the future

Platforms?
Banks?
Tech firms?

Each bank has a separate data center
high costs
no scaling
little network externalities

AWS etc
Use specialized IT providers
Network with external providers (FinTechs)

Share data with external parties at customer request
Platforms will emerge
Customers can switch at the drop of a hat
How will basic banking work?
Who will run the platform and how will you survive on a platform?

What will a platform work in financial services look like?
What roles will current banks play?
How will a bank earn money in a platform world and with which services?

Distributed Ledger/Blockchain Technology

A "joint, single system"
Features:
- secure storage of information and transfer of value
- guaranteed execution of code
Promise
- open platform
- global reach
- frictionless finance

Version 3: They use different banks that have no direct relationship

Sue's bank transfers from Sue's account to its own account

Bob's bank transfers from its account to Bob's account

Central Bank

Central bank transfers from Sue's bank's account to Bob's bank's account

International transfers

Sue's bank transfers from Sue's account to its own account

Bob's bank transfers from its account to Bob's account

use the Swift network of correspondent banks

Bottom Line

very complex

many parties

lots of frictions and points of failure

very expensive

Crazy thought: Wouldn't it be nice if there was a single ledger?

Existing solutions

Problem:
power concentration/Monopoly

Key features of blockchain

How do we agree on updating of the data?

Idea: mechanism to randomly select a proposer and have incentive to build on the correct past

Blockchain

Distributed ledger
($\to$ shared source of information)

linked and secured
(by cryptography and economic incentives)

Note: doesn't have to be entirely "serial"

Text

Source of picture: Cai, Long, Park, & Veneris (2020) (IEEE-BRAINS), original protocol: Li, Li, Zhou, Xu, Long, and Yao (2018)

Private vs. public

some key questions

Who gets to update?

Can a higher body prevent
transactions?

Can the past be altered?

consensus

immutability

censorship resistence

Public Blockchains provide

from Forbes

Azure Blockchain Tokens [...] lets enterprises, or anyone really, design, issue and manage a wide range of assets,

Currently, the platform is a permissioned version of the ethereum blockchain that uses Microsoft’s Azure cloud computing.

In the future Azure Blockchain Tokens will interact with the public Ethereum blockchain or even at distributed ledgers created by some of Microsoft’s own competitors.

https://www.forbes.com/sites/michaeldelcastillo/2019/11/04/microsoft-to-help-enterprises-mint-their-own-ethereum-tokens/#5048848a18f9

Blockchain $\not=$ bitcoin/Cypherpunks

Items that get lost in blockchain discussion

blockchain $\not=$ Bitcoin and blockchain $\not=$ cryptocurrency

cryptocurrency $\to$ attempt to bootstrap the network

blockchain is more than money - Ethereum is guaranteed execution of code

proof-of-work is horrible, but there are many efforts to get other systems to work

issuance of tokens

escrow contracts

auctions without an auctioneer

decentralized securities exchange

is not just about the money (Libra Coin)

NB:

Reality Check: Capacity

	TPS	T per 12 hours
Bitcoin	7	302,400
Ethereum	30	1,296,000
Athereum	5000	216,000,000
Algorand	2000	86,400,000
Payments Canada retail	648	28,000,000
US retail	7639	330,000,000
Canada number of equity trades	46	2,000,000
Orders on Canadian equity markets	3588	155,000,000
Conflux Network (Ethereum-like)	3600	155,000,000

One more application:
a stock trade

Sue wants to sell ABX

Bob wants to buy ABX

sell order

buy order

Clearing House

Stock Exchange

Broker

3rd party tech

custodian

record beneficial ownership

central bank for payment

With Blockchain: single ledger for money and securities

0xA69958C146C18C1A015FDFdC85DF20Ee1BB312Bc

0x91C44E74EbF75bAA81A45dC589443194d2EBa84B

0xA65D00Eda4eEB020754C18e021b1bF4E66C9Ed90

cryptocurrencies' volatility?

Cryptocurrencies are (currently) useless as
money

fiat money cannot be used in smart contracts on the blockchain

solutions:

stablecoins

central bank digital currency

The One the world is talking about

What is Libra and how does it work?

BUT: more than money, also code execution and added functionality

each Libra coin will be backed by a basket of SIX fiat currencies

idea is conceptually similar to IMF Special Drawing Rights (pegged to USD, EUR, YEN, GBP, YUAN)

developed by a consortium of firms (e.g., Facebook, Uber) and not for profits (Creative Destruction Lab)

Digital ID

Why?

Digital IDs would almost entirely eliminate KYC requirements and simplify AML

Currently spearheaded by: Digital ID & Authentication Council of Canada (DIACC)

Side effects: makes switching between banks easier

Digital ID: SecureKey's DLT Solution

Source: Consumer Digital Identity Leveraging Blockchain, report to DIACC by Securekey

Why does Digi-ID matter?

reminder:

private sector solution to proving who you are

simplified access to

civic services

banking

taxes

other businesses, e.g. telcos

central bank issued digital money

Newest Developments: CBDC

CBDC = Central Bank issued Digital Currency

not a cryptocurrency $\to$ just a "normal" liability on central banks balance sheets

BIS Jan 2019: "Proceed with caution"
BIS Jan 2020: "Impeding Arrival"

Is it coming?

players (inter alia)

China: in test mode; provinces prep own initiatives, coming next year
U.S.: has bigger problems and is always a last mover
UK: preparing
Canada: contingency planning (it'll happen within two years)

players (inter alia)

What's the problem and what should a CBDC look like?

current problems

future concerns

crib sheet

too slow

too expensive

not flexible

lack of competition

disintermediation
by new players (Libra)

data harvesting
with no way out

ineffectiveness
of monetary policy

demise of the Loonie

two-tiered world in Canada

fast

cheap

flexible/programmable

universally accessible

Possible CBDC architectures

Source: BIS Quarterly Review, March 2020

What is "disintermediation"?

two types of money

government:

reserves
cash

commercial

each commercial loan $\to$ deposit

cash withdrawl

convert commercial money into government money

lowers bank's balance sheet

disintermediation $=$

Would a CBDC destabilize the banks?

BoC analysis (August 2020):

[banks] are well-positioned to absorb potential temporary negative effects on profitability and liquidity
Banks[can] absorb the shock under plausible adoption scenarios.
[No] threat to the stability of the financial system or to banks’ competitiveness in terms of ROE.
banks will maintain healthy liquidity levels, and liquidity could become a concern only in the most extreme scenario.

Key question: what business opportunities will arise?

Current State of Real-Time Settlement

immediate transfer of funds
no exposure to credit & liquidity risk, no systemic risk
participants must maintain sufficient funds & send each payment through system
requires intraday borrowing from central bank

Canada:
Large Value Transfer System

Most other G10* countries: Real-Time Gross Settlement

*Bank of International Settlement: Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States