In this instalment of ‘Why banking infrastructure is broken’, we’ll take a look at payment rails. We’ll explore the issues with payment rails today, what needs to change and setting the right foundations for creating payment rails which are fit for purpose.

Payments are the part of the banking system that people touch every day. This exchange of value might seem straight-forward, but in fact it involves quite complex processes that are locked into the past by legacy practices and old technology.

Over recent years, payment needs have changed significantly. There has been an enormous growth in demand for immediate payments to support the fast-growing gig economy and a big rise in the need for micro payments to underpin new subscription-based business models and the emerging Internet of Things. These are fundamental shifts in the way people, businesses and, increasingly, machines pay each other. While there has been substantial improvements in front-end retail payments, the core payment infrastructure that everything runs on has not kept pace and is desperately in need of modernization.

The reality behind the mask

Fundamentally, commercial banks weren’t set up to facilitate payments – their main purpose as businesses is to lend. However, through convenience over centuries, they developed rules and methods to pay each other which were then globalised and automated piecemeal throughout the 20th century. This infrastructure, bolted onto and incrementally patched over generations, traps today’s payments industry into old, pre-digital ways of moving money.

The result is payment infrastructure that is locked in old methods and standards, is slow to change and is bereft of the intense focus needed from the world’s banks to improve it.  Examples of these problems are everywhere. For example, strict limits on how much information can travel with a payment, over-complicated and fragile technology that can break easily if changed, enormous sums of money parked in the world’s banking system to allow payments to flow internationally because liquidity cannot be efficiently managed and long delays bringing value-add services to market because legacy technology is so slow and expensive to adapt.

For those fintechs, financial services providers, and increasingly non-financial brands trying to innovate payments, building on existing outdated bank rails is difficult and costly.  And it’s going to get worse: as time goes by and the payments industry moves increasingly to micro, international, immediate payments with volumes that will be orders of magnitude greater than today, these problems will get a lot more visible.

It will be like trying to build a PS5 open world game on PS2 hardware – it simply won’t work.

Payment providers have done a remarkable job over the years of masking these problems, making the payment experience seem simple to end-users. A prime example of this is the domestic cardless payment; immediate, simple, easy. Behind the scenes however, the payments process is frustratingly complex. Facilitating one payment requires multiple bank stakeholders, multiple rails and intricate processes that further add to the cost and complexity.

This problem is magnified when it comes to cross border payments, where the issue is much bigger, and the mask slips off entirely. Sending money often takes days, with the funds in transit difficult to track, and the value of the transfer when it arrives is cut as each middleman takes a slice of the pie. The opaqueness and unpredictability of the process is a major headache: the customer sees their account has been debited, but it can take days for the recipient’s account to be credited, with neither party being able to track the funds’ journey easily. You cannot run an immediate, high-volume micro-payment-powered business on these foundations.

Businesses providing payment services need to be empowered to do the job more easily. They need banking infrastructure which better supports their aspirations and enables them to create new value.

Ditch the frenemies

One major problem is that the banks which payment firms rely on are competing with them for the same end-customers. This creates ambiguity which can never result in a true partnership. The reality is that traditional banks are frenemies, who may not always be working in the best interests of the partners they serve.

Changing this engrained ‘frenemies’ situation is hard. But it is already beginning to happen. New types of banks are coming on-line that focus primarily on processing payments on behalf of payment providers and fintechs without trying to also compete for their end-customers. They are fintech-friendly, and focus almost entirely on improving the way they execute payments.  The result is the emergence of a global digital foundation that could be the catalyst for wholesale change to our financial infrastructure.

These banks specialise in Embedded Banking, in effect plugging bank infrastructure tightly into payment provider technology, using API technology to create the banking ‘widget’ needed for fast, excellent payment processing.

Embedded banking goes hand in hand with the growth of Open Banking, which allows banks and payment companies to access information and instruct payments with minimal friction, again using the power of APIs.  If traditional banks are able to integrate this technology into their payment rails, they will also be able to better support businesses to facilitate payments more easily.

The Embedded Banking revolution has a long way to run and will have a profound and positive impact on bank infrastructure - including challenging what it means to be a bank in the digital age.

Re-imagine the foundations

Despite the growth of embedded banking and new payment-focused banks, the underlying rails are still a problem.  And here, there is a need for not just incremental change, but a creative re-think of what is means to hold and move money.

On the incremental level, the industry has been adopting the much richer information standard ISO20022 to fix the problem of limited and non-standard information - but this evolution is taking an enormous amount of time and is painfully costly to banks, with legacy formats like SWIFT FIN still the workhorses of the global financial system.

In parallel, far more disruptive concepts are being incubated and trialled. New entrants and fintech leaders are working on exciting alternatives, tapping into blockchain and internet principles to create alternative low-level rails, that could potentially unlock payment flow in the same way that the internet unlocked information at the turn of this century.

Intense research and experimentation in digital currencies and distributed network clearing could minimize risk and obscurity in payment infrastructure, and research into interconnecting bank ledgers internationally could pave the way for an internet-style network for money, which would be revolutionary. These new challenger infrastructures also have the benefit of zero legacy, so they are able to create foundations that finally cut the payment world loose from the constraints of the old.

There will be an increasingly wide range of alternative payment rails coming available this decade as new ideas come to market.  Navigating this multi-faceted world won’t be easy for payment providers and the embedded banks that increasingly support them. Some new ideas will fail, some will fade, and a few will balloon to become the financial infrastructure and standards of the future.

The key here is agility, and payment providers are already running with several methods at once - both legacy models like SWIFT as well as modern blockchain and API-based models like rtgs.global.  And because most tech now runs on cloud software, switching between winning and failing infrastructure has become much easier.

Coming up in the next blog…

The next blog in this series will focus on how the fabric of money is changing, in which we’ll explore the move from analogue to digital currency and it’s wider implications.