Expert view

Technological change in the payments space

Beyond the trends: What’s next for payments digitalisation?

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The pace of technological change in the payments space is hard to overstate. Commerzbank Insights speaks to Simone Löfgen, Commerzbank’s Global Head of Payment Platforms, about what she sees as the major innovations and developments defining the sector.

The payments industry is often regarded as being at the forefront of digitalisation in the finance industry. What do you see as the main drivers shaping innovation in the payments space?

Simone Löfgen: Indeed, payments have always been a driving force for innovation within the finance sector and wider economy. This has not changed. In fact, as we celebrate 50 years since the inception of SWIFT – a true landmark for the industry – the payments space is evolving at a pace rarely seen before.

As payments are multifaceted, the road towards payment digitalisation is not necessarily linear. As such, progress has been, and will continue to be, multi-directional. But one common driver of change across the payments landscape has been the pandemic. Now that we can look back with some perspective, there is no doubt that it was a real game-changer, dramatically accelerating existing trends in e-commerce and payment digitalisation. There was a 27.6% jump in global retail e-commerce sales in 2020, for example1. Even here in Germany, traditionally a cash-dominated market, the pandemic encouraged many banks to embrace near-field communication (NFC) devices for payments, allowing customers to pay using their mobile phone.

And while the pandemic was an unusual trigger, innovation in the payments landscape is more typically shaped by regulation and technology, in one form or another. At the beginning of this year, for example, the migration to the new ISO 20022 message format was completed. The changeover went smoothly, which can be in no small part attributed to the great efforts made by banks in preparing for it.

In terms of technology, in today’s open banking world, APIs have become well-established and continue to influence the services banks offer. Simultaneously, financial institutions (FIs) are also pursuing instant payments, and this is an area that could be transformational for transactions.

The advancement of real-time transactions is perhaps one of the most tangible developments in payments in recent years. What is the current state of play in terms of the progress made so far?

SL: Achieving widespread, frictionless transmittance of data from A to B has always been a key goal for the industry. Instant payments put the focus back on the account, in some ways reversing a trend we saw during the pandemic. With the dramatic rise of e-commerce, we witnessed an acceleration of non-traditional payment methods – involving Amazon, PayPal or other similar schemes as intermediaries. Traditional banks were somewhat left behind, with credit card providers also enjoying an increase in use. With instant payments, banks are making themselves better equipped and more relevant for the e-commerce age.

Significant progress has been made in countries across the globe from a domestic payments perspective. But it is the application of instant or real-time capabilities to cross-border payments that is the “holy grail”, and that is a major goal at the heart of the G20 Roadmap – an important international initiative to address the challenges often associated with international money transfers.

Upcoming legislation from the European Commission, which is designed to complement the Eurosystem’s broader retail payments strategy2, signals that the market will gradually move towards making instant payment solutions mandatory. In the Eurozone, about 14% of SEPA credit transfers are currently instant. Once this regulation comes into play, we expect it will increase to between 40% and 50%.

We’ve seen successful pilots in Asia, such as in Malaysia and Singapore, where separate instant payment systems are very well-connected. In March, the two countries linked their DuitNow and NETS payment systems, to allow customers to make both in-person and online cross-border transactions using QR codes. This initiative is being seen as a possible forerunner to a larger ASEAN network of interconnected real-time payment systems.

To what degree does the implementation of ISO 20022 support the adoption of instant payments? How does the new standard make instant payment flows safer and more secure?

SL: The introduction of such a comprehensive standard is an important step towards making payment systems interoperable, which is critical if we are to leverage domestic instant payment systems as a way of enabling instant cross-border payments.

Another primary benefit of ISO 20022 is the range of new analytical tools that it enables. The majority of banks’ data comes from payments. By providing high quantities of enriched, structured data, the new standard allows banks to apply analytics – such as cashflow projections and trend analyses – to provide insights that can ultimately be used to benefit corporate clients.

These data tools can also be put to work to support the rollout of instant payments. Currently, one of the big challenges with real-time payments relates to fraud risks. Unlike a regular credit transfer where, if you suspect wrongdoing you have a couple of hours to stop a payment, with instant payments there isn’t that window of time to halt a transaction once it has been processed.

Fraud checks therefore need to become much quicker, in line with the speed of the payment itself. Advanced analytical tools, which can detect patterns of suspicious behaviour using large datasets, will be a crucial part of the solution. Through ongoing analysis of payment data, important insights into the behaviour of payers can be used to detect and prevent fraud in advance. In the credit card space, this process is already well-established. The pre-validation of payments is another option, providing an additional layer of security.

There are also use cases for AI and machine learning, which could help FIs refine their fraud prevention strategies on a larger scale. Building up this sort of analytical capacity will be essential to convincing clients that instant payments are secure. Commerzbank is part of EBA Clearing’s analytical pilot project, which focuses on anomaly detection, aggregating data from all associated banks to fight fraud.

The progress being made with respect to real-time payments is impressive. Are there other innovations on the horizon – distributed ledger technology or digital money?

SL: The adoption of distributed ledger technology (DLT) is becoming increasingly mainstream, and this is particularly exciting with respect to the development of digital currencies. While seemingly a longer-term goal for now, both central and commercial banks are exploring the possibilities of creating their own forms of digital money. For central banks, providing a general-purpose digital currency is a means of adapting public policy objectives to a digital world. This is not only a response to the increasing dominance of credit card providers and digital behemoths such as Apple Pay and Google Pay, it is also a solution that pre-empts the ongoing shift towards a cashless society.

Commercial banks are naturally also exploring the pros and cons. But with so many technological options, the landscape is still very much in flux, and it is unclear what model will emerge as the optimal one, what form it will ultimately take and what investment is needed in order to make it a reality.

For example, should every major bank have its own stablecoin (a form of cryptocurrency whose value is tied to a stable asset)? Or will central bank digital currencies (CBDCs), such as an ECB-led digital euro, become the main standard to be embraced by other institutions?

With a digital euro, individuals would have a central bank wallet on their device to store this new form of money. It could conceivably either be a standalone application or be integrated into each commercial bank’s ecosystem – which would give customers the choice to pay for any given purchase with their traditional accounts, or their wallet. In this respect, a digital euro would replace cash, rather than commercial bank money.

What is certain is that there is potential for tokenised money to play a role in the banking system. This is especially the case with trade and supply chain finance, where DLT offers the possibility of having payments triggered directly on chain. In a trade finance transaction, tokenised money can also represent the goods on chain – which would also allow more KYC data to be shared instantaneously.

Is the industry making a collective effort to come to a consensus on the applications of DLT?

SL: Collaboration is always at the heart of Commerzbank’s approach to innovation. We form part of the new technology market contact group of the ECB, where we exchange views on a variety of topics with European market leaders. We also actively participate in discussions with the German banking community through the Association of German Private Banks (BdB).

It is fair to say that the industry is approaching CBDCs through a process of joint experimentation. We are playing our part – in fact, we recently contributed to a joint industry whitepaper exploring the possibilities of tokenised deposits in relation to trade finance3.

Together with 16 other major institutions, Commerzbank is also a shareholder of Fnality, a UK-based fintech that aims to create a peer-to-peer digital cash asset to settle tokenised transactions. Fnality is looking to explore the possibilities of synthetic CBDCs, a setup that involves less direct management from central banks and more collaboration between private and public institutions.

This format is ideal, marrying the speed of development of a fintech with the unrivalled industry expertise from established FIs. Because, while barriers to entry in the financial sector are still relatively high, innovation still relies on speed. The most promising idea has to be implemented quickly in order to make a real impact. We don’t move at the speed of an instant payment – but it’s a goal to aim for!