European Payments Landscape 2023: Shift from turbulence to a new-normal

The last three years have been a time of incredible disruption in the payments ecosystem. But as the rate of change settles down and we head into a new normal, the Oliver Wyman Payments Platform examines trends impacting the European payments landscape and the potential evolutions and disruptions we expect to see in 2023.

We examine three overall areas and themes, the potential for changing ecosystems, evolutions in payment methods, and the impact of the changing regulatory and risk environment. We also explore the potential actions that players in the payments value chain can take to help themselves better position for the future.

Changing ecosystems

????Payment operating models

? Embedded Finance

? B2B Payments

Changing payment methods

????Cash

????M-Commerce

????A2A solutions

????BNPL

????Digital Euro

Changing regulatory, risk and economic environment

????Fraud and financial crime

????New regulation

????Payment economic models

1.?Payment Operating Models: Banks across Europe need to review and evolve their operating models

Payments processing is a scale business (cards and accounts based payments), involving a large amount of fixed cost, we estimate that competitive unit-cost can only be achieved with 3.5-5 BN of transactions a year. This is only likely to get harder, given the increasing complexities of processing (e.g. multiple channels, increasing breadth of payment options, fraud and financial crime requirements).

Smaller to medium sized banks are increasingly facing an “investment wall” given the major improvements needed in their technology stack to enable cloud-based, API-ready, instant processing. These banks are faced with the strategic choice to:

????????Invest in sub-scale in-house processing capabilities which is often expensive and tech talent to enable this is difficult to find

????????Outsource to a third-party processor which creates a variable cost base (especially interesting when card volume goes down), however this limits long term strategic optionality and risks cost inflation

????????Partnering with other banks or third-party processors to create a JV or dedicated payments processing venture, which can be an attractive option although aligning incentives and getting the right cost structures for multiple parties can be challenging

Larger banks need to make similar investments into their technology stack and infrastructure, however they are in a stronger position to “lead the pack” and consolidate payments volumes into dedicated payments ventures (partnering with other banks).

Reviewing and adjusting a bank’s operating model can lead to significant cost savings as well as drive higher equity valuations (given payment businesses favorable equity multiples for non-balance sheet processing activities vs the multiples of traditional banks).

In 2023 we have already seen one major continental bank sell their payments and acquiring business, and expect further deals in this space.

For banks & traditional acquirers: review existing business model and evaluate options to move.

For next generation PSPs: continue to focus on targeted use cases and client sets in order to maintain the competitive edge. Avoid the temptation to diversify too early and weaken the overall go to market proposition.

2.?Embedded Finance: Increasingly, PSPs, acquirers and fintechs are positioning to eat more of the traditional bank’s lunch

Embedded finance – where a financial enabler (e.g. bank) distributes financial services products to customers through a customer facing platform (e.g. online retailer, marketplace, SaaS solution etc.) – is growing and is an increasingly popular way for banks to distribute their products, reaching a larger group of end-users in a more engaging and seamless way. This is particularly the case in consumer, as well as SME banking.

Some examples include:

????????Deposits: Various banks distributing savings account through account aggregator Raisin

????????Current accounts: Adyen partnering with Moneybird to embed current account into accounting software proposition

????????Lending: Partnership between Amazon and ING in Germany to provide merchant finance

????????Investing: John Lewis partnering with Nutmeg to provide investment accounts

However, banks are still struggling to make significant headway in this space, with some of the more prominent examples of embedded finance, showing cracks and resulting in significant losses. Most embedded finance solutions are being provided by Neobanks or payment institutes (e.g. Stripe, Adyen), rather than the traditional banking set.

Delivering Embedded Finance solutions requires a different set of capabilities to traditional banking, with a stronger focus on tech enablement, and deploying customer servicing and risk management into 3rd party ecosystems. Distribution capabilities, and the ability to dial up and down different elements of the balance sheet to drive the P&L also need to evolve.

For banks: going forward, banks to need to clearly define how they want to play within an Embedded Finance ecosystem: do they become a specialist EF player, or how do they otherwise ensure they retain/protect their ability to establish a customer relationship to be broadened over time.

For Acquirers/PSPs: with strong relationships to existing platforms, acquirers can look to accelerate revenue diversifying into other Embedded Finance revenue lines. Leading PSPs in this space are now driving 40% of their revenue from non-acquiring revenue lines.

3.?B2B Payments: API based B2B solutions expected to accelerate with growth and penetration of Real-time Payments in Europe and US

Business-2-Business payments remain a major pain point for corporate Treasurers globally. Supplier payments, trade finance payments, wires, are all relatively manual, costly and inefficient when compared to consumer payments.

There is significant innovation coming into this space (Nomentia, Tipalti, Atlar), and strong interest from incumbents too (e.g. JP Morgan-Kyriba partnership), in order to start moving payments from traditional file based systems, into real-time live API based payment platforms. Equally, propositions are focusing on multi-rail payout solutions, giving corporate and merchant clients a combination of A2A and virtual/corporate card payments to enable them to optimize their payment terms and, where relevant, their FX rates.

With the mandating of SEPA Instant, and real-time ACH systems in the US coming online, we can expect API based payment solutions to start to accelerate.

For banks: given B2B is an area where corporate payment solutions are likely to trump over open banking, there is an opportunity for banks to deliver commercialized or unregulated API solutions in this space, to create sticky and integrated propositions with their customer base.

For acquirers/PSPs… there is further potential expansion opportunities by growing share of wallet supporting corporate clients with disbursement and payables solutions.

4.?Cash: Cash usage remains more stubborn than thought but the trend remains on cashless

While the trend of decreasing cash-usage accelerated across Europe during the COVID pandemic, the decline has slowed in the post-COVID era, and in some markets like the UK, cash use has plateaued. It seems that cash usage will remain stubborn in some areas and campaigns to support cash, given its inclusive characteristics, are gaining ground.

Nevertheless, we still expect strong growth in cashless payments for two reasons: (1) upcoming regulation will accelerate cashless payments and increase their reach (e.g. SEPA Instant mandate, Digital Euro); and (2) In the mid- to long-term, the international card schemes and brand-new digital solutions (European Payments Initiative or EPI) are seeking to grow share-of-wallet and are backed by large marketing budgets.

There are some interesting country level specificities (e.g. the petition for a referendum in Austria to make cash acceptance compulsory), but we do not expect these to break the trend. Moreover though, they highlight a challenge for banks globally in maintaining cash in the system at a lower level. Innovative and efficient solutions need to be built which can operate at a smaller scale without impacting the overall profitability.

For banks… Examine potential for alternative networks and solutions to address clients’ cash needs (e.g. withdrawal via POS in supermarkets, community banking hubs), supporting twin goals of financial inclusion and operating efficiency.

5.?M-Commerce: Online commerce is a big growth engine but is increasingly shifting to m-Commerce and wallets

With lockdowns across Europe, COVID provided a significant boost to eCommerce transactions and drove a transition in many businesses from face-to-face retail transactions to online.

This trend was partially broken in the post-COVID era, where consumers seek the “in person” experiences instore, but the desire for “touchless” interactions led to growth in mobile based ordering and payment. M-commerce has thus accelerated much more rapidly, and according to Worldpay now makes up ~60% of e-Commerce transactions in some European markets (Italy and Spain being the leaders).

In the m-Commerce space, the wallets are driving much higher penetration (30%+ in some markets), with wallets leveraging a mix of debit and credit cards, as well as A2A based solutions (both SEPA direct debits e.g. Paypal, and domestic wallets like Bizum, iDeal and Swish). The share or mix of business differs significantly across geographies. While the card networks are the main beneficiaries of the growth in the Apple and Google Pay wallets, alternative rails are also growing in some markets.

For banks: there is a threat that mobile wallet providers are taking large revenue shares or re-routing transactions from card rails, so revisit wallet strategy market by market to ensure you are optimising for your customer’s mobile experience.

For acquirers/PSPs: continue to invest in omnichannel and mobile first solutions, seamlessly integrating between the online and physical world, with specific m-Commerce integration solutions (e.g. SDKs).

6.?Account-to-account (A2A) schemes: A2A will play an increasingly significant role in the European payments landscape

Debit cards, credit cards, and e-money are seeing increased competition from account-to-account (A2A) schemes. In many European markets, A2A have established themselves, e.g. Bizum in Spain, Blik in Poland or paylib in France. There are further regulatory and industry initiatives to support their growth too (e.g. open banking, SEPA Instant, Request-to-Pay, etc.), and with some making a push into POS payments with various solutions, it could be their time to reap market shares from the card networks.

But the true success of A2A across Europe is only likely to come with a pan-European solution. While solutions today have limited cross-border interoperability, a pan-European solution that also offers payments could become a threat to the card networks and a winner for the European banks. While the European Payments Initiative (EPI) has had several attempts to get going, 2023 should be definitive in establishing whether EPI can establish itself as one such pan-European solutions.

Other A2A solutions are also working on interoperability in various forms, and the launch of P27 and the EMPSA initiative may also be a catalyst for greater interaction.

For banks: understand implications and potential of A2A schemes and provide appropriate solutions for consumers and corporate clients. Evaluate impact of EPI on existing business models.

For acquirers and PSPs: evaluate which pockets of clients are likely to adopt and drive A2A penetration and use this opportunity to roll out and improve overall margins and economics across your portfolio.

7.??????Buy-Now,Pay-Later: BNPL may have passed its peak as strong headwinds emerge

Buy-Now,Pay-Later (BNPL) has seen significant growth and traction over the last few years, with Worldpay Global Payments Report showing BNPL has increased to a 10% share of the eCommerce checkout in 2022 (up from 8% in 2021). This is partly a shift from credit cards (down from 25% to 24%) but also adoption from broader customer base.

However, BNPL providers are facing some severe headwinds, particularly in the consumer space and growth is expected to taper.

The current economic environment has seen credit provisions for BNPL increase, and this is hurting overall profitability of the sector. Openpay has now appointed Administrators, and others may follow suit, particularly in a market with more restricted access to growth capital.

The regulatory burden is also expected to increase. In the UK, Europe and Australia regulators are revisiting whether BNPL providers should be exempt from the consumer credit regimes. Such measures would likely lead to tightened lending criteria and a less seamless onboarding experience curtailing growth. Furthermore, some merchants have also noted that the BNPL providers are no longer delivering strong affiliate channel revenue from their customer base, and so may no longer be worth the premium price point.

All in all, we expect there to be a shakeout in the consumer BNPL solutions over the coming years.

For banks and acquirers: there is an opportunity to revisit strategy around embedded credit or BNPL solutions, to potentially build share in the wake of rationalisation of BNPL providers. Growth could come from potentially acquiring portfolios of consumer borrowers.

For merchants: they should review their BNPL offering to reduce any exposure and risk and ensure their BNPL providers are delivering value for money.

8.?Digital Euro: On the cusp, 2023 will be the make or break for the Digital Euro

The European Central Bank (ECB) is the most advanced central bank in the western world when it comes to the exploration of central bank digital currency (CBDC) with its “Digital Euro” investigation project. A “go/no go” decision is expected in Autumn 2023 along with a legal framework to be proposed by the European Commission and voted on by the European parliament.

If the project goes ahead, the impact on the European payments industry, and the banking system more broadly, could be tremendous: Digital Euro will not only be a currency but also an end-to-end payments solutions covering P2P, POS and E/M-commerce with a processing platform and a payments scheme operated by the Eurosystem, bringing complete harmonization across the Eurozone. The legal framework could force mandatory acceptance at all merchants and give right to access to all citizens, free of cost for basic services.

Access to Digital Euro is foreseen to be distributed by intermediaries (banks and non-banks), which would need to connect to the Eurosystem Digital Euro processing platform as well as adhering to the scheme rules. Significant integration impacts should be foreseen. Although a Digital Euro can be seen as a risk for many players of the European payments sector (e.g. competition with private schemes, disintermediation of banks as holder of deposits, unclear compensation model…) it could also bring opportunities (e.g. zero scheme fees and zero processing fees foreseen for intermediaries, innovative functionalities foreseen by design such as offline payments and programmable payments…).

For banks: monitor developments and understand potential impact of Digital Euro on your payment solutions and offerings to client, as well as potential to change overall deposits model.

For PSPs: look for potential opportunities to participate in and leverage the Digital Euro scheme.

9.?Fraud and Financial crime: Risk vectors continue to evolve, but increasing heat being place on financial crime

Financial crime risks never stop – they just evolve. Some vectors are shut down, while others emerge.

2022 saw the full implementation of Strong Customer Authentication (SCA) across e-Commerce in Europe, and card fraud is already reducing, with instances in the UK down nearly 20%. However, SCA adds friction and the industry needs to balance SCA with a seamless customer experience in the payment journey. Where merchants, acquirers and issuers are leveraging SCA exemptions effectively, challenge rates are reducing significantly while still protecting against fraud – the challenge is for all players in the value chain to apply the SCA judiciously.

But with card fraud reducing, Account-2-Account (A2A) payment fraud is growing – mainly driven by Authorised Push Payment (APP) and Account Take Over (ATO) fraud. For too long the industry has dragged its feet on the issue. Now, a levy on the payment scheme – to provide a form of insurance against bad actors – is under consideration. The industry needs to quickly align on an alternative approach, which balances innovation, consumer protection and appropriate responsibility (e.g. for social media and tech platforms) without just taxing the whole industry. Confirmation of Payee is a big step and should be applied universally to A2A transactions across the UK and Europe.

AML/CTF remains a hot topic, particularly with growth of crypto and the Russia-Ukraine War increasing the challenges in 2022. Regulators across Europe are applying greater scrutiny on providers, with several major PSPs working through remediation plans in this space after their respective regulators found deficiencies in their current approach. This additional scrutiny from the regulators is likely to lead to trouble for other payment providers too, and the impact on a business can be catastrophic where the regulator finds deficiencies in your AML/CTF risk management framework.

For banks: ensure you are applying SCA exemptions to optimise payment experience for your customers; develop a strong customer centric approach to APP and ATO fraud in your business.

For PSPs: test the robustness of financial crime risk management frameworks, particularly around AML/CTF risks.

For merchants and acquirers: ensure SCA exemptions are being applied wherever appropriate to optimise the customer experience.

10.??New regulation: A continually evolving landscape

Regulators never stop. A host of new initiatives and regulation are being introduced to bring greater competition into the payments landscape and reinforce consumer protections.

The upcoming regulation from the European Commission to promote euro instant payments may impose deadlines to European PSPs offering and accepting SCT to offer and accept SCT Inst. This will impact PSPs implementation plan and investments and create growth opportunities for SCT Inst payment-based solutions.

The next iteration of PSD2 and the ‘Open Finance’ framework is now being discussed through consultation with the European Commission. The revision will reinforce scrutiny on market players to improve the PSD2 implementation and enforcement of PSD2. It also establishes Open Finance foundations to allow financial and credit account data sharing.

The EU Digital Services Act intends to create safer digital space, leading intermediaries to implement reinforced protection systems. The EU Digital Markets Act aims to tackle imbalances caused by the market power of powerful ‘gatekeeper’ firms, creating opportunities for payment service providers. For example, non-Apple payment solutions might obtain access to NFC technology for iOS devices.

The outputs of the consultation of the Settlement Finality Directive might grant electronic money institutions (EMIs) and payment institutions (PIs) direct access to accessing payment system (e.g. clearing and settlement houses)– currently direct access is primarily available to credit institutions.

Cryptoassets are set to come into the regulatory sphere at some point in the next 12-24 months. EU Parliament is set to vote on the Markets in Crypto Assets (MICA) Regulation, while the UK Government has announced its intentions to introduce crypto regulation both with the intention of harmonizing assets within the existing financial system and protecting consumers.

For banks, PSPs, acquirers: understand the impact of evolving regulatory initiatives on your business.

11.??Industry economics: Increases in scheme fees, but some opportunities too

Following the introduction of the Interchange Fee Regulation in 2015, which capped interchange at 0.2% for debit transactions and 0.3% for credit in the EEA (European Economic Area), the average cost per card transactions charged to merchant (MSC: Merchant Service charged) decreased in the EEA. Since then, the MSC in the EEA have increased: acquirer scheme fees and acquirers’ margin have increased overcompensating interchange cuts.

A similar story has emerged in the United Kingdom, where the PSR’s Market Review into the Supply of Card-Acquiring Services found increases in card scheme fees had offset many benefits to merchants from the Interchange Fee Regulation in 2015. Following Brexit, there have been further cost increases for merchants. While interchange caps were maintained to EEA levels for domestic card transactions, card schemes increased interchange fees for UK-EEA transactions from 0.2% and 0.3% to 1.15% and 1.5% for consumer debit and credit transactions respectively.

Card scheme fee increases have mostly impacted the acceptance side (merchants and acquirers). On the issuing side large banks have leverage over card schemes as they can switch their portfolio from one scheme to another. On the acceptance side, merchants and acquirers do not have the same leverage as issuers as they, typically, must accept multiple card schemes to meet customers’ needs.

From a B2B perspective, the result of Brexit has meant that how banks treat payments (wires, ACH, etc.) between the UK and EEA has changed. Some key changes that have been noticed include additional third-party bank charges (i.e. deductions on Wire payments or bank fees for SEPA transactions) as it is no longer defined as “intra-EEA” under PSD2 regulations and now treated as cross-border.

For merchants: continue to look at APMs and other alternative solutions to optimise for cost and conversion, as well as where you hold your EUR accounts, particularly for merchants with significant cross-border payment flows between UK-Europe.

For acquirers or PSPs: the increased fee component on acquiring side, and schemes limitations in paying out on the issuing side given the interchange regulations, gives greater scope for acquirers to negotiate around incentive funds and rebates paid by the Schemes. Spend time analysing fees and negotiating rates with Schemes.?