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Payments: The Financial Ecosystem Growing in the Banks' Shadow

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Hi there! I am a finance professional and am interested in finance, technology, and everything in between.

The Secret Growth of Cashless Payments

Payments, particularly cashless payments, have followed the existing banks around like a shadow. Before this wave of Fintech, the banks could not conceive the notion that cashless payments would happen without them.

Of course, payments itself existed way before banking was instituted—with cash or the previous store of value (e.g. gold). But when banking first started to use paper to replace gold, then digital bytes to replace paper, it was assumed that the payment process was part and parcel of the banking business.

Well, times have changed.

There is now a thriving ecosystem growing in the banks' shadow. No, this is not 'shadow banking', but instead, a whole new ecosystem of processing cashless payments, and it is growing under the long shadow of the banks.

It is just like how when you move, your shadow moves with you. So when you start walking down the street, your shadow will follow your footsteps. Now, when you walk away, your shadow stays there. And, scarily enough, it seems like your shadow is starting to move independently of your movements.

That's how much the payments industry has grown, vis-à-vis the banks.

How has this impacted the banking industry? Well, let's explore...

The Banks Have Withstood the Regulatory Onslaught

If you are not aware, the banking industry is one of the more heavily regulated industries.

The payments industry, however, seems to have gotten off lightly.

This is because the main focus of the regulators are the banks. In the aftermath of the Great Financial Crisis, the regulators piled up the regulations thick and fast, and the banks have had to shoulder this burden for the longest time.

The payments companies, however, have managed to escape this scrutiny (for now...).

Additionally, a key component of worldwide regulations, the Anti-Money Laundering (AML) regulations, have been dumped on the banks. The bulk of KYC (Know Your Client), CDD (Customer Due Diligence), and AML requirements have to be fulfilled by banks, and the payment service providers can just leverage on the banks to have done the proper KYC. After all, one big regulatory hurdle is cleared if the payment serrvice providers are entitled to rely on the CDD done by the banks, and so do not have to perform many of the same checks on the payments they process.

Regulators are also careful to not strangle this industry with over-regulation. After all, if a new payment Fintech had to comply with the full suite of regulations (or even just a robust AML framework), it is likely that none of them will get off the ground.

Thus, the regulators are also mindful that since the Fintechs do not yet pose a systemic risk (unlike the banking sector), they would not want to stifle innovation too early, but only step in when the risks grow too big.

Many payment services are also provided as an 'add-on' service, to complement and reduce the friction of the core business that a Fintech actually conducts.

Payments Didn't Start Out in Isolation

Another reason why the payments ecosystem can thrive in the banks' shadow is because there is usually another business that supports it.

For example, Alipay and Wechat pay didn't just get born because someone wanted to do payments. They were born to complement other wildly successful businesses, namely Alibaba's e-commerce store and Wechat's super-app.

From a Singaporean context, GrabPay didn't just start off trying to do payments either. It was born to support the existing GrabCar business, and only from there did they grow GrabPay.

But of course, there are companies like PayPal and Stripe. But just recall that PayPal was spun off from eBay, and Stripe supports many big tech companies (e.g. Uber) that do not have payments embedded in their model.

So, such companies also grow because they provide the support to other tech players in the ecosystem, not that they set out to just be a 'payments company' out of nothing.

Well, what role does the bank play in all of this?

It is actually still a key one—it is the source of funds, i.e., the deposits. The ecosystem was able to grow in the shadow of the banks because the banks provided the deposit infrastructure and dealt with the deposit regulations (which is basically a banking licence).

Today, some BigTech companies have grown so strong that they don't need a bank to hold the deposits anymore (think Alibaba/Ant Financial), but that was after years of prospering in the banks' shadow.

Due to this growth, the wide shadow that is cast by the banks is no longer sufficient to contain them. Regulators have started to take note, with a notable act being passed by the MAS (the Payment Services Act).

To Round It Off, I Cannot Forget to Mention Bitcoin

Just bear in mind the original wording of the white paper. Remember that the original intent behind Bitcoin was a peer-to-peer payment system!

A purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.

— Satoshi Nakamoto

The whole point of Bitcoin was to grow a separate ecosystem where people did not have to rely on banks to process payments.

Of course, Bitcoin, Ethereum, and the whole cryptocurrency and blockchain system has grown way beyond the original white paper that Satoshi wrote.

Now, not only are private companies jumping into the fray with Libra, Central Banks are also taking part with Central Bank Digital Currencies (which I still have my reservations of as shared in my previous article).

But again, these mechanisms adhere to the founding principles of Bitcoin—to create an ecosystem where you can make payments without needing to go through the banks.

With Bitcoin, it kind of grew out of the shadows of the banks because it really enables people to bypass the whole banking and fiat system entirely, and to rely solely on computing power and trust in the algorithm.

This is why some people criticise it has having no intrinsic value, but honestly, no fiat has any intrinsic value either, other than faith in the government (since there is no longer the gold standard). Of course, the government itself gives legitimacy to the currency, but not all governments are equal, and that is one reason why cryptocurrency is more readily accepted in areas with weak or no government presence.

Of course, regulators are trying to bring crypto into the fold by applying regulations to the 'points of entry' (e.g. exchanges) and the ICOs, but unless they manage to shut off the internet, Bitcoin mining can still go on (if there were no ASIC miners, Bitcoin is truly an unstoppable force).

The Banks Take Notice

Now, when the banks look over their shoulders, they see the thriving ecosystem growing in their shadow. The banks have taken notice. Whether it is too late, only time will tell.

It is a scary thought for the banks that now when they start to move, the 'payments shadow' that they cast no longer move with them. Sometimes, the shadow even moves ahead of them.

It is an exciting yet scary time—there is so much out there to learn and explore.

And of course, the banks now have to watch their backs—not just from other banks, but from their own shadow.

© 2019 Russell