There are 29 million small businesses operating in the United States, according to a recent Markets and Market’s report. These businesses provide a steady stream of regular income to the financial institutions that serve them. Banks that are able to successfully target small businesses have enjoyed higher net interest margin and greater return on assets than average, at a time when larger multi-nationals are retrenching and battening down the hatches.
A substantial amount of income from small businesses has been derived through wire transfers. Even though checks still dominate business-to-business payments in the United States, when electronic or same-day transfers are required, wire payments are often the preferred option for smaller businesses. Without the payment volume to justify investment in sophisticated payment initiation or online banking technology, wire transfers have been an important business tool for SMBs and the banks that serve them.
Until now, wire transfers have been a necessary but imperfect solution: posting and reconciliation of wire transfers has been a painfully manual process, often requiring time-consuming follow-up. The implementation by Fedwire and CHIPS of expanded information-rich payment message formats begins to address this problem, and on the face of it presents banks with improved opportunity to serve their resource- and time-limited SMB customers.
In ordinary circumstances, the update to wire transfer protocols is good news for SMBs and smaller banks. Corporations of all sizes have routinely indicated that a more convenient wire transfer service would encourage them to migrate some of their substantial check volume to electronic wire payments. Even if only 2 percent of the check volume moved to wire transfer systems, it would represent a 47 percent increase in wire transfer volume in the U.S, according to a report published by The Clearing House Payments Company and the Federal Reserve Banks titled “Business-to-Business Wire Transfer Payments: Customer Preferences and Opportunities for Financial Institutions.” CHIPS’ own research has also shown that more than half of all businesses would be willing to pay more for wires that include remittance information, a third of whom would be willing to pay at least an additional $3.
But it seems likely that the long-awaited infrastructure update could be overshadowed by NACHA’s recent proposals to introduce same-day ACH transactions, particularly when considered in the context of downward pressure on margins faced by all banks.
Need for Change
Margin pressure is the number-one concern of the industry. Figures from Boston Consulting Group indicate that over the next 10 years banks can expect a 2 percent decrease in annual revenues and a simultaneous increase in transaction volumes of 9 percent CAGR. And although this is a universal problem, it will be most profoundly felt in the United States where the Durbin Amendment and changes to Reg E are exacerbating pressures of the global downturn.
According to a 2011 report from McKinsey, the effect of the Durbin Amendment will be margin erosion of as much as 50 percent. And, as shown in Oliver Wyman’s 2011 study, the latest version of Reg E has resulted in a reduction in income of 45 percent, which hits even those banks too small to be directly affected by Durbin. In these circumstances, the attractions of ACH, whose costs are lower for both acquiring and receiving houses, are obvious.
Same-day ACH can be seen as a lower-cost alternative to credit, debit, and of particular interest to SMBs, checks. By diverting debit and check traffic to same-day ACH, banks can greatly improve their deteriorating margins. Check conversion, which currently accounts for approximately 30 percent of total volumes, is the most immediate opportunity. If priced right, it can make sense for small and large corporate customers who would benefit from same-day fund availability.
Equally, same-day ACH offers banks the opportunity to compete against lower-cost solutions offered by new entrants and payment types that are already applying downward pressure on existing revenues. Both person-to-person transactions and mobile payments become more viable, and are expected to see significant growth in volume during the next few years. Yankee Group estimates $1 trillion in mobile payments by 2015, while Gartner suggests that the face value of purchases and transactions made via the mobile channel will hit $633 billion.
With same-day ACH, banks have the opportunity to provide a new, more-profitable payment mechanism that maintains the immediacy of mobile payments but costs a fraction of checks and wire. Consequently, same-day ACH could offer traditional banking entities an opportunity to adopt new payment types and stake a claim to the ground that is currently owned by the newer players in the low-value payments space.
Finally, same-day ACH is another step closer to creating a complete circle of payments. The traditional distinctions between wire, ACH and others are broken down so that customers no longer need to understand the difference between various payment types. They choose to make a fund transfer and the bank selects and routes the transaction in the fastest, most effective and cost-efficient manner. It also plays into the strengths of community banks whose competitive differentiation is often found in the level of personalization involved in the services on offer accompanied by in-depth customer knowledge.
There are caveats, of course. ACH payments will need to become closer to real time before they are able to underpin mobile payment schemes in full. In addition, same-day ACH is likely to be compulsory for NACHA members only; non-members face no such obligation. But if same-day ACH transfers are to deliver on expectation, then adoption will need to be mandated for all banks, by regulation if necessary. Furthermore, customers will need to be convinced that virtual strangers can be trusted with their account details. The only other alternative is an industry-wide database that matches phone numbers with DDA accounts — a far less likely proposition.
Mandating a shorter time frame in which ACH transactions must be processed and funds made available to receiving banks also potentially reduces float and interest revenue and can contribute toward the challenge of reduced margins. There are also legitimate questions about whether same-day ACH payments will cannibalize existing income from wire transfers to the point where they are not viable. Banks will therefore need to ensure that the costs associated with implementing any new payment scheme will be offset by improved broader solution and service delivery.
They will also need to ensure that the technological infrastructure needed to support their payment services is up to the task. This means modern payment systems are needed that offer streamlined and highly efficient workflow, and which support all payment channels, initiation methods and business units on a single platform, and break down the information and functional silos that can stifle the development of new products and services.
These systems can reduce operational costs associated with support, licensing and maintenance, but they are also more flexible and allow users to respond to changes in the market and bring on board new initiatives much more quickly. The challenge for any bank then is twofold: first, ensuring that it has the means to support the immediate changes — in this case new wire transfer messaging formats — as well as likely long-term shifts in market dynamics and customer demand; and second, persuading SMBs of the advantages. To date, ACH has not featured highly among the service offering to smaller businesses, simply because they tend to use other options for non-urgent transactions. But if ACH payments move to a same-day time-frame they open up a raft of new products and services that can create a significantly improved banking service for the SMB sector.
There are certainly tough decisions ahead for smaller banks and their customers. Significant changes are coming in core areas of their business, which cannot be ignored or shrugged away. Short-sighted or limited-impact strategies, in which financial institutions patch up their infrastructure without full consideration of the long-term challenges are likely to prove a false economy.
It seems inevitable that all banks will be faced with growing volumes of electronic payments. Preparing for that change sooner rather than later with technology that provides the means to adapt — rather than holding back service innovation — will enable banks to take advantage of the opportunity.
Updates to wire transfer and ACH services may be the next big change small banks and small business face. They will certainly not be the last.
Louis Blatt is senior vice president, strategic planning and marketing, for Waltham, Mass.-based ACI Worldwide Inc. He can be reached at louis.blatt(at)aciworldwide.com.
Copyright (c) March 2012 by BankNews Media