By Brandes Elitch
CrossCheck Inc.
Here in Sonoma County, (we call it Wine Country) we are contending with a serious challenge: lack of water. And it takes about five gallons of water to make one gallon of wine. John Williams, owner of Frog's Leap winery in nearby Napa County, said Napa wineries are drawing over 1 billion gallons of water and putting it on vines that don't really need it. Why? Because the best wines are made from vines with deep roots, and irrigated vines don't have to push down their roots far to get water.
Shallow root systems lead to fruit that lacks flavor until later in the season. So growers pick later than they need to, and this leads to higher alcohol levels, which is not necessary for good wine and can be counterproductive. However, once vines are established with an irrigation system, it's difficult to return to dry farming. You can't just turn off the water.
This doesn't bode well for growers, or even those who drink the wine, many of whom are bankers. And the focus of this article is current issues in banking, including challenges and opportunities highlighted at the March 2015 ProfitsStars annual educational conference. Unlike, growers, bankers aren't experiencing a severe drought, but they are facing an altered business landscape.
Like vines to roots, ISOs are joined to their acquiring banks. However, most ISOs are unaware of the challenges their banks are handling. Banks play an irreplaceable role in linking ISOs to the card brands. There are only a small number of issuing and acquiring banks. Issuing has always been a business of very large scale; you would have to issue tens of millions of cards to be a meaningful participant in this space.
As a result, the barriers to entry are formidable. The dozen or so banks dominating the issuing business aren't worried about new entrants among the 6,000 U.S. commercial banks. Previously, acquiring was somewhat more open; many readers will remember the days of "Rent a BIN" acquirers who would always take "high risk" and other hard-to-place merchants.
Until recently, bank regulators, such as the Federal Deposit Insurance Corp. and the Federal Reserve Board, were focused on the quality of a bank's loan portfolio and anti-money laundering practices, but in the last few years they have turned their attention to automated clearing house (ACH) origination and card processing, and have focused on not only knowing your customer, but also knowing your customer's customer.
The result is fewer acquiring banks. On the surface, it would seem commercial banks (defined as "taking deposits and making loans") have a fairly predictable business. But all you have to do is search for the words "bank disintermediation," and you will find that many businesses banks used to own, such as mortgage and auto lending and investment planning, are now owned by nonbanks or dominated by a handful of players, shutting out the other banks.
A recent survey by Javelin Strategy & Research revealed that banks are losing ground in payments to technology companies such as Apple, Amazon, PayPal, Google and Facebook. Smartphone makers have entertainment platforms that consumers use constantly, and at some point, innovation begets trust. Consumers still look to their banks for mobile wallets though, but the window is closing on this opportunity.
As for mobile payments, most consumers still find other methods (cash or card) to be more convenient, and the frequency of phone-based payments is low. Consumers are also very concerned about security. By mobile payments, I mean bill payments, donations, person-to-person transfers, online or in-app purchases, and phone-based purchases in stores. The most popular trigger is a quick response code read by smartphone. Neither tapping nor waving has gained much traction, but that is expected to change this year.
The current volume leaders are PayPal, Starbucks and Google Wallet. The most popular funding method is debit cards, then credit cards, and then transfer from bank accounts or PayPal. Prepaid cards and carrier billing both have negligible adoption rates. Bankers must think about the implications for them resulting from these products.
A commercial bank is different from most businesses in that there is zero room for failure. Yes, I have heard about Six Sigma (a set of tools for process improvement with the goal of achieving stable, predictable results). But consumers expect their transactions to be posted immediately and their statements to be 100 percent correct. They expect an ACH credit or an outgoing wire or even a simple deposit will never be inaccurate, and that the bank will prevent fraud or hacking of their accounts. They expect their deposits to be insured by the government, so they are never at risk of a bank failure.
But banks rarely fail these days, and even if they do, they are quickly acquired by other banks, which assume all their liabilities. Imagine running a manufacturing or software company this way.
Change is constant: remember that we upgrade our phones every two years. Computer operating systems change every three years. A small business customer might suddenly switch to LendingClub, Cabbage, OnDeck, or similar nonbank vendors. One third of millennials surveyed said they won't need bank accounts. Indeed, two thirds of them don't have credit cards, and one quarter don't write checks every month. And only a third of millennials are interested in mobile wallets. If you are a bank product manager, how do you deal with this?
Banks are also contending with various software systems: demand deposit, loans, funds transfer, trust accounts, etc. The largest banks sometimes develop their own programs and software, but this would not be economical or even feasible at a smaller bank. Thus, three large enterprises provide the core accounting and processing systems for almost all U.S. banks.
One of the three is Jack Henry and Associates, which provides these services for 1,400 banks. ProfitStars, a JHA subsidiary that focuses on payments, currently provides one third of the revenue for JHA and has 10,800 clients.
ProfitStars is a leader in remote deposit capture installations. It also supports nonbank businesses and sells through ISOs, which should be of interest you, as ISOs and merchant level salespeople. I joined 800 other payments and banking professionals at ProfitStars' March 2015 conference. There were 147 training sessions and over 50 vendor presentations.
Topics discussed included technological change (smartphones, the Internet of Things, mobile commerce), demographics (culture has to be ready to adopt new products), the economic imperative of improving net interest margins, fee income, return on equity, and managing fraud.
When it comes to demographics, how do you attract and keep gen Y consumers when some of them eschew checking accounts and feel they can find alternatives to traditional banking? Also, millennials will very soon be the largest group of consumers. To top it off, they stand to inherit the largest transfer of wealth in history from their parents in the coming years. They will dominate the consumer payment space. Banks want to get and retain these consumers, and not lose loan interest income and fee-based services to nonbanks.
While it's exciting to learn about innovations in payments, keep in mind that in 2014, the U.S. banking system cleared about 125 billion transactions, and most of those cleared via checking accounts (even cash and prepaid card purchases need to be deposited in a merchant's account somewhere). Consumers buying cars and boats, auto repair and other services are paying from accounts where their paychecks are deposited; even their credit card bills have to be paid from there.
All payments begin and end in the checking account (except for the 70 million people who are unbanked or underbanked, and banks need to find a way to bank those people too).
Banks are challenged to predict consumer behavior and have products to support them. Many, if not most, of the new types of payments we see now will not be profitable or will never achieve meaningful market share. But right now it's hard to tell who will win and who will lose.
ProfitStars showed at its March conference that it's preparing to support whatever new forms of payment finally achieve market dominance, and provide a bulletproof solution for clients – where there is no room for failure. Payment pros and winemakers alike must prepare, as well.
Brandes Elitch, Director of Partner Acquisition for CrossCheck Inc., has been a cash management practitioner for several Fortune 500 companies, sold cash management services for major banks and served as a consultant to bankcard acquirers. A Certified Cash Manager and Accredited ACH Professional, Brandes has a Master's in Business Administration from New York University and a Juris Doctor from Santa Clara University. He can be reached at brandese@cross-check.com.
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