Virtual Currencies Part 2: the Impact on Banks' role in Payments

Wednesday, 01 October 2014 00:00

Given the listed advantages of Virtual Currencies the question can be raised whether banks are needed for payments at all. Can one envisage a payments industry which does not need banks for payments any longer?

This article is the 2nd  of 3 Payments Advisory Group articles on the subject of Virtual Currencies:

1. Introduction to Virtual Currencies: the advantages & disadvantages

2. Virtual currencies and the impact on Banks’ role in payments

3. Virtual Currencies & regulation; what will the future hold for VC’s?

Banks have traditionally enjoyed a dominant role in providing payments. Bank customers hold accounts at banks which transfer funds from the ordering bank to the beneficiary bank. This has been a model which has existed for decades. Recent developments have made payments more standardised, more secure, more transparent, as well as generally cheaper and faster (the Single Euro Payments Area is a case in point), but the model that a payment needed at least one bank in the middle to make it from point A to point B pretty much stayed the same. In other words, the payments industry is a network industry.

Critics of banks´ dominant position in payments would say yes. While SEPA has brought many benefits to payment users in the euro payments area, the situation for cross-border payments outside SEPA has not changed much. Banks charge hefty transaction, account maintenance, interchange, reporting and FX fees. Information is not always forthcoming or transparent, payment execution is slow and uncertain. Compare this with VCs instant processing, minimal transactions cost, absence of FX fees, and the ability to trade borderless around the world. It is easy to see why this may be more appealing than banks´traditional payments models.

Does this mean that VCs could and should be used for international remittance flows? This is a tricky area for banks. As compliance requirements are increasing, particularly around anti-money laundering (AML), know-your-customer (KYC) and know-your-customer´s-customer (KYCC) rules, banks face not only enormous complexity but also increased cost in the payments business. To meet their compliance obligations, banks have been taking a closer look at their payment flows to emerging markets as well as their customer base and their customers´ customers. In many cases it is impossible for them to meet the KYCC regulatory requirements. As a result, many banks have cut back the number of customers they will service and have reduced or even closed down their international remittance business. No wonder these cut-backs have caused an outcry and a desire to find alternative ways to make payments into emerging markets.

Some VC enthusiasts perceive VCs as replacing banks in the international remittance area and hail VCs as a tool for financial inclusion: theoretically, VC payments could benefit countries which receive remittance inflows but which have a large “unbanked” population without access to bank accounts or mobile money platforms. To date, international remittances to these countries have been expensive, especially if traditional banks and payment systems are used. Yet the global remittance market is huge, growing and vast flows take place. So some VC promoters advocate VCs as stepping into this payments area, replacing traditional banks. However, the challenge remains how to transform theory into practice. VCs like Bitcoin require access to a computer or at least a smartphone. Exchanges would be needed to allow converting VCs into cash for buying food. All in all there is still a considerable number of prerequisites to be met before VCs can step into the payments space from which banks are currently retrenching.

Should banks therefore adopt a complacent “danger over, return to normal” position? Definitely not. Banks should take consumers´ dissatisfaction with slow, inefficient and costly (cross-border) payments to heart. They need to work on improvements in payments, in order to adopt rather than counter the benefits of VCs such as speed, low cost, absence of FX and increased use of the internet, in order to reinvent their position in Payments.

In any case, it is clear that there is a ‘virtual’ movement ongoing, yet the big question is: where will it take us? This will be explored in the 3d article in this series: Virtual Currencies & regulation: what will the future hold for VC’s?

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