Do regional banks need a payments strategy?
Be in-the-pack, it’s all you need
Key insights in this post
Payments is a scale business that is partially commoditized by networks & processors
Wholesale payments requires scale to serve the large corporates who dominate volumes, and has therefore concentrated
The big 3 dominate Treasury Services; Citi is material with multinationals
Commercial cards is led by American Express with the Big 3, Citi, Capital One and USB in the hunt
Wholesale merchant acquiring is almost entirely within Fiserv, JPM, WorldPay and Bank of America
In Retail payments 2 of the 3 product areas have concentrated into specialists with regional banks less competitive
In DDA-based payments, the transactions are usually free and commoditized across banks.
Customers buy the account not the payments
The account is still largely chosen by physical proximity and brand
In consumer & small business cards, the top issuers capture 80%+ of spend. They do this by capturing all the major cobrands and by leveraging national scale for processing and marketing. Regional bank cards are often second or third in wallet, without much spend or revolve
In merchant acquiring, regional banks mostly distribute for scale acquirers, but those acquirers are losing share to vertically focused ISVs.
In most cases, the right strategy for Regional Banks is to stay in-the-pack on functionality and to market through captive channels
In Wholesale, leverage the commercial lending relationship to capture a fair share of Treasury Service and Commercial Card volume. Don’t even try in Merchant Acquiring
In Retail, the standard strategy varies by product
In DDA, don’t try to differentiate the payments as consumers don’t value the marginal differences. In-the-pack is good enough. Instead improve the experience for exceptions like NSFs, Chargebacks, Zelle fraud, etc. These are major dis-satisfiers that can impact relationship
In Credit Card, consider becoming an agent bank for a scale issuer. If you must stay in-house, find ways to bind the credit card more tightly to the core-DDA to strengthen the relationship
In Merchant Acquiring, accept the role of a distribution partner but try to link your partner’s product into your own digital experience.
Regionals might also create a thin layer atop the lines of business to deal with cross-LOB payments topics
Relationships with infrastructure providers like networks, processors and Fintechs. These often serve both Retail & Wholesale
Project management when introducing new payments methods across the enterprise. Today that might include FedNow and Request for Payment.
Introduction
My day job, part-time, is doing payments strategy at a regional bank in their market-leading embedded payments business. So, it may seem odd to be advising other regional banks to avoid that path. One could view it as self-serving. But, Fifth Third is the exception. The bank had a long history in the payments sector, including one-time ownership of what has become WorldPay. We got some capabilities via acquisition, but we did that acquisition to get banking operations not payments operations. Our market position would be hard to replicate because no other bank had our starting point.
Most other regional banks don’t need to differentiate in payments. They should be competitive with in-the-pack capabilities. Investments to be distinctive likely won’t have a return. That doesn’t mean regionals should not invest in payments, as investment is required to stay in-the-pack. But, trying to punch above your weight is often a fool’s errand.
If you have been reading this blog for a while, you know that payments is a scale business that is partially commoditized by networks & processors. Software is the key differentiator today. The big 3 are exceptions, plus the credit card specialists. But most regional banks should adopt a straight-forward fast-follower strategy that leverages vendors & partners rather than bespoke development.
Wholesale payments
Wholesale payments consists of Treasury Services, Merchant Acquiring, and Commercial Cards. All three are heavily concentrated:
In Commercial Cards, American Express leads the way but JPM, BAC, WFC, C USB and COF are all in the hunt. Most regionals have small portfolios that they cross sell with Treasury Services
In Merchant Acquiring, four wholesale processors, JPM, Fiserv, WorldPay and Bank of America have dominant processing share.
A few other acquirers have single digit share including Wells, PNC, USB/Elavon and Global Payments. Adyen & Stripe are gaining traction by focusing on eCommerce
Most regional banks are simply distributors for one of these players, leveraging their branch networks to source small merchants. For this they get a finder’s fee and revenue share
In Treasury Services, JPM, BAC & Wells serve virtually all domestic large corporates. Citi competes among multinationals. Regionals serve the middle market. For evidence of this see my post: Treasury Services is concentrating
This concentration is driven by the needs of large corporates. They insist on the lowest prices in return for their high volumes. The only way to deliver those low prices is with high scale – in some cases, global scale. Regionals simply cannot compete for large corporate volume, and without large corporate volume they can’t generate enough scale to drive down unit costs — Catch 22.
However, regionals do have an advantage in the Middle Market. They lend to in-footprint middle market companies and therefore get a share of their commercial payments volume and associated balances. This volume is usually Treasury Services but may include Commercial Cards. Merchant Acquiring is generally decoupled, although JPM & BAC coincidentally have many relationships where they do all three.
Because the Treasury Services allocation is a consequence of lending, the payment products do not have to be best-in-class. Generally, in-the-pack is good enough; but the bar for in-the-pack keeps rising, so regionals do need to invest. Key capabilities include API integrations with the most popular ERP systems, “integrated payables” to pay invoices with virtual cards, flexible reporting, real time payments, and other modern capabilities.
For commercial cards, virtually the entire industry uses the same processor and network, so functionality is not differentiated. The exceptions are American Express and Citi which both issue globally. Because the processor charges less to larger portfolios, the big issuers have a built-in cost advantage. Nothing a regional does can overcome that gap, so they need to sell their products to smaller clients that are less price sensitive.
An issue in commercial payments is that the clients themselves are consolidating and migrating to the bigger providers. There is some bank consolidation as well, such as PNC/BBVA & USB/MUFG that raises the scale gap for to smaller regionals. But the gap between even those two and the big 3 is still very wide. Even Regionals that grow organically fall behind on scale. See my Treasury Services is concentrating post for evidence of this.
Verticalization is another way to differentiate that is hard for regionals to pull off. To justify a vertical investment, the regional needs a big enough in-footprint prospect base to support the investment — this is rare. Successful verticalization often requires national scale. For example, both JPM & BAC have national health care payments businesses drafting on their national lending and capital markets verticals.
Many regionals have a Commercial Real Estate (CRE) lending vertical that operates out of footprint, but since so many banks specialize in CRE, it is hard to break out. Instead, regionals might partner with specialized Fintechs to get vertical capabilities, but it is rare that a Fintech will go exclusive, so the functionality is available to all comers. Acquisitions get exclusivity, but rarely pay off. See Should bank buy payments Fintechs? for why.
To summarize, middle market clients allocate commercial payments volume among their lenders. A Regional bank’s services don’t need to be best-in-class to get their fair share. The best strategy here is to be a fast follower that relies on horizontal vendor solutions rather than bespoke development and vertical specialization. Nothing fancy is required.
For more detail on the wholesale payments market see my post on The structure of B2B payments markets.
Retail Payments
Consumer & Small Business (Retail) also have three broad product sets:
Merchant acquiring where most regionals are distributors for scale acquirers but are losing share to the vertically focused ISVs
DDA-related payments including Debit, Zelle, ACH, Wire, ATM, Bill Pay and Instant payments. Don’t forget checks!
Credit cards for both Consumers and Small Businesses, which is concentrating
Merchant-acquiring
This one is easy – the market has become unfriendly to banks. The biggest ISVs like Toast and Square distribute directly and their software is so good that material demand is inbound. The third titan, Clover (Fiserv), does distribute through banks in return for a revenue share, but the end merchant becomes more of a Fiserv client than a bank client.
No bank will be able to compete directly with verticalized ISVs like Toast (restaurants), Mindbody (Salons) or Lightspeed (Retail). Focused ISVs have emerged to serve every vertical and sub-vertical. It is literally impossible for any provider to compete effectively in every vertical. The five biggest banks have taken different approaches to this challenge:
JPM & BAC have licensed the NCR Silver platform to serve restaurants and retail, so they don’t have to do bespoke investment in the underlying software. They sell only to branch-based merchants. However, Silver is not a functionality leader in any vertical
Wells & PNC are both Clover JV partners. Notably, Wells is letting its JV lapse and PNC bought a Clover competitor (Linga) for the restaurant space. Linga is not particularly competitive with Toast or Lightspeed
USB’s Elavon unit bought the Talech ISV platform several years go. They distribute both through USB branches and community bank branches. Talech is functionally competitive, but not market-leading in any vertical
Virtually all other regionals are distribution partners of a big acquirer – usually Fiserv/Clover. The bigger the bank, the higher the revenue share. These relationships have some tension as Clover does not carry the distributor bank’s brand. Further, the revenue from some add-on products, like lending, is not part of the revenue share. Nevertheless, this is the only game in town right now.
The Talech, Linga, and Silver options don’t really differentiate their banks with small business clients. Toast, Square, Clover and other vertical ISVs are still outgrowing the market in small business – including all the big banks who did these strategies.
DDA-payments
All DDA payments rely on third parties and are not materially distinguishable across banks. Most of these payments are also free to the consumer, so even price is not a lever. They all rely on a network that commoditizes the payment:
Debit relies on MasterCard or Visa and one or more of the PIN networks. They all have virtually universal coverage and all use the ISO 8583 message standard. Durbin gives small banks an interchange advantage
Zelle relies on EWS and only competes with Fintech alternatives. By policy, Zelle charges every bank the same fees regardless of size
Wire relies on Fedwire
ACH relies on NACHA for rules and TCH & the Fed for switching – the switches are interoperable
Bill Pay usually relies on Fiserv’s Checkfree, although a few banks developed their own for cost reasons, not competitive reasons
Instant payments relies on the two switches, TCH RTP & FedNow
The partial exception is ATMs. They rely on the same networks as debit, but a bank can customize the screen set. However, ATM usage has been declining as payments digitize. I don’t believe any customers choose their bank based on their ATM screen sets, although ATM location and density does matter at the margin.
Even the technology providers behind the scenes are concentrated. Almost all banks use Fiserv’s PEP+ software for ACH. The two exceptions are the market leaders, JPM & Wells, which built their own. As other examples, Checkfree is the market leader for Bill Pay and most banks drive their ATMs on ACI BASE 24 software.
Finally, debit is becoming even more commoditized through the use of digital wallets. While Apple Pay does show a card image, most users just tap and go without paying attention to the screen. While users are aware the debit card was issued by their primary bank, they are not thinking of that at transaction.
Most consumers still choose their primary DDA bank by physical proximity and brand, so even if payments were distinguishable, they likely wouldn’t be sufficiently motivating. It just doesn’t pay to be leading edge. Having a slightly better version of a payment will not cause fewer customers to defect or more prospects to convert.
The quality of service might. Resolving check NSFs, ACH returns, Zelle scams, debit chargebacks etc. are potential dis-satisfiers. Banks generally can’t control the frequency of these, but they can improve the resolution experience. Exception processing like this is a better investment than marginal improvements in the payments themselves. These are priority use cases for AI assistants in my opinion.
Finally, small business is somewhat different than consumer. SBs increasingly want software to help manage their business, sometimes vertical-specific software. ISVs do this for merchants, but different providers do this for non-merchants. No regional bank can do this in-house given their limited in-footprint TAM. Partnering with Fintechs makes more sense. Many banks already partner with BILL or Melio for this purpose. Partnering is lower cost and less risky.
Credit Cards
80%+ of credit card spend is concentrated in the top 5 issuers, assuming Capital One can complete its Discover deal. That rate will also go up if JPM takes on the Apple portfolio. A few card specialists like Synchrony, Bread, and Barclays also have a few share points among them. Yet all those issuers collectively account for only about a third of primary DDA accounts.
Regionals are under-weight on Card share relative to their DDA share. The regionals I know typically generate ~90% of their credit cards as a cross-sell to their DDA customers. But even when they convert a card, they have trouble engaging that card to spend or borrow. Their cards are often second or third “in wallet”.
Part of this has to do with the rich rewards on Cobrand Credit Cards. Only a handful of big or specialist issuers support cobrands and only the biggest issuers can issue the biggest cobrands. JPM, AXP & C, serve virtually all of the big airline and hotel cards. Alaska Airlines from BAC is the one exception that comes to mind. Retail cobrands are spread a bit wider to include Capital One, Synchrony, & Bread. TD & Wells also have a few.
Cobrands are popular because some pay outsized rewards (5% on Amazon Prime Rewards) while others have an aspirational currency (e.g. Frequent Flyer miles). Bank-brands usually focus on cash-back propositions that mostly converge on a single percentage reward capped by the Interchange rate set by the network. Cash-back is very transparent and hard to differentiate.
The biggest issuers have bank-branded portfolios that appeal to a broad population. For example, Chase has Sapphire for Affluent, Freedom for Mass, Slate for Revolvers, and Ink for Small Business. The other big issuers have a similar product array. It is very difficult for regionals to support such a portfolio as their volumes are too low to cover the overheads of each product.
It’s about scale. Credit Cards are a national business where marketing costs are significant. Only the biggest issuers can drive operational costs low enough. Underwriting also requires an expensive level of sophistication.
Regionals’ cross-sell strategy offsets some of these deficiencies:
Distributing in captive channels keeps marketing costs low
Underwriting DDA customers can be based on factual cash flow and income data
Leveraging third-party processors avoids big tech investments
These offset some of the scale advantages held by the giants, but some of these are threatened by technology. Any bank can now use Open Banking to see DDA transaction activity, so that is becoming less of a proprietary source of insight. Digital marketing can be more targeted and less costly than mass advertising. Conservative underwriting can be uncompetitive when other issuers are using more advanced techniques to give better deals.
Essentially, there is limited reason to use the regional’s cards. Their rewards are no better, they don’t deliver more generous credit terms, and they function identically to every other card. Their only advantage is convenience via a common statement and digital experience. But credit cards are pretty low engagement on digital channels, so this is a very modest advantage.
My sense is that regionals are becoming less competitive in Credit Card as the mega-issuers keep investing. At some point we may go back to the Agent model where the Regional bank becomes a co-brand for a mega-issuer. This was popular around the time of the Credit Crisis. The agent model is fee-based, so it also de-risks the balance sheet.
Conclusions on Retail
In general, Regional Banks can’t differentiate their payments products because they are tied up in a web of networks, vendors, regulators and standards bodies. Further, it doesn’t pay to do so as long as consumers and small businesses still choose their bank by proximity and brand. Simply staying in-the-pack is sufficient in most cases.
I cover some of this material in more detail in my post entitled The structure of Retail payments markets.
Conclusion
If you buy my analysis, then virtually all regional banks can simplify payments strategy down to the following elements:
Wholesale
Treasury Services: Stay “in-the-pack” on functionality, relying on lending relationships for distribution
Commercial Cards: Continue to rely on third-party functionality, bundling with Treasury Services for distribution to lending clients
Merchant Acquiring: Don’t even try
Retail
DDA-based payments: Leverage utilities and third-parties for functionality, sharpen exception processing and servicing to differentiate. Focus on selling more DDA, not more payments
Merchant acquiring: Become a distribution partner to a large, multi-vertical ISV in return for a revenue share. Even the biggest banks have a hard time in this space
Credit Card: Consider becoming an Agent for a large issuer. Insist on tighter integration with your bank’s digital channels to reinforce the relationship
Both Wholesale & Retail rely on the same third-party infrastructure (networks, processors, associations, etc.). So it may be worth developing a thin layer on top of the lines of business to ensure the bank speaks with one voice in these industry forums. Some banks call this a “network office” as Visa and/or MasterCard are the primary counterparties, but I would add TCH, EWS, the Fed, NACHA and even some regulators. Maybe add Fintechs monitoring as they often serve both small business and middle market.
Further, payments touch many parts of the bank, so introducing new payment methods needs to be coordinated across lines of business. In the last 10 years this impacted Same-Day ACH, TCH RTP, Zelle, and FedNow. Next up is Request for Payment in RTP. A thin project management layer that understands all the touch points and has relationships across operations and technology can expedite and de-risk implementation.
While there still may be room for payments strategies in select situations or for specialist banks, the results of such projects are likely to match this summary.