The following article was originally published in Capital One Bank’s Capital Perspectives.
Responding to transaction platforms that no longer meet their needs, a growing number of banks are developing centralized payments hubs. This paper will explain current payments platform drawbacks, why banks see centralized payments hubs as a solution, the difficulties in developing them and — most importantly — how these hubs will enable banks to improve corporate payments services and the client experience.
WHY THE NEED FOR CHANGE?
In the ongoing transformation and modernization of payments, many banks find themselves maintaining multiple high-cost, high-support platforms for discrete payment capabilities. Across these platforms, there is little synergy, and data is difficult to analyze and merge. This segregation of systems inherently comes with duplicative processes, increased risk and added operational costs.
Traditionally, banks have maintained different payments processing systems for each payment method they offer to their business clients. For example, they have had separate systems for processing checks, credit cards, wire transfers, Automated Clearing House (ACH) transactions and low-value international payments.
Unfortunately, when banks are managing payments across multiple legacy settlement platforms, regulatory changes can prove to be very costly and disruptive. Each new payment regulation can add significantly to information technology costs if it requires a bank to update multiple systems.
What’s more, these segmented environments inhibit product innovation, client experience improvement and market segment growth. Operating with numerous platforms offers limited capabilities to interact, merge and analyze data. It also makes it difficult to align with an organization’s different business units.
Indeed, as the payment industry changes and adapts to growing market needs and budding technologies, it’s become clear that if financial institutions don’t take steps now to modernize their infrastructure, they won’t be able to compete. As a result, a growing number of banks — both large global banks and increasingly many superregionals as well — are working on developing an IT infrastructure solution: a “centralized payments hub.”
WHAT IS A CENTRALIZED PAYMENTS HUB?
A “centralized payments hub” can take different forms. But generally, it’s a technology infrastructure that enables a bank to route all of its electronic payments to a centralized engine for processing.
A centralized payments hub can employ business rules to select the most efficient payment network to use for clearing any particular payment. The hub’s choice — whether Fedwire, SWIFT, CHIPS or a low-value clearing network — is based on objectives built into the business rules, such as minimizing cost and reducing time to settlement. (This service capability is sometimes referred to as “least cost routing.”)
These hubs can be designed a number of ways, but one of the more streamlined configurations is to have the hub sit between the payment clearing networks and the bank’s front-end access channel — which could be a digital platform, a file delivery service, an application programming interface (API) or messaging service, or even a mobile channel.
McKinsey & Company further defines such a hub and what it can do for a bank1: “A payments hub can be seen as the infrastructure that ties together the specialized services required to build payments applications, such as data completion, exception handling and settlement. There are also ancillary services, such as anti-fraud screening, risk management and dispute resolution. In the legacy architecture prevalent in most banks, each payments application would need to have dedicated functionality in all of these areas. With payments hubs, banks can deploy a common set of services to support the full gamut of payments applications.”
OVERCOMING CHALLENGES TO HUB DEVELOPMENT
The concept of a centralized payments hub isn’t new in commercial banking. There are financial institutions that have been trying to do this for several years — but it’s been slow going for a number of reasons:
A centralized payments hub represents a sizable investment. Replacing a bank’s core payments infrastructure, including multiple legacy systems, with a new centralized system requires a major capital investment.
If it’s not broke, don’t fix it (or so the thinking goes). A bank may see the value of a payments hub, but if its current payments infrastructure is working and generating revenue, it can be a difficult leap to allocate major dollars to a hub development project. Remember, many banks refused to update a lot of their 1980s technology architecture until forced to by Y2K risk concerns.
Banks have other major initiatives on their plates these days. Currently, a major focus at most banks is managing regulatory compliance and risk issues. It’s hard for other important projects, like developing a centralized payments hub, to garner senior management attention.
Some banks aren’t making new payments infrastructure a priority because they have a limited vision of what a centralized payments hub can do for them. Some only see a payments hub as a cost efficiency play. The banks that have made a greater commitment and are moving faster to develop a payments hub see it as a source not only of greater cost efficiency, but also as a means to offer new payments services and features, generate more revenue and improve the client experience.
Despite these hurdles, a few banks are in the process of building a new vision for payments services that incorporates a centralized payments hub and are moving toward that vision.
HUB BENEFITS FOR BANK CLIENTS
A centralized payments hub can benefit corporate clients by enabling a bank to:
Personalize clients’ payments experience and help them improve liquidity management. Today, most banks package products to target a particular market segment (i.e., small business, middle market or large corporate). A centralized payments hub can enable a bank to provide a unique experience to each client.
Banks are positioned to provide a more customized experience if they have comprehensive data regarding a client’s various payment activities, which a payments hub can provide. With that information, a bank could offer intelligent alerts. As an example, when a client logs into its treasury portal, a bank could provide an on-screen reminder that the client must pay a certain invoice that day in order to take advantage of a prompt-pay discount.
A centralized payments hub also could enable a bank to offer transaction tracking similar to what overnight courier companies provide for packages in transit. This could be particularly valuable in relation to high-value payments. Say a company sends a $1 million payment and wants to determine the status a few hours later. The company’s bank could provide an up-to-the-minute view of that payment online, including whether the client’s account has been debited and whether any credit has been utilized.
Reduce client risk related to corporate account takeover fraud. Having comprehensive information about a client’s payment activities, through a payments hub, can also help a bank spot potentially fraudulent transactions. If a bank sees 10 wire transfers, each for $800,000, initiated from a client’s account, and its payments hub fraud monitoring tool reports there has been no precedent for that sort of activity in the account, the bank can investigate the questionable transactions and potentially help the client avoid a fraud loss.
In addition, the greater visibility to transactions provided by a payments hub can give a bank real-time payment notification capabilities. A client could ask the bank to send a dashboard alert any time a payment is initiated from its account over a certain dollar amount, for example.
Increase payments efficiency. It’s safe to say that the majority of middle-market and large companies use multiple payment types. With a centralized payments hub, a bank can determine which payments network will provide the fastest settlement at the lowest cost for any particular payment, and route the payment accordingly. For instance, business rules programmed into the hub might tell the bank to route a payment to China through a particular correspondent in order to reduce settlement time by two days.
A bank with a payments hub might also be able to help a client reduce repair fee charges. The bank could build an operational analytics dashboard that shows the client how fast their payments are being sent and the reasons for delays. Moreover, the dashboard could tell the client why certain payments are requiring repairs so the client can proactively correct its instructions and reduce repair-related bank fees.
WHAT’S NEXT IN PAYMENTS?
A bank can leverage a centralized payments hub to be more agile in reacting to changes in the payments market and more nimble in adapting to new regulations. In addition, a payments hub can allow banks to offer more services, such as low-value international payments that are more cost effective for clients making smaller recurring payments overseas.
As the domestic and international clearing networks develop new features and products, having a centralized payments hub will make it easier for banks to offer these new products to clients, as they won’t need to build out regulatory or product requirements across multiple systems.
Look for banks with centralized payments hubs to leverage their standard, open and integrated platforms to build new services and digital offerings in areas such as mobile payments, P2P transfers and B2B remittances.
Other future payments developments for corporates to keep an eye on include:
New payments services offered by non-bank technology companies aren’t likely to offer the same robust reporting that banks with payment hubs will be able to provide. A technology company might introduce a real-time international money transfer service, but it might not be able to offer the same view of liquidity throughout the day or the same level of financial information to manage its daily business.
Payments hubs will give banks the ability to more easily add interfaces, such as APIs. An application programming interface is a tool for building software applications and allowing them to talk to one another. In the context of payment processing, an API can enable a client to communicate payment instructions to a bank directly, using a common structured format, without having to log in to a portal or send a file, and then receive a response back from the bank — all in real time.
Thanks to centralized payments hubs, as adoption of standardized file formats such as the ISO 20022 XML format becomes the norm, banks will have more flexibility to accommodate these formats for their clients.
More transparent payment processing may lead to more client self-administration opportunities. For example, rather than automatically repairing transactions and charging clients for those repairs, a bank might decide to use enhanced interface capabilities to return items to clients for repair. Greater digital self-administration has become the norm for consumers, and the trend is likely to take hold for business clients as well.
HOW CORPORATES SHOULD RESPOND
Corporate treasury managers should talk to their banks about their payments infrastructure strategy and investments — and assess their banks’ agility as new payments technology and regulations emerge. Keep in mind that only those banks that continue to invest in a payments infrastructure that is moving toward a centralized platform will be able to offer emerging payment methods at a low cost.
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“Payments hubs: Redefining the industry’s infrastructure,” McKinsey on Payments, p. 17, June 2010."