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BirdsEye View

did you realize how much of your income comes from the payment business?

The payment business is only considered a business by the large banks. Most SuperCommunity banks do not view it as an important or controllable income stream. This article is aimed at dispelling this notion. Consider it as you're doing your holiday shopping and you'll see why... and use the attached worksheet to calculate your own position.

Have a fabulous week,

Did You Realize How Much Of Your Income Comes From The Payment Business?

Revenues from the payment system snuck up on us. In fact, many banks still do not aggregate the many income streams from various payment-related activities to find out how much of their bottom line is associated with payments. The number might surprise you, regardless to bank size. Payment income isn't the purview of large banks alone. ALL banks are benefiting from the electronification of the payment system and its impact on consumer behavior across all sectors.

This process began fifty years ago, but its progress accelerated so rapidly in the recent decade that the change, an accumulation of fifty years of activity, snuck up on us.

All electronic payments have four components in common:

  • Source of funds (such as a checking account, credit card etc.)
  • Settlement method (such as ACH, ATM, debit card etc.)
  • Unique identifier of the payer (such as checking account number, debit card number etc.)
  • Authentication of the payer's identity (such as a PIN number, in person ID verification etc.)

Technological innovation has helped reconfigure these components and combine them in such ways as to enable both commercial and retail customers to access and remit funds in methods that were previously unheard of. These innovations were made piecemeal, but, altogether, they had a profound impact on the way people access and remit their money.

The first significant sign of this transformation came in the 1990s, when the volume of paper checks has declined for the first time. This event was predicted again and again for decades, so, when it actually happened, it was a surprise to many. In fact, the Federal Reserve closed 13 of its 45 check processing centers in 2003 and 2004 due to lack of volume, and 9 more are expected to close by year-end. At the same time, it has increased the cost of processing paper items by 45% over five years.

The underlying reason for this enormous change lies in the ability to convert paper into an electronic form. Consider the following:

  • Paper checks can now be converted into ACH transactions at the point of sale
  • Paper checks can also be converted at the point of sales into a debit check, in which the check payment is authorized by the payee's bank immediately, much like a secure PIN based debit transaction
  • Mailed payment checks can be converted to ACH at the billers' lockbox
  • Bounced checks can be resubmitted electronically to speed collection
  • Check 21 established the legal equivalence of paper checks with electronically imaged substitute checks
  • Buyers can use ACH to facilitate purchases by phone and internet

As a result of these and many other changes, checks and electronic forms of payment are converging into one. This trend is welcome by most payees due to the huge convenience implications it offers. Their desire for greater convenience and efficiency is at the core of these payment innovations. Merchants welcome the changes as well, since they expand the universe of buyers well beyond cash-based while reducing payment processing costs without negatively impacting float.

Several methods of electronic payments have emerged:

  • Access demand deposits, consumer credit and stored value accounts
  • Present and pay bills
  • Move funds from one account or person to another

This flexibility of payments appeals to all segments of the market, and creates income for financial institutions. For example, I find the debit card the most beautiful product we have. It's a "win" for all major constituencies of banks:

  • The consumer gets greater convenience, doesn't have to wait in line for ID verification and isn't compelled to borrow in order to access the electronic payment system – all for free
  • The bank makes fee income, which is not paid by the consumer
  • The merchant increases the universe of its customers by offering this method of payment, and pays for it through interchange income

Everyone wins!

Consider the various elements of the payment business:

  • Debit revenue
  • ATM revenue
  • Credit card revenue
  • Bill pay
  • Expedited payments
  • NSF/OD
  • Check printing
  • Lockbox
  • Wires
  • ACH payments Information reporting
  • Service charges

I recommend that you utilize the Payment Business Worksheet, developed originally by Ron Baldwin of Huntington Bank, to get a better idea of how much of your income is derived from the various payment activities you conduct. I am confident you'll find the number meaningful.

Certain aspects of this business are extremely scale sensitive, and preclude smaller banks from directly benefiting from their revenues. However, so many other elements of the business, as described above, are available to anyone who offers a checking account to either retail or commercial customers. Many of you have already realized that and embarked on fee income generating activities, most notably the courtesy overdraft privilege product. However, everyone will benefit from a more comprehensive view of the business and better understanding of where the revenues come from, and how vulnerable they are.

We have found, through the imposition of ATM fees and the courtesy overdraft products, that customers are learning beings and they will change their behavior when heavily feed. This implies that the lifecycle of new payment products might be limited, or, at minimum, that the income streams will reach a peak and then ebb, typically to 70% of their peak levels, for a run rate. A deliberate view of these income streams and their future is necessary as banks contemplate their payments revenues on the future.

One certainty is that new payment mechanisms and greater fees will be invented in the near future. Approaching this diversified fee income stream as a single business and planning your position in it is a wise move in these changing times.