• Milos Dunjic

Annual Checkup Of Canada Payments '2020 Vision'

First let's get one thing straight, right from the start - the new decade actually didn't start on Jan 1, 2020. Yes, you got that correct - according to the official The National Research Council of Canada website, since there was never 'year 0', a decade should always officially start with years ending with '1' ... i.e. mathematically speaking, start of the next decade is still a full year away, meaning we only entered the last year of the current decade. However, that doesn't make this year any less important, as it will likely be the year of sharpening Canadian 'payments 2020 vision' (pun intended) and getting it ready for the next decade. Keep reading to find out how.

Although considered being on somewhat conservative side (which helped Canada weather global financial crisis better than most of the world back in 2008), closer analysis reveals that Canada's financial sector has been fairly open for and at the forefront of payments infrastructure standardization and innovation in last ten years. With very small number of major incumbent banks in Canada, it is relatively easy to collaborate and work together at the industry and country levels and to adopt important standards.

The EMV payment card infrastructure has been officially mandated about a decade ago, with official 2010 liability shift, although industry wide rollouts of EMV technology started long before that. Similarly, standardization of P2P payments (based on Interac e-Transfer) was in place for almost as long. If you noticed, Venmo has never taken off in Canada. In fact, so far, all attempts by nonbank players to challenge Interac P2P rails have failed, with startup Tilt’s P2P payments shutting down in June 2017 and PayPal never publishing their Canadian P2P statistics (well, if they were great they would gladly publish them, wouldn't you agree?). All mainly because of success and wide consumer adoption of Interac e-Transfer.

In 2019 Canadian banks again came together and collaboratively worked together on launching Digital Identity network, for consensual secure sharing of customers' digital profile attributes, between Digital Asset Providers (DAP) and Digital Asset Consumers (DAC). As the most trusted financial service providers, Canadian banks are well positioned to play DAP role. With the solid Digital ID foundation firmly in place, it is to be expected that the new year should bring more DACs and DAPs to the Verified.Me rails, and hopefully pave the road toward its ultimate ubiquity.

Clearly, most Canadians generally trust and are fairly comfortable with the incumbent banks and have been fairly receptive to adopting new payments capabilities, rolled out at the wider industry levels, thus enabling all important ubiquity. Only 3% are classified as unbanked, meaning they have no any relationship with a mainstream financial institution such as a bank or credit union. In addition, 15% are considered to be underbanked, i.e. they may have a chequing or savings account, but their engagement with the mainstream financial sector is somewhat limited, mainly due to:

  • Being perceived as too risky to access basic credit products such as lines of credit, credit cards, or no holds on cheques/accounts.

  • Not meeting conditions and rules like minimum balances, for basic credit products like overdraft protection. NSF fees often can exceed $40.00 at most major banks.

Assessing Canadian 'Payments 2020 Vision'

By looking at the industry track record of standardization and collaboration so far, one could get an impression that Canadian 'payments 2020 vision' is already in fairly good shape and that there is no need for any corrective actions. However, although current set of available payments options has been adequate for majority of Canadian consumers and businesses so far, it may be showing signs of age and thus may require to be modernized, to be able to compete going forward.

Retail Payments

On the retail side (i.e. individual consumer focused payments) - both the EMV payment card POS acceptance network and Interac P2P e-Transfer rails - have significant built-in security and fraud prevention measures. Those include, but are not limited to, recurring equipment certification requirements and stringent network participation rules and regulations. Although banks and payment networks must be praised for visible reduction of fraud levels, by applying these expensive measures, the same rules can also present potentially serious barriers for entry for new entrants trying to play roles in current ecosystems.

That's probably why most of the FinTechs and digital neo-banks so far, have focused their efforts to playing relatively peripheral roles in Canadian context, mostly addressing niche needs, i.e. those that may have been seen as unprofitable by the incumbents (like targeting unbanked and underbanked population segments). Those more ambitious and disruptive FinTechs, which tried to launch new and alternative payment rails (anyone remembering Dexit maybe?), faced inevitable 'chicken and the egg' challenge, failed to scale and have shut down due to their inability to achieve ubiquity and after running out of the original VC investments.

Over time, these failures of status quo challengers to steer impactful disruption, created a perception (whether the perception is justified or not, clearly depends on an individual points of view) that incumbents may not be enthusiastic enough to rapid innovation, which resulted in calls from the FinTech and merchant communities for regulative changes, similar to what is underway across EU, UK and Australia.

We also can't ignore the proliferation of new communication capabilities and channels (NFC, QR codes, voice and ultra sound to name major ones) and emergence of IoT, voice assistants and other network connected devices, which offer whole new spectrum of possible innovative form factors capable of initiating payments.

Can fully frictionless commerce using these emerging form factors be achieved on top of the existing card and P2P payments rails? Or do we potentially need brand new rails established, for this to materialize? Can AI play more prominent and broader role (outside of its traditional and default 'fraud detection' role) in enabling frictionless payment experiences and transaction processing cost optimization?

China and India (and EU to a lesser degree) seem already well on rapid payments innovation path, with massively ubiquitous digital wallets and mega-apps that completely leapfrogged traditional card rails and are already dictating pace for the rest of the world to learn from, match and emulate.

Commercial Payments

Commercial payment innovations have been traditionally and unjustifiably (in my personal view) neglected by FinTech and incumbents, which were almost exclusively focused on retail payments (full of attractive but still somewhat elusive shiny objects). Nevertheless, these types of payments are extremely important for efficient functioning of national and global economies.

Vast majority of the commercial payments in Canada are processed through EFT rails, which is based on proprietary Canadian EFT standard (Canadian ACH equivalent, which is otherwise incompatible with US ACH message formats). Since EFT doesn't support rich remittance information embedded with payment instructions, the corporate banking customers are still unable to rely on automated programatic reconciliation of invoices / receipts against the payments they initiated / received AND to predict, as accurately as possible, their monthly cashflows, and avoid incurring overdraft fees. That creates friction and unnecessary expenses due to need for slow and inaccurate manual reconciliations processes for big corporations or SMEs.

Clearing And Settlement

All current Canadian retail and commercial payments methods rely on multi-day clearing and settlement processes (facilitated and guaranteed either by major credit card networks or by Payments Canada), meaning that actual net settlement amounts between payer's and payee's banks happen (in best case) on the next business day.

Although Canadian FIs participating in Interac e-Transfer successfully managed to achieve the illusion of near real time P2P transfers (from the point of view of end consumers), by immediately debiting sender's and crediting receiver's bank accounts, in reality they accept the risk of existing non real time / overnight clearing and settlement of their mutual net settlement amounts.

Due to inability to clear and settle transactions in real time, between payer's (sender) and payee's (receiver) banks, the industry is burdened with inherent settlement risks, i.e. risk that any of the participating FIs may default on its settlement obligations before actual settlement takes place. In order to properly mitigate, reduce and manage this settlement risk, the non realtime payments require careful and sophisticated liquidity management techniques by the participating banks and clearing and settlement network, combined with very strict participation requirements, in terms of required capital on deposit in participants' settlement accounts. This increases the overall costs of transaction processing and also further increases barriers for entry for new and smaller entrants.

Real Time Payments - Prescription For Perfect 'Payments 2020 Vision'?

All of these inefficiencies are just some of the examples, from the retail and commercial payments space, that may be blurring Canada's 'perfect payments 2020 vision'.

Good news is that the Canadian payments ecosystem is already on the path toward fairly fundamental, industry wide changes - main examples being:

  • mandating ISO 20022 as the official message standard

  • introduction of the REAL Real-Time Payments Rails that is ultimately based on immediate, real time gross settlement between sender's and receiver's payment providers.

These two changes alone, can have following positive impacts:

  • ISO 20022 can enable automated, programatic reconciliation of actual payments (sent and received) vs. original invoices and receipts and eliminate costly and inefficient manual processes, since it can accommodate and embed rich remittance information (invoice numbers, SKU info, etc) together with payments instructions in the same message

  • ISO 20022 can also enable seamless participation in international payment ecosystem by relying on globally accepted messaging standard (although this important benefit may unfortunately be reduced by regional nuances and differences in the way some ISO 20022 fields may be interpreted)

  • Real-Time Payments Rails has potential to significantly minimize inherent settlement risks in today's payment methods, by debiting sender and receiver payment provider's settlement accounts with appropriate clearing and settlement facilitators (i.e. Bank Of Canada, credit card networks, etc) in real time

  • Real Time Rails may also be able to reduce barriers to entry for new entrants, by enabling the risk based participation policies - i.e. since the settlement now happens in real time, the total amount that individual participant is allowed to move through the Real Time Rails at any moment in time, could be made directly proportional to level of participant's settlement account balance ... no more and no less.

Despite current challenges, I am very optimistic that with these transformational changes underway, Canada has great opportunity to sharpen its 'payment 2020 vision' this year and further enable next wave of purposeful innovation.

Welcome to 2020 ... although decade has not yet officially started, this year should be an important year for laying out proper foundation for Canadian payment innovation in the next decade.

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