Facing SEPA: One size does not fit all banks

By Rob van Bergen, Capgemini Payments Centre of Excellence

Driven by its aspirations to become ‘the most competitive and dynamic knowledge-driven economy by 2010’, the EU is fundamentally transforming the financial services industry. SEPA is a regulation that will erase the current distinction between national and cross-border euro payments and is spurring banks to reconsider their current strategies. In the new reality, the winners will be those banks that develop successful new strategies for products, pricing, market positioning and sourcing, addressing how to maximise revenues and reduce costs.

For banks in particular, SEPA transformation has major consequences. Building on increased competition scenarios and levelling off of current price differences, revenues will decline, major investments in payment processes and systems will be required, and the competitive landscape will change. The 2005 World Payments Report by Capgemini, EFMA and ABN AMRO (www.capgemini.com/worldpaymentsreport) found that euro-area bank payments revenues are likely to fall by up to €29 billion by 2010 as competition and transparency increase, causing prices to erode. Prices will probably converge at a lower European-wide level.

Banks face three challenges simultaneously: to rethink their offerings to compensate for revenue loss, rethink their value chain to adapt their costs structure to a new profitability paradigm, and to reconsider the way that they participate in the different payment organisations (like ACHs, RTGS, etc.)

To comply with SEPA, banks will need to adjust their payment processes and systems. But compliance alone will not be enough. Competitors with a coherent SEPA strategy will be better positioned to offer attractive value-added services to the market and to process at lower cost. The second SEPA phase in 2010, however, poses the biggest challenge. By then, banks will have to migrate domestic payment schemes to uniform SEPA payment schemes. This implies substantial investments in their payment front-, back- and mid-office systems and processes.

Competition will stem not only from existing market players but also from new entrants that will target the most profitable parts of the payments value chain. Banks will also be confronted with a changing role of the automated clearing house (ACH) as it evolves from a utility into a commercial and internationally competing payment service provider.

At first glance, addressing SEPA appears to be a big headache. However, it also offers great potential. Unified products and standards will simplify payments processing and offer considerable cost-savings potential in the long run. The single market will provide a gateway to offer payment products and services in different geographies.

What should banks do to prepare? Perhaps the most important message is that they should begin immediately in order to avoid 2008 deadline crunches – and to position themselves to capture the opportunities. SEPA implies that banks will have to manage two agendas in parallel: the compliance and strategic agendas (both commercial and sourcing).

SEPA compliance: banks are moving now

By 2008, banks need to be able to offer and process SEPA payment products based on the SEPA rulebooks. Compliance is not optional – it is essential for banks in order to prevent damage to their reputation. Banks will need to develop payment products and adapt their payment systems and processes accordingly.

Although SEPA is primarily a business issue, the impact on processes, organisation and IT infrastructure is considerable. Non-IT issues such as SEPA product development and pricing will also need to be addressed. Banks may need to determine the impact on current’s clearing interfaces as SEPA puts different requirements on ACHs concerning their reach, their product and service offerings and prices.

Another important element on the compliance agenda is the migration of current national payments to SEPA. Analysis in the 2006 World Payments Report shows that in the six main euro countries 85 percent of the current non-cash payments already take place in some SEPA-like form. Of these volumes, 13 percent are SEPA compliant and another 45 percent can be ‘SEPA-dized’ relatively easy. The remaining 42 percent show a considerable gap towards SEPA. There is however no SEPA-equivalent for 15 percent of current non-cash volumes such as cheques. Banks and banking associations will need to address and plan substitution of these products to SEPA-standards in their national migration plans.

The compliance analysis provides relevant input for future strategic repositioning. Banks should realise that compliance is just an initial step towards SEPA. Compliance alone will not reduce payments processing costs, provide competitive advantage or yield additional revenue opportunities.

Strategically assess the payments business

Besides compliance, banks also need to manage the strategic agenda. Basically, banks need to evaluate the case for staying in the payments business and determine which areas can be viable. The starting point is a thorough understanding of SEPA’s potential impact on the current strategy, financials, internal organisation and environment in which the bank operates. Factors such as scale, geographic presence, existing payment processing infrastructure and business model will show different results for different banks, but the approach is similar.

The analysis has two major dimensions – the business (or commercial) and the sourcing strategy – both of which are strongly interwoven and require a holistic approach. SEPA must be embedded as a multi-disciplinary effort in which business, operations, IT and legal align to prevent silo-oriented initiatives.

Defining the business strategy

Compensating for declining payments revenues in the new SEPA world is a fundamental challenge. Payments are already commoditised, making volumes and costs decisive factors. Commoditisation will expand to a pan-European scale, further squeezing revenues.

For answers, bankers can turn to a scenario-driven approach that highlights several strategic alternatives. Doing so requires a detailed understanding of the current payments market and its trends. By analysing the revenues per payment product and per client segment, the bank can see which payment products and services are generating revenues. Using the current revenues as a starting point, bankers can visualise the impact of SEPA by applying different hypotheses. These results offer banks more guidance to focus on profitable segments and products when designing a new strategy.

Addressing the sourcing issue

Another important topic is the bank’s sourcing strategy: insource, outsource, or partner? If outsourcing is the most likely scenario, banks should invest in SEPA compliance defensively and at minimal cost. When insourcing is preferred, a bank’s compliance investments should provide the flexibility to develop and offer value-added services. The most successful banks in the new SEPA reality will have a flexible and mixed sourcing strategy.

Determining this strategy is a complex task, requiring strategic, practical and contextual considerations, which again differ by bank. Decisions on the sourcing strategy depend on a solid analysis of the current capabilities of the existing IT payments infrastructure (e.g., STP, flexibility), the payment volumes at stake, the current cost base and its real improvement potential.

How should a bank approach the issue of sourcing? There are four phases:

1. Conduct SEPA compliance scans to gain insights into the bank’s current payment processing capabilities and an initial direction on sourcing.
2. Reposition the bank strategically. Banks should assess their current payments business using detailed metrics on revenues and costs per payment instrument. A holistic view is important.
3. Assess core payment competencies. Determine which products and services to keep and which to exit based on a detailed breakdown and SWOT analysis of each step in the value chain.
4. Evaluate the various sourcing options on their merits.

More information on payments usage and evolving trends, can be found in the 2006 report at www.capgemini.com/worldpaymentsreport. Developed by Capgemini, ABN AMRO and EFMA, it covers nine countries and provides an update on SEPA revenue impacts with hard and soft competition scenarios. Look for a perspective on sourcing strategies and why banks need to explore these options for payments processing now.