Cross-border payments - The road to profitability for European mobile wallets?

Many mobile wallets in Europe are struggling with profitability. Incumbent banks and card companies still maintain a dominant position in B2C and in P2P payments margins are slim. The cross-border payments market is still largely untapped by wallets despite high profitability both in B2C and P2P. Wallets are hesitant to enter the market due to concerns about risks related to AML and also a lack of capital to pre-fund accounts. These concerns can be mitigated by using the latest available technology in cross-border payments, opening up the road to profitability for European wallets.  

Contrary to its peers in emerging markets, European wallets have had difficulties in finding profitability. While wallets in emerging markets have flourished, both in P2P and in B2C, its peers in mature markets have struggled to make ends meet. In mature markets banks are stronger in the sense that most people hold a bank account with cheap domestic P2P transfers. In B2C the level of card penetration is much higher compared to emerging markets and most merchants have taken a sunk cost on PoS. 

 

In e-commerce, the wallets have had more success but competition is fierce in banks and cards. Furthermore, other competitors in the form of neo-banks and Fintechs have entered the market with attractive user experience and aggressive credit terms. This has ultimately led to a crowded market with limited profitability for most wallets. 

In P2P payments the wallets have demonstrated more success. The incumbent bank apps are not as user friendly as the wallets with neo-banks and other Fintech not having focused on this segment due to low-income potential. The problem for wallets with P2P payments is that the profitability is low with many consumers expecting the service to be free. Even if your user experience is strong it is difficult to change behaviour to accept a charge for something now as since before, it has been given away for free. 

Cross-border payments still largely untapped by wallets

The question then arises how wallets in developed markets can use their widespread market penetration to conduct profitable business? The reality is that the possibility for cross-border payments remains. The traditional banks charge high fees and generate substantial revenues from FX income. Estimates show that banks are charging anything from 0.5-7% in FX spreads*, depending on the currency pair. 

 

For the B2C segment cross-border payments are still largely controlled by incumbent banks and card companies. A few numbers of Fintechs have tried to compete but with limited success. Newcomers have been more successful in the P2P space where many incumbent banks are retreating due to AML risks. In this space, more and more remittances are managed by Fintechs and specialized remittance companies. 

 

At first look the cross-border payment space is an area where the wallets could be successful. The wallets have a superior user experience compared to bank apps and can cooperate with other wallet partners to reach local merchants as well as help with last-mile delivery for P2P. In e-commerce wallets and wallet partners could compete both in terms of cost and user experience with the card companies. What is holding them back then? 

AML/Sanction screening a major hurdle for many wallets

Many wallets have considered entering the space but in particular AML is an important concern. As one wallet executive expressed it, “The problem (with cross-border payments) is not technology, it is AML”. The risks of breaching sanction lists or funneling illegal funds have made wallets very hesitant to enter. Banks have been fined billions for not complying with rules. AML is costly and time consuming and not in the least, managing “false positives” can create bad will with customers. 

 

Fortunately, the tools available for digital AML/sanction screening have rapidly increased as technology has developed. Many Fintech and established data analytics firms have developed a new generation of digital services. By using their latest technology one can screen large volumes of transactions in real-time, substantially lowering risks at a reasonable cost.  

 

Many are also developing AI that can detect suspicious payment patterns. In addition, blockchain-based payment solutions can be used to mark and track suspicious transactions. Wallets can ultimately reduce risks further by focusing on low-risk jurisdictions such as the EU and the UK and capping the size of each payment.

Lack of capital and foreign exchange knowledge stops some wallets

Challenges facing wallets are the lack of access to capital/liquidity as well as limited experience in foreign exchange management. The nature of wallets is that real-time (or near real-time) settlement is a necessity. In a cross-border transaction, a merchant wants to see its account credited before releasing goods as there is no collateral in place. With today’s traditional “correspondent banking” chain of settling payments, it becomes costly with small amounts and real-time payments are typically not possible. 

 

The alternative is to pre-fund accounts in every market which is the modus operandi for many remittance companies. This requires that the wallet has access to capital and liquidity and implies credit risks with deposits held. The wallets frequently also lack the know-how of executing and pricing FX which is the prerequisite to obtain profitability from the cross-border payments. 

 

In this aspect, technology has also dramatically improved with new blockchain-based payment platforms enabling real-time transfers in small values, at low cost across different currencies. New DLT technology has resolved the problems related to Bitcoin and the likes and are now able to offer low risk and fast solutions. All of this naturally leading to the disruption of  the traditional correspondent banking models. This development is also partially a result of the rapid development of multi-bank FX platforms and functionalities that have narrowed FX spreads for smaller players, including wallets. This gives wallets the same pricing power in FX as global banks, enhancing competitiveness abilities. 

Opportunities with disrupting technology

As technology continues to rapidly develop many new opportunities arise and disrupt the payment markets. Many incumbent banks are working with old legacy systems and are unable or unwilling to adopt new technology. For a small nimble wallet it is much easier to adapt fast with new technology.  

 

There are large opportunities for wallets to enter into the cross-border market both in B2C and P2P. In B2C there are opportunities both in e-commerce and with physical merchants, where wallets user experience is superior to cards. In P2P flows, usually a low-margin business in domestic markets, profitability can be found from both fees and FX income. 

 

Start-ups such as Transferwise and Revolut are taking market share from incumbents in this space with wallets also being well-positioned. In Asia, some wallets have already entered cross-border payments for intra-regional flows and anecdotal evidence points to the fact that it is already generating an important part of their revenue. There is no reason that this could not be replicated in Europe. 

This article is published by Centiglobe Technologies. Centiglobe offers instant payments through a blockchain-based platform where wallets in different regions can communicate with each other. Centiglobe offers a better customer experience and gaining new revenue streams from FX. If you are interested in knowing more about this topic or other related issues please contact the author Petter Sandgren at Petter.Sandgren@centiglobe.com or Isak Nyberg at Isak.Nyberg@centiglobe.com.

*https://remittanceprices.worldbank.org/sites/default/files/rpw_report_march_2020.pdf

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