Evolution of card-based and A2A payment processing! 💳

Both card-based payment processing and financial institution account-to-account payment processing have come a long way over the past decade. What was once an arguably commoditized landscape of providers with a clear delineation, payment card issuing, and account-to-account (A2A) payments have undergone significant changes in technology and business models whilst witnessing a rise in new market entrants. 

The landscape for card and A2A payment processing 👨‍💻

Changing patterns of supply and demand are shaping the payments landscape. On the supply side: 

• Traditional incumbents are consolidating through M&A activity
• Next-generation processors are experiencing rapid growth and achieving high valuations (e.g., Marqeta's IPO)
• Initial steps towards convergence, with traditional incumbents focusing more on non-banks and new generation processors starting to focus on banks and neo-banks. 

On the demand side, buyers are seeking: 

• Straight-forward, robust integrations
• Fewer silos (esp. for payment cards)
• More rapid time-to-market
• New turnkey business models
• Quality, digital VAS providers (onboarding, risk and fraud management, etc.)
• Back-office automation tools
• Clear, transparent pricing, including coverage of regulatory requirements. 

These changes have created a landscape of technology providers that offer buyers significantly more options than were available five or ten years ago. Where there used to be two or three provider options per category, often with geographic limitations, there are now more providers with broader geographic coverage, support for a wider range of business models, and the capacity to support both card-based payment and A2A payment processing. 

We can broadly classify the provider landscape into "Traditional" and "Next Generation" providers. Traditional providers primarily target financial institutions, while Next-Generation providers successfully realize strong growth and high valuations by focusing on previously underserved categories such as debit and prepaid cards, virtual cards, B2B payments and Open Banking. Next-Generation providers target fintechs and corporates, often using "as-a-service" business models, but are likely to target financial institutions to seek cost savings.

Traditionnal providers:

• Products: 
  • Legacy with major updates to enable more advanced architecture and APIs to be built  
  • Add-on value-added services 
  • Software licensing for account-to-account 
  • Managed services for payment cards. 
• Go-to-Market: 
  • Direct sales force
  • RFP driven
  • Sell on reputation via successful deployments and migrations
  • Licensing mode: license fee
  • Outsourcing for cards: historically complex pricing, moving towards more simplified "per-account" pricing plans. 
• Way of Working: 
  • Designed for reliability, compliance and large-scale functionality 
  • Built around robust product, methodologies and documentation
  • Regional sales and account management hubs
  • Formalized structures.

Next-Generation providers: 

• Products: 
  • Next-generation architecture with open API 
  • Highly customizable “plug-and-play” 
  • Cloud-based and ”as-a-service” 
  • Bundled pricing. 
• Go-to-Market: 
  • Lean heavily on partners, especially with core banking platforms
  • Selling capabilities based on technology, flexibility, and time-to-market
  • Build credibility through smaller clients 
  • Significant marketing investments
  • Wide range of pricing: bundled, subscription, and bespoke
• Way of Working: 
  • Designed for flexibility and speed 
  • Built around technology and development
  • Strong pre-sales and after-sales support
  • Emphasis on client self-service (“please see our developer portal”).

Source: Flagship Advisory Partners - "The Processing Landscape for Card Issuing and A2A Payments"

Client needs and buying behaviors vary considerably from one segment to another. While banks often seek well-established brands and have long and idiosyncratic buying behaviors, fintechs and corporates place a premium on speed and ease of integration. As many financial institutions digitize and seek to reduce technical and business silos while increasing agility, traditional vendors have adapted and next-generation vendors are seeing opportunities for entry.

How payment card processing works? 💳

There are a variety of different players involved in payment card processing: We have the payment cardholder at an issuing bank (the bank that issues the card used by the customer) to pay for goods and services, the merchant who can be any type of business that is required to be able to accept card payments, the merchant bank to manage accounts and accept deposits generated by card payments, payment processors who process the transaction and connects all the parties involved to make the payment possible, and the card networks who set the payment rails and interchange rates.

Card processing can be broken down into three distinct processes: authorization, settlement, and funding. 

As part of the authorization process, the cardholder presents their card to a merchant (e-commerce or point of sale) in exchange for goods or services. The merchant sends a request for payment authorization to their payment processor. The payment processor then passes the transaction to the appropriate card network, which communicates with the cardholder's issuing bank. Next, the authorization request is made to the issuing bank (CVV, AVS validation, and expiration date), which must approve or decline the transaction. The issuing bank then sends the approved (or declined) status back to the card network, merchant bank, and eventually to the merchant. This card authorization process takes only a few seconds. 

In terms of the settlement and funding process, merchants send batches of authorized transactions to their payment processor. The payment processor passes the transaction details to the card networks, communicating the appropriate debits with the issuing banks. The issuing bank charges the cardholder's account for the transaction amount and transfers the funds to the merchant bank, minus interchange fees***.  The merchant bank deposits funds into the merchant account. Settlement and funding processes that used to take days can now invariably be completed overnight, enabling merchants to get paid quickly. 

***Interchange fees Even if you know a lot about payments, the chances are you've misused the term "interchange." The fact is, interchange is just one of three components of the total cost of the card payment process called the merchant discount rate (MDR). Each component represents a financial institution or technology provider that handles the processing of a transaction. Of these, we see the MarkUp (or processing fee) which is the fee charged by the payment service provider or processor/acquirer (fixed, variable, and negotiable fees). The second component is the assessment fee (or dues/assessments) paid directly to the card networks (non-negotiable and reviewed twice a year). The final component is the interchange (issuing bank fee), which is ultimately paid by the merchant to the issuing bank and then shared with the issuer's processor and the card program manager. Interchange rates are set by the card networks and only reviewed twice a year. Understanding processing fees is the first step toward demystifying payments for your business.

Technology-led shifts and opportunities in card-based payments  🚀

Payments are an essential part of today’s global economy. As a result, issuers, card networks, payment processors, and merchant acquirers are investing heavily in revamping their payment systems, capitalizing on several technological advances to better align with customer preferences and sector-specific business requirements. 

Recognizing that disruptions and new challenges exist, banks and payment processors are modernizing their three payment layers:  infrastructure and deployments (e.g., data, switching, system of record, and tokenization), middleware ecosystem (e.g., routing, analytics, risk and authorization management), and front-end channels and execution systems (e.g., customer/user experience, new point-of-sale solutions, etc.). 

By the early 2010s, the startup PayPal was already processing over $350 billion in payments annually. Advances in open-source, decentralization, and the cloud have since enabled flexibility and on-demand capacity provisioning. Fintechs like Adyen, Stripe, and Square have disrupted the payments industry in this way. In this new era, these fintechs are able to provide "as-a-service" payment functions while relying on flexible and fully automated payment systems. With the benefit of open source technology, it is also easier to apply deep learning to simplify credit decisions, reduce churn rates, and optimize authorization rates while lowering declines. 

We expect the card-based payment processing landscape to transform into an automated and optimized payments-as-a-service (PaaS) future state, in which we will see a variety of separate, assembled and extended payment functions such as tokenization, routing and a choice of intelligent payment service providers that offer a superior customer experience. In addition, the PaaS model supports a personalized end-to-end experience, including CVVs, token swapping and backward compatibility. By adapting quickly and making investments In payment infrastructures, card providers can rise to the challenge and launch new products/services faster.

The possibilities of Account-to-Account (A2A) payment rails 📱

Account-to-account (A2A) payments facilitate money movement from one account to another, removing the need for intermediaries at the time of the transaction as with payment cards. There are two types of account-to-account payments: 

1. Push payments allow you to transfer funds manually to another account on a one-off basis. These include bank transfers and instant payments. In the context of Open Banking and payment initiation, APIs also enable push payments to be triggered by sending notifications of actions in the customer's banking environment.  
2. Pull payments are used to withdraw funds from customer accounts. This model is widely used by companies for recurring payments, such as telephone subscriptions or subscriptions to electricity suppliers. This type of payment requires the customer's consent by completing a direct debit mandate, for example.

These new payment rails are networks that facilitate the movement of money from one bank account to another. However, there is no single global, standardized payment rail; each country or regional organization is responsible for building and configuring their own account-to-account (A2A) payments. In recent years, a number of central banks have launched innovative projects to build A2A payment rails. Some countries, such as Mexico, Australia and the Netherlands, have developed regulatory sandboxes to encourage the creation of new and innovative offerings to promote the use and interest of these new payment rails. Here are a few specific examples:

• Mexico: Banco de México, Mexico’s central bank, has launched an A2A payment rail called SPEI (Sistema de Pagos Electrónicos Interbancarios). In an effort to combat fraud, corruption and the heavy use of cash, the Mexican central bank has created a large-scale QR code offering, CoDi, which leverages the SPEI payment rail to use real-time payment functionality This payment service allows for point-of-sale payments and facilitates the opening of payment accounts. 
• Australia: The New Payments Platform (NPP) is the most innovative payment infrastructure in the country. Launched by the Reserve Bank of Australia, it enables real-time payments between all Australian banks and allows consumers to transfer funds via the secure PayID system. 
• Netherlands: iDEAL, for example, is a very popular online payment system used for 65% of the country’s e-commerce payments. It became very popular when SCT or instant payment was introduced. Uptake of real-time payments has increased in the Netherlands and is expected to continue to grow over the next few years.  

The possibilities and benefits of A2A payment rails are very real and will continue to transform the payment landscape in the coming years.

• Enhanced customer experience: The emergence of Open Banking means that companies are able to offer a smoother user experience. You no longer have to integrate your payment card data. APIs will facilitate the ability to accept instant one-time or recurring payments.  
• Changing needs and real-time payments: Increasingly, consumers want more convenient and time-saving payment alternatives, and are turning to these new, faster payment methods, whilst maintaining convenience and reliability. There is an awareness that card payments offer too few advances or new innovations compared to account-to-account payments. 
• SCA and fraud reduction: SCA, or strong customer authentication, is a regulatory requirement for reducing fraud in digital transactions. By proving their identity via knowledge (password or code), possession (a phone) or a personal characteristic (biometrics), customers can conduct secure transactions while enabling businesses to be compliant, to reduce fraud (payment card fraud causes more than $24 billion in losses annually), all without compromising their payment experience.  

Open Banking as a catalyst for Account-to-Account (A2A) payments 💡

Open Banking facilitates the exchange between software and technology platforms. These APIs can create a link between different banking, fintech or technology platforms, enabling direct money transfer between payer and seller accounts. This means that account-to-account payments can now be made at the point of sale instead of using a payment card. This new payment rail offers speed and convenience, without the need to re-enter banking information or charge merchants transaction fees. As new payment alternatives such as e-wallets are making everyday transactions easier, they are becoming increasingly popular, and Open Banking is the catalyst for this estimated 78% annual growth in the European Union 

Conclusion 

The payments industry is preparing itself for a "cardless" world. There is a natural reluctance on the part of card issuers and networks to encourage consumers to adopt new alternative payment methods because of the commercial interest in maintaining payment card revenues. However, change seems inevitable, based on catalysts like Open Banking, which banks, merchants and consumers will embrace over time. As a result, card networks have already taken the threat of A2A payments seriously, attempting to diversify their product portfolio with a series of strategic acquisitions such as Mastercard with the buyouts of Vocalink and Nets, or American Express launching Pay By Bank Transfer to allow consumers to make real-time payments from their bank accounts. 

Banks, for their part, are seeking to better control the payment rails so that they no longer have to rely solely on the Visa/Mastercard duopoly. They have also launched the EPI (European Payments Initiative) project to create a new payment infrastructure capable of managing and processing account-to-account payments. Thanks to the growth of Open Banking, new companies have begun to participate in the A2A payment ecosystem, including Trustly, Fintecture and Token. A2A payments provide a payment infrastructure that will enable new payment methods such as QR codes, payment wallets, buy now pay later (BNPL), crypto-currencies and stablecoins to gain in importance. 

Skaleet's SaaS banking platform facilitates card and A2A payments not only for issuers, but for processors/purchasers too, while also rethinking existing IT infrastructures and fee structures in order to generate more revenue. 

Skaleet’s solution allows you to (1) orchestrate merchant payments by managing the integration of the payment players of your choice to distribute a wide range of payment methods to marketplaces and POS providers, (2) create a payments-as-a-service (PaaS) platform to facilitate the distribution of payment instruments or third-party collection solutions to financial and non-financial institutions (Embedded Finance), and (3) launch new financial institutions (digital banks or neo-banks) with the capacity to manage a payment card program (card creation, authorization management or payment processing) to speed up time-to-market, reduce technological resources and costs associated with launching the program.