mckinsey on payments - bkm

Volume 9 Number 23 June 2016

Payments

Rethinking correspondentbanking

Consumer finance: Bringingbanks and retailers back intoalignment

Digital marketingtransformation: Payments ata crossroads

At the forefront of paymentsinnovation: An interview withSoner Canko, CEO ofTurkey’s BKM

Payments and the rise ofAPI-driven banking

11

30

3

25

18

Contents

McKinsey on

McKinsey on Payments is written by experts and practitioners in the McKinsey & Company Global Payments Practice.

To send comments or request copies, email us at: [email protected]

To download selected articles from previous issues, visit:http://www.mckinsey.com/paymentspractice/knowledge_highlights

Editorial board: Tim Arscott-Mills, Rohit Bhapkar, Philip Bruno, Olivier Denecker, Vijay D’Silva, Flavio Litterio,Robert Mau, Marc Niederkorn, Kausik Rajgopal (Chair)

Editors: John Crofoot, Peter Jacobs, Glen Sarvady, Jill Willder

Global Payments Practice manager: Natasha Karr

Executive editor: Allison Kellogg

Managing editor: Paul Feldman

Design and layout: Derick Hudspith

Copyright © 2016 McKinsey & Company. All rights reserved.

This publication is not intended to be used as the basis for anytransaction. Nothing herein shall be construed as legal, financial,accounting, investment, or other type of professional advice. If any suchadvice is required, the services of appropriate advisers should be sought.No part of this publication may be copied or redistributed in any formwithout the prior written permission of McKinsey & Company.

ForewordWelcome to the 23rd issue of McKinsey on Payments. This issue marks the pub-lication’s ninth year, and we look forward to continuing to deliver our perspec-tives on the ever-evolving payments landscape.

Our lead article (page 3) looks at a business on the cusp of significant change.In its fundamentals, correspondent banking—that is, one financial firm carry-ing out transactions on behalf of another—has actually altered little since it firstemerged centuries ago. Today, three forces are leading to change: increasingcustomer expectations, regulatory demands and the emergence of digital inno-vators. (If this trio of forces sounds familiar, it is because few financial servicessectors have been immune to their impact.)

In correspondent banking, the stakes are high. Global losses for banks of up to$230 billion (70 percent) could follow if cross-border revenue margins were tofall to domestic levels. The answer for banks is not to retrench, of course, but toharness the forces at work. Banks need a new model. This may lead to lost rev-enues in the short-term, as banks modernize and streamline processes and en-hance the value they bring to clients. But improved operational performance andmore customer-friendly solutions should lead to a balancing growth in volume.

Our second article examines consumer finance (page 11), where the interests ofbanks and retailers often start out in sync, but can gradually diverge as the de-sign and operation of credit products grow apart from the aims of the retailbusinesses they support. Partnerships that begin by boosting sales for retailersand new customer acquisition for banks can falter as, for instance, bank and re-tailer views of customer creditworthiness become misaligned. New models areneeded that preserve banking credit mechanisms while keeping strong links tostore operations. For instance, if banks and retailers took a broader view ofcredit that incorporates the incremental margin from goods that might go un-

1

Kausik Rajgopal

2 McKinsey on Payments June 2016

sold, it might bring them into closer alignment. Rethinking consumer financegets trickier as markets mature, but there are ways to improve no matter thelevel of development.

Rapid advances in digital marketing are leading payments firms to a decisivemoment, according to our next article (page 18). In order to protect their rela-tionships with their customers, banks need to expand their value proposition tocover the full spectrum of a customer's experience to search, shop, buy and en-gage with products and services. With their vast stores of historical customerpayments data, banks are in a strong starting position to understand buying be-havior. To get to the next level they must focus on the three “d”s of data aggre-gation, decisioning, and distribution.

Next is an interview with the CEO of Turkey’s Interbank Card Center (BKM),Soner Canko (page 25). Mr. Canko’s role places him at the heart of payments in-novation in the country, working with member banks towards the goal of acashless society. He talks with us about the unique challenges and opportunitiesin the Turkish market, the future of payments in emerging markets, and thenew National Payments System his organization helped to develop.

Our issue concludes with a look at the increasing role of application program-ming interfaces (APIs) in financial services (page 30). Once a tool for internetgiants such as Amazon and Google, APIs are now emerging across the bankinglandscape–enabling transactions that do not compromise the systems integrityof the institutions involved. Many banks, however, are just now consideringtheir approach to APIs. A good starting point is to consider which API ap-proach—public, private or internal—is the best fit for the bank’s long-termstrategy. The decision will have important implications in terms of risk, tech-nology, security, operations and economics.

We hope you find the articles in this issue thought-provoking and informative.As always, we look forward to your comments and questions.

Kausik Rajgopal is a senior partner in McKinsey’s Silicon Valley office.

What’s more, revenue margins in cross-border payments have remained healthyover time. As margins for domestic pay-ments were squeezed by regulation andcompetition in recent decades, banks wereforced to pare back costs and improve the ef-ficiency of their systems and products. Butcross-border payments have not yet experi-enced such pressures, so banks have had lit-tle incentive to work on their back-endsystems and processes or to develop innova-tive customer offerings.

That is now changing. The traditional corre-spondent banking model for cross-borderpayments has come under acute pressurefrom customers, regulators and competitorsalike:

• Customer expectations for real-time, digi-tally enabled cross-border payments are

growing as domestic retail payments un-dergo rapid digitization.

• Regulatory compliance is driving up thecost of cross-border payments systemsand forcing banks to review their corre-spondent relations.

• Digital innovators are attracting cus-tomers with new solutions and enhancedvalue propositions that threaten not onlyto cut banks out of their correspondentbanking relationships but also to loosenbanks’ ties with end customers, at leastwhere payments-related activities areconcerned.

If these growing pressures were to drivecross-border revenue margins down to do-mestic levels, industry revenues would dropby 70 percent, inflicting losses of $230 bil-lion on banks globally. To avert this stark

3Rethinking correspondent banking

Olivier Denecker

Florent Istace

Pavan K. Masanam

Marc Niederkorn

Rethinking correspondent banking

Correspondent banking—in which one financial institution carries out

transactions on behalf of another, often because it has no local presence—has

been used as the instrument for cross-border payments since the time of the

Medicis. The intervening centuries have brought surprisingly little in the way of

fundamental change, and banks still generate considerable value from cross-

border payments. According to the 2015 McKinsey Global Payments Map, these

transactions represent 20 percent of total transaction volumes in the payments

industry, yet they generate 50 percent of its transaction-related revenues

(Exhibit 1, page 4).


scenario, banks need to embrace changeand grow the market by delivering new cus-tomer solutions through far more efficientoperations. This article examines how cor-respondent banking is changing and pro-poses options for banks to consider todefend and enhance their position in cross-border payments.

Drivers of change

Three forces are driving change in corre-spondent banking: the customer impera-tive, the efficiency squeeze and thenonbank offer.

The customer imperative

As consumers and businesses grow accus-tomed to the benefits of using technology intheir daily lives, their expectations rise. Infinancial services, digital entrants are offer-ing products and services with thoughtfullydesigned user interfaces that provide a

great experience in terms of transparency,convenience, price and speed. These bene-fits are gradually becoming table stakes forall participants in the industry. Meanwhile,domestic payments are moving to real-timesolutions at marginal cost to the user.Cross-border payments have yet to embracethese developments, and the gap betweencustomers’ expectations and their experi-ence is widening.

In fact, cross-border payments continue tobe expensive, slow and lacking in trans-parency on both costs and delivery times. In2015, a McKinsey survey on consumer cross-border payments found that consumers typi-cally pay a fee of €20 to €60 on top of theprevailing foreign-exchange spread. And thisfee does not even guarantee timely delivery:although most cross-border payments couldin theory be executed in one to two days, thesurvey revealed that a typical retail cross-

160

110 2

550

Share of total domestic and cross-border payments 20%

Domestic

Trade finance3Payments

20142 transactional revenues$ billion

22

2

xx Revenue margin, bps

From and to consumer

Business-to-business

240

120 255

30

285

75

50%

20141 payments flows$ trillion

Cross-border

20142 transactional revenues$ billion

20141 payments flows$ trillion

20

325

1 Excluding flows between banks.

2 Includes transaction fees, float income and FX fees; excludes revenues not directly linked to individual transactions, mostly maintenance fees, net interest income, and incident fees related to cards.

3 Includes fee revenue from documentary business but not revenues from trade-related financing.

Source: McKinsey Global Payments Map

Exhibit 1

Cross-border payments represent 20% of global payments flows but 50% of transactional revenues

border payment took three to five workingdays to complete.

More positively, the correspondent bankingnetwork still provides distinctive benefits tousers. It remains the only solution that isgenuinely ubiquitous. It can reach any coun-try or currency and can be used by anyonewith a bank account. It is also safe. Banksact as trusted providers of both bank ac-counts and the elaborate compliance-drivenregulatory framework that guarantees neces-sary security for the cross-border paymentsthat underpin the global economy.

The efficiency squeeze

Maintaining an open global network acrossmany different standards and under a strictregulatory framework incurs high costs forbanks, making cross-border transactionsconsiderably more expensive than domesticpayments. Even leading transaction bankscan no longer afford to maintain large inter-national correspondent bank networks, andhave been closing down less profitable loca-tions and reducing the extent of their net-works. During 2013 and 2014, one leadingU.S.-based global bank stated that it had cutties with 500 network banks, mostly in theMiddle East.

The complexity of cross-border transactionsbrings with it a relatively high failure rate. A

2015 study by Traxpay indicates that about60 percent of business-to-business (B2B)payments require some kind of manual in-tervention, each taking at least 15 to 20minutes. Major variations in account struc-tures, messaging and bank systems generatefar more corrections, investigations, returnsand stalled payments than are seen in do-mestic payments or in payments where oneparty controls the transaction from begin-ning to end. Over 90 percent of the resultingcosts are incurred in banks’ efforts to man-age counter-party bank relationships in theback office, rather than in the technologiesand networks that handle the value transfersbetween banks. As a result, the cost of han-dling international payments is counted indollars, not cents.

The nonbank offer

The high margins and low efficiency ofcross-border payments have long attractedthe attention of money-transfer operators(MTOs) such as MoneyGram and WesternUnion. In the past, these companies mostlytargeted unbanked or under-banked con-sumers and differentiated their offerings byspeed, convenience and predictability ratherthan price. They barely competed withbanks, as each institution targeted differentsegments: banked customers and businessesfor banks, and unbanked customers usingcash-to-cash payments for MTOs. TodayMTOs command some 40 percent of globalrevenues for cross-border consumer-to-consumer (C2C) payments, but less than 5percent in the business-to-consumer (B2C)and B2B segments.

But things are changing. PayPal was thefirst successful digital player to threatenbanks’ payments business. More recently,


Even leading transaction banks can nolonger afford to maintain large

international correspondent banknetworks, and have been closing down

less profitable locations.


digitally enabled attackers have intensifiedcompetition by altering the ways that pay-ments are made. Companies such as Trans-ferWise and Xoom have gained tractionwith banked as well as unbanked cus-tomers by offering superior consumer valuepropositions for C2C cross-border trans-fers, outperforming traditional correspon-dent banking offerings on key dimensionssuch as price, speed, convenience andtransparency (Exhibit 2). For instance,TransferWise provides full upfront trans-parency on fees, exchange rates and deliv-ery time at a very low cost. Seeing theopportunity, MTOs are rapidly boostingtheir digital capabilities. Some banks, in-cluding India’s ICICI, have also started of-fering customer experiences comparable tothose provided by digital attackers, and arebypassing the traditional correspondentbanking infrastructure.

This disruption is now moving up at an ac-celerated pace from C2C to business-drivencross-border payments, starting with smalland medium-sized enterprises (SMEs) (Ex-hibit 3). Companies such as Traxpay andTaulia provide business solutions for finan-cial supply chains that mimic the features ofconsumer digital offerings, including pay-ments functions. Western Union’s wu.comoffers an increasing array of business serv-ices. Companies such as Earthport delivercross-border mass payments such as payrollat lower costs using a direct link to local au-tomated clearing houses.

These solutions often include support for in-tegrated accounting software (as PayPal pro-vides with Intuit), supply-chain finance ordynamic discounting (like Taulia). For trade,some solutions redefine the customer needby introducing services such as conditionalpayments, as Traxpay does, or alternative fi-

4

4

4

5

5

5

4

5

5

4

5

4

3

2

3

3

3

4

3

3

5

1

5

5

Correspondentbanking

Price

Security and compliance

Openness and inclusivity

Convenience and ubiquity

Transparency and predictability

Speed

Customer experiencedimensions

New solutions

Bitcoin Western Union

Remittance banks (ICICI Bank Money2India, State Bank of India)

TransferWisePayPal

4

2

2

5

1

1

Customer-to-customer cross-border payments; customer experience ranked 1 to 5 (1 lowest, 5 highest)1

Better than the average for new solutions

Worse than the average for new solutions

1 McKinsey researchers acted as retail customers and transferred €100 or the local currency equivalent back and forth across a set of corridors (routes between the sending and receiving countries, such as UK to India) chosen to be representative of the market conditions encountered by customers across the globe.

Source: McKinsey Global Payments Practice

Exhibit 2

New solutions outperform correspondent banking on most dimensions of customer experience

nancing, like Alipay. All of these innovativeofferings weaken banks’ relationships withtheir customers.

Such moves by new players are triggeringchange in correspondent banking. As Ex-hibit 3 shows, B2B cross-border paymentsaccount for almost 80 percent of all cross-border payments revenues, and this segmentis expected to grow rapidly as the economicrole of SMEs expands and their supplychains fragment. For banks, maintainingtheir hefty share of this sector—more than95 percent—is a battle worth fighting, espe-cially since new rivals increasingly offer linksto other services such as alternative sourcesof financing or fully digital foreign-exchangeservices.

Overall, the new wave of innovation set inmotion by financial technology providers isproving unsettling for many banks, espe-

cially those with strong transaction bankingfranchises that have the most to lose.

Rethinking correspondent banking

Banks are aware they need to act. At Sibos2015 in Singapore, a session on the need toreinvent correspondent banking attractedthe second-largest attendance of the week.Cross-border payments must becomecheaper, more transparent and more effi-cient. Although change will mean forfeitingsome revenues in the short term, success willbring substantial rewards in the form ofstructurally lower costs, higher volumes asSMEs and commerce globalize, and oppor-tunities to cross-sell to satisfied customers.

But banks face a challenge. How can theyquickly change while continuing to meetcustomer expectations, remain compliantand maintain their global reach? Moreover,


15

C2B 20

C2C 40

B2C

255B2B

Revenues$ billion

Bank sharePercent

>95%

95%

60%

70%

CAGR,2014-19Percent

6

3

16

1

SAPTraxpayTauliaWestern Union Business Solutions

B2B Corporate

PayPalTransferWiseTraxpayWestern Union Business Solutions

PayPalTransferWiseWestern Union

B2B/B2C SME

C2CConsumer

Cross-border solutions

Source: McKinsey Global Payments Map

Exhibit 3

Disruption is shifting from consumer to SME and corporate, where banks derive most of their transaction revenues


this is not a time for going it alone: collabo-ration will be key to ensuring reach andadoption. There are three major initiativesthat banks need to pursue in parallel:

1. Redefine core processes andcustomer value proposition

Change is inevitable in cross-border pay-ments. Smart banks will work to future-proof their products by acceleratingoperational redesign and rethinking theircustomer value proposition.

Legacy architecture will need to be over-hauled to meet the coming real-time imper-ative. That means reconstructing corebanking platforms so that they can be up-dated in real time; ensuring that fraud plat-forms and processes can operate in very nearreal time; and making clearing systems ca-pable of handling real-time exchange of in-formation, posting of transactions tocustomers and funds availability. Opera-tional changes will also be needed to movetoward 24/7 availability.

Even with today’s internal and interbank op-erational constraints, banks have ample op-portunities to revisit their cross-borderpayments value propositions to bring them

more into line with those of attackers, espe-cially where pricing and transparency areconcerned.

Banks that start to prepare now will be able tocapitalize on the opportunities that emerginginterbank capabilities will create, includingshorter cycle times, increasing cross-sell op-portunities and lower operational costs. Get-ting ahead of the curve will enable them tobenefit from changing customer expectations,while taking advantage of the global foot-prints that give them a distinct advantageover new attackers.

2. Move to correspondent banking 2.0

Banks can already deliver payments in lessthan a day, and at cost levels comparable tothose of attackers. However, this appliesonly to clean straight-through-processing(STP) payments between banks that strictlyadhere to industry practices. Not all pay-ments follow this pattern, and the excep-tions dramatically increase the overall costto the system. Increasing the share of STPpayments or differentiating them from theexceptions would allow banks to bringcross-border payments to market at priceson a par with attackers’ offerings, whilesafeguarding margins. And this could hap-pen in a very short time frame.

To reduce inquiries and corrections andspeed up payments times, banks could es-tablish a clear set of enforceable obligationson how to initiate and collect payments, andset maximum limits on response times be-tween banks. This could be achieved withtoday’s technology, but would require strongcommitment among participating banks andan enforcement mechanism for any failureto comply with requirements—neither ofwhich is in place yet.

Banks that prepare now will capitalize on the

opportunities that emerging interbank capabilities will create,

including shorter cycle times,increasing cross-sell opportunities

and lower operational costs.

Another major improvement would be forbanks to inform payors in advance about thetotal cost of a transaction and its “crediting”time, as well as confirmation when the benefi-ciary is credited. The real-time tracking ofpayment status would be even better. No tech-nical wizardry would be required, but bankswould need to share information, handle con-firmations diligently and ensure they commu-nicate appropriately with customers. To makethis happen, banks could introduce a bindingindustry rulebook enforcing the sharing ofstandardized information across the paymentsjourney and defining who charges for thetransaction.

These modifications could usher in a newworld of cross-border payments wheretransactions are handled in a real-time flowand delivered on the same day anywhere inthe world with full upfront end-to-end pric-ing transparency and real-time tracking forthe customer. Such a value propositionwould match or even exceed those of emerg-ing providers hampered by local infrastruc-ture capabilities.

3. Investigate new infrastructure tech-nologies with a mid- to long-term view

In this age of digital innovation, banks arepaying a lot of attention to new networkingtechnologies that promise greater efficiency,especially distributed ledger solutions suchas blockchain. Such technologies bypass ex-isting infrastructure and connect banks di-rectly across the world, as well as providealternative sources of settlement, such as theconcepts developed by Ripple. (See “Towardan Internet of Value: An interview withChris Larsen, CEO of Ripple Labs,” McKin-sey on Payments, Volume 8, Number 21,May 2015.)

However, solutions based on these technolo-gies are still in their infancy. It will take timefor them to achieve universal reach in desti-nation and currencies, resolve compliancequestions, and equip themselves to handlethe high-value, high-volume payments re-quired for international trade. To be valid al-ternatives they would also need to enablefull connectivity across all countries, curren-cies and bank accounts worldwide—a mas-sive undertaking.

The immediate focus of these new solutionsshould be on reducing banks’ back-officecosts rather than improving infrastructure.Early blockchain initiatives are thereforelikely to focus on internal operations first.

Finally, solutions based on distributed ledgertechnologies still require banks to make cor-respondent-like agreements to define therights and obligations of participants inthese systems. Technology alone is not a suf-ficient condition for success. As a result, theinvestments that banks make in simplifyingand tightening their existing correspondentbanking relationships are likely to be usefuleven when new technology-based solutionsreach maturity.

* * *

Tomorrow’s cross-border payments will go be-yond utility models based on legacy systemsand old-school correspondent banking. Theywill adopt future-proof digital technologiesand industry standards that promote cross-country integration and greater transactionefficiency. Such moves can help banks rede-fine their international networks, reduce theneed for manual intervention in investiga-tions and reconciliation, and deliver customervalue throughout the transaction cycle.


These changes will mean much lower pricesfor cross-border payments and lower sharesfor banks, forcing them to review their com-mercial and operational set-up. However, abusiness with improving operational per-formance, more accessible global commercesolutions and better service to customers canaccelerate volume growth, be more prof-

itable, and make corporate and retail cus-tomers happier.

Olivier Denecker is director of knowledge for

payments and Florent Istace is a senior knowledge

expert, both in McKinsey’s Belgian Knowledge

Center; Pavan K. Masanam is a senior research

analyst in the Indian Knowledge Center; and

Marc Niederkorn is a senior partner in the

Luxembourg office.


Despite the maturation of new channels likee-commerce and m-commerce, several basicconsumer finance truths remain, and aremost readily observed in traditional settings:

• Consumer finance remains the entry pointto formal credit markets for many con-sumers.

• Retailers—both brick-and-mortar and on-line—still need credit offerings to estab-lish a competitive edge as a sales lever andprofitability booster.

However, as retail credit markets evolve theinterests of banks and retailers can becomemisaligned. A case in point: the widespreadavailability of credit cards for consumers in

many markets has removed friction from thesales process and simplified commerce for agrowing segment of the population. Yet thismodel often distances the design and opera-tion of credit products from the core retailbusinesses they are intended to serve. Retail-ers can lose the ability to manage credit offer-ings in coordination with store promotionsand operations. This leads to the rejection ofcustomers who would on balance be desirableto retailers (taking into account both creditrisk and commercial margin) despite fallingbelow banks’ approval thresholds.

Moreover, the need to integrate the onlineand offline components of the consumer de-cision journey makes execution far more

11Consumer finance: Bringing banks and retailers back into alignment

Consumer finance: Bringing banksand retailers back into alignment

Credit availability for shoppers is essential for retailers, as both a sales

enabler and a profit generator in its own right—in some markets financing

profits even surpass those from retail operations. Banks have likewise come

to rely on retail credit as a source of customer acquisition, a lever for

deepening relationships and a driver of incremental net interest margins.

Credit cards are of course the most common—though not the only—tool

enabling such lending, extending from closed-loop private label cards to

cobrand relationships to bank-branded general purpose cards. Models such

as installment plan lending and rent-to-own also fill key niches in

developing and mature markets.

Clecio Dias

Julio Giraut

Flavio Litterio

Emily Slota

Gustavo Tayar


complex. To maintain the effectiveness ofconsumer lending, and to reaffirm its initialobjective of helping retailers increase salesand engage consumers, new models areneeded. Such models should preserve thecredit mechanisms provided by financial in-stitutions, while tightening linkages to storeoperations. The path forward, however, willdiffer based on the stage of a given market interms of consumer finance market maturity.

The market stages of consumerfinance evolution

Consumer finance typically takes hold as agiven market’s financial and retail sectorsbegin to mature. As retailers and banks pursueemerging consumer credit opportunities, theirperspectives are at times aligned, paving theway for collaboration (e.g., private-label rela-tionships), and at others in conflict (e.g., fight-ing for the same set of customers). Thedevelopment of a consumer finance markettends to occur over four phases:

• Incipient phase: Limited availability ofconsumer finance, and little retail sectorformalization. A lack of effective creditmodels prevents banks from entering themarket in a meaningful way—there are noformal credit bureaus and limited datasources from which to draw. Conse-quently retailers leverage sales data to in-

form credit decisions. However, the sectoris typically insufficiently consolidated todeliver standardized offers. Credit risk ishigh, but exposure limited for partieswith access to data.

• Nascent phase: Retailers offer consumercredit programs. Consumer lending beginsto be viewed as a viable business ratherthan a mere lever for sales enablement. Asretailers assume more credit risk, they be-come increasingly vulnerable to macroshocks. Retailer and bank credit cards gainpenetration among affluent consumers,while middle class and underbanked con-sumers remain underserved.

• Maturing phase: Established consumerlending products are offered by retailers,with the primary goal of stimulating sales.Retailers remain responsible for issuance,decision making and collections. As databecomes more widely available, banksleverage their expertise to build and de-ploy risk models, allowing them to issuegeneral purpose credit cards to a broadermiddle-class segment. Partnerships be-tween retailers and banks emerge as a wayto serve the middle market.

• Mature phase: Banks meaningfully enterthe consumer lending arena, usuallythrough cobrand partnerships with retail-ers. The primary goal of consumer creditshifts to maximizing profit. Consumer fi-nance becomes a stand-alone business unit,with performance targets set independentlyfrom the retail business. With equal accessto credit scoring data and off-the-shelf deci-sion models, third-party disruptors enterthe market with new approaches, threaten-ing to disintermediate banks and redirectprofits from the value chain.

As retailers and banks pursueemerging consumer credit

opportunities, their perspectives are attimes aligned, paving the way for

collaboration, and at others in conflict.

There are variations to this pattern, ofcourse. When banks grow in sophisticationmore rapidly than retailers, outright salesof consumer credit portfolios can occur. Forretailers, such portfolio sales further widenthe gap between the credit function and thecore business, negatively impacting theconsumer finance value proposition on two

fronts. Retailers can no longer leverageconsumer lending to enhance the prof-itability of their core business. They alsolose the ability to use consumer lending toboost sales during hard times, as banks typ-ically hold the final say on credit decisionsand lack incentive to sacrifice financialprofitability to support the retail operation.


One region, two stories

Chile is a prime example of a market in which retailers evolved

faster than banks in consumer finance. Falabella, one of the coun-

try’s largest merchants, developed a financial operation that even-

tually acquired a bank charter. Falabella’s CMR card launched in

the 1980s to address of the lack of consumer financing options,

quickly becoming one of Chile’s leading credit cards by offering fi-

nancing options associated with loyalty programs.

In the early 1990s Falabella further explored opportunities in the fi-

nancial arena, creating a bank by the end of the decade. Through

the bank the retailer expanded its portfolio of products to include

mortgages and auto loans, but kept its focus on consumer lending

and continued to leverage Falabella’s retail outlets. Many bank

branches were within Falabella’s stores, later evolving into inde-

pendent branches.

Closely linking its financial and retail operations allowed Falabella

to offer customers a unique proposition—a card with a lower inter-

est rate than bank card alternatives, combined with a loyalty pro-

gram and other benefits. At the same time, Falabella’s retail opera-

tion was able to build customer loyalty and use financial information

for targeted promotions. CMR is currently Chile’s largest credit card

issuer, with 4.6 million cards as of 2014.

The potential downside of having an independent financial opera-

tion was minimized by the scale of Falabella’s business, given its

predominant market share in Chile’s retail sector. By chartering a

bank, it was also able to diversify its portfolio to some degree, miti-

gating its risk.

During the same era, Brazil’s consumer credit market took a differ-

ent path. Until 1994, extremely high inflation all but prevented

Brazilian banks from offering consumer credit. Consequently, most

retailers developed in-house consumer lending operations, building

sizeable portfolios. Once inflation was controlled, client acquisition

became a focus for consumer banks. Retailers were attracted into

bank partnerships by significant upfront signing bonuses and the

prospect of mitigating future credit losses.

As these partnerships progressed, however, retailers believed too

much emphasis was being placed on the financial side of the equa-

tion. Card approval rates plunged as the market matured, limiting

retail sales growth.

Under this model, the core product offering—primarily cobranded

open-loop credit cards—provided little incentive for customers to

stay loyal to a given retailer, opening up opportunities for purchases

at competitors’ stores.

The financial performance of these acquired portfolios eroded for

banks as well. Card-inactive and cancellation rates ballooned,

keeping portfolios immature for longer and significantly stretching

the payback periods for upfront acquisition costs. Both banks and

retailers grew unhappy, suggesting the need to explore new part-

nership models rebalancing bank and retailer interests. Banks have

pulled out of most small and medium retailer partnerships; mean-

while, retailers with sufficient scale have been looking to redesign

their bank partnerships or, failing that, to restart their internal finan-

cial operations. With a stronger foundation established upfront,

such turmoil could have been averted.


Conversely, when retailers evolve more rap-idly than banks, they can be emboldened toenter retail banking directly. While retail-ers may find this scenario appealing inconcept, they must overcome some signifi-cant challenges to make it work. First, re-tailers often lack the operational scale andcapabilities to match banks’ efficiency in fi-nancial functions such as credit, collectionsand processing, not to mention regulatoryand compliance issues. Retailers also haveaccess to fewer sources of capital, and thusface challenges in funding financial opera-tions at competitive cost structures.

Retailers face another challenge in riskmanagement, managing credit portfoliosfar less diversified than those of banks.This leaves retailers more vulnerable toeconomic downturns—as demonstrated inthe early 2000s when many of Brazil’s re-tailers were forced to sell their consumercredit portfolios to banks, or after the 2008financial crisis when several U.S. retail is-suers (including Target and Kohl’s) soldtheir portfolios following bouts withcharge-offs.

The makings of a new model

There are compelling reasons to maintaintight integration of consumer finance with

retail operations, creating benefits for allparties—banks, retailers and consumers.

When deciding to extend credit to a con-sumer from a purely financial perspective—the norm when retail and financial servicesbusinesses grow apart—both banks and re-tailers miss out on the incremental marginfrom goods that otherwise go unsold. Thisfactor alone, if incorporated into decisioning,can justify increased approval rates for retail-ers with a large sub-prime consumer base.

Partnerships between retailers and bankshave ample win-win potential. Banks pos-sess the scale and portfolio diversity to bet-ter absorb credit losses, de-risking retailers’operations. Additionally, the opportunity forretailers to cross-sell and up-sell clientsdeemed low priority for standard credit andbanking products is too lucrative to dismisswithout further analysis. The key is identify-ing actionable measures that prioritize long-term customer value across both sectors,rather than merely the projected value of thefinancial relationship.

Since retailers and banks will naturally havedifferent business objectives (much of thegap can be attributed to regulatory man-dates on banks to standardize creditprocesses, for instance), a flexible ownershipstructure of consumer finance operations isrequired for an integrated approach to takehold. Partnerships continue to make sense,perhaps complemented by more independ-ent retailer-owned operations.

A holistic decisioning approach requires acredit product portfolio extending beyondcobranded cards into installment plans andopen-loop cards. Retailers (or banks) maynot be comfortable with the risk of extend-ing monthly renewable credit lines for some

Since retailers and banks will naturally have different business

objectives, a flexible ownershipstructure of consumer finance

operations is required for an integratedapproach to take hold.

customers, but may be willing to finance asingle purchase, or to require a couple ofpayments before delivering a valuable good.These alternative financing methods, whenproperly combined and implemented, candramatically increase approval rates amongsub-prime clients (Exhibit 1).

Commercial prices and interest rates can bejointly set for financed goods, displayed as amonthly installment amount rather than thefull price for consumers financing their pur-chases. In this fashion, commercial pricescan be adjusted for consumers who do notneed financing, enhancing retailers’ compet-itiveness across segments.

New advanced analytics solutions and digi-tal interfaces and processes are capable ofsupporting an integrated view of consumerfinance, not only from a credit decisioning

perspective, but also in terms of customerengagement, infrastructure and the retailer-bank relationship (Exhibit 2, page 16). Cus-tomer relationship management and loyaltyprograms can be designed in an integratedfashion, rewarding both brand loyalty anddesired client payments behavior.

The way forward

In incipient markets, where banks and re-tailers are relatively underdeveloped, thegoal of building a market is shared andstraightforward. Retailers and banksbegin to craft partnerships with clear rulesof engagement, documenting future rolesand objectives as the market evolves.These partnerships should be basic, withsimple products and straightforward oper-ations. Three factors characterize an effec-tive partnership:


15-20% 60-70% 100%

General purpose cards (GPC)

Commercial margin fully captured

Alternativeplans, such as installments, prepayment

Currentretailers’ perspective

Currentbanks’ focus

15-20%

30-40%

50-60%

60-70%

GPC + Private label (PL)

GPC + PL + Consumer direct credit

Credit product offer and approval rates

MarginsPercent

Approval rate Percent

Financial revenues – losses

Financial revenues + commercial margin – losses

Source: McKinsey analysis

Exhibit 1

An integrated margin perspective allows for higher approval rates


• Clear responsibilities for both parties

• Clear and aligned ambitions in terms ofretail support, integration and financialresults. Partners should define thebreadth of financial products, design andagree to high-level financial and commer-cial models, and build a business case

• Simple commercial processes/tools andcredit, collection and pricing models

In nascent markets, partnerships shouldstrive to optimize their operations, focusingon developing key capabilities. Retailersneed to develop distinct products for differ-ent consumer segments and customers withdiverse credit profiles. The ability to provide

targeted offers (value-added features, pric-ing, payment conditions) becomes a key dif-ferentiating factor as competition grows. Asretail operations move online, consumerlending capabilities must evolve to ensure aconsistent customer experience.

To strengthen credit, collections and cross-sell models, retailers must develop robustdata architecture, a structured process fordata-gathering and cleanup, clear use cases,and either the right in-house analytical tal-ent or the right partnerships.

In mature markets, the challenge shifts tothe banks. With increasing credit penetra-tion and heightened competition, banks

Advanced analytics

Digital (all interfacesand processes)

Infrastructure

Route to creditCombination of

hybrid and private- label cards, as well as consumer direct

credit

Customer relationship management

Ownership structure

Pricing

Credit/collection

Customer journey

Source: McKinsey & Company

Exhibit 2

Advanced analytics and digital interfaces can support an integrated view of consumer finance

must innovate to maintain gains and com-petitive advantage. They should explore op-portunities to enhance consumer loyalty andleverage dynamic pricing at the point of sale(POS). A review of differentiation strategiesfor prime versus sub-prime clients is worthexploring. It will be essential for banks topursue new avenues of growth, such as offer-ing consumer finance solutions to smallerretailers to increase market reach. Inte-grated POS solutions will make infrastruc-ture available to do so, and merchantacquirers can become a promising channelfor distribution.

* * *

Through its evolution consumer finance hasdiverged from its original purpose, with the

retail and the financial components growingapart. The time is ripe for a new model—en-abled by innovative technologies—that bet-ter integrates the financial elements ofconsumer lending (e.g., credit and collec-tions) and core retail activities such as storeoperations and loyalty, while also integratingonline and offline commerce. This new ap-proach will encourage ongoing partnershipsbetween retailers and banks, and result inbetter offers for consumers.

Clecio Dias is a senior expert, Flavio Litterio

is a partner and Gustavo Tayar is an associate

partner, all in the Sao Paulo office. Julio Giraut

is an associate partner in the Bogota office,

and Emily Slota is an associate partner in the

Lagos office.



No matter how broadly or narrowly pay-ments firms decide to compete in the dig-ital ecosystem, personalized marketingwill be critical for strengthening cus-tomer relationships, and to get it rightbanks and other payments organizationsmust organize their technology,processes and people around the three“d”s of data aggregation, decisioning anddistribution.

Digital is where the growth is

Most banks now recognize that digitalwill be the central channel for engagingindividual customers. Already, 80 per-cent of purchases are digitally researchedin some way. By 2020, one in every five

dollars of consumer spending will betransacted digitally—online or by mobilephone. As the technology continues toevolve and consumers increasingly preferdigital tools, payments will be seamlesslyintegrated within a highly personalizedshopping experience, where, for example,a single click takes care of initiation, au-thentication and authorization (Exhibit1). The strength, durability and prof-itability of customer relationships willdepend not only on how well variouschannels—branch, ATM, online and mo-bile—are integrated, but also on thebank’s ability to engage individual cus-tomers with highly personalized and rele-vant interactions.

Digital marketing transformation:Payments at a crossroadsTechnology has been slow to deliver on the promise of one-to-one

marketing, in part because innovations have been a challenge to digest.

However, powerful analytical tools and the near ubiquity of smartphones

and tablets in developed economies are enabling organizations of all sizes

to create highly personalized digital shopping environments and address

individual customer needs and preferences at scale. The new competitive

threats and opportunities accompanying these advances have led payment

incumbents to a crossroads: They must now decide whether to remain

focused strictly on payments (and banking) or more broadly on retail

marketing.

Jason Heller

19Digital marketing transformation: Payments at a crossroads

Keep it simple or go on theoffensive?

Advocates of the narrow focus on “pay-ments” will say, “keep it simple, stick to thebasics of lending, deposits and transactions.”Banks, after all, still own the payment, andperformance is strong. Despite 20 years ofrapid change brought by technological inno-vations, regulatory challenges and marketupheaval, the old operating model stillserves. And today mobile payments arebarely 2 percent of total consumer spending.The payments business is strong, represent-ing a growing share of total banking rev-enues, and ROI is good.

However, ROI is not the only metric, and asmooth-running back-office may find itselfliving a Kodak moment. Digital disrupters,including Alipay, Amazon, Apple and Ten-cent, are threatening traditional banking

relationships by building payments habitsamong consumers and providing low-costmarketing, payments and even financingcapabilities to merchant organizations of allsizes. Small challengers, from Stripe toStarbucks, are also gradually capturing rev-enue and are increasing market share at theexpense of long-established payments serv-ices providers.

Owning the payment is key in thedigital ecosystemThese challengers aim to control the entireuser experience, including the interface be-tween consumers, merchants and the clearingand settlement networks. Data-driven mar-keting organizations understand that withthe right analytical tools the payment is thekey to recognizing which search behaviors re-sult in a purchase decision. This strategicallyvital insight positions them to win customers

By 2020...

of U.S. consumer spending will occur through digital channels20%+

of digital spend will occur through a wallet$850billion+

will be transferred between consumers as P2P payments$400billion

will be disbursed by businesses to consumers$1.7trillion

shoppers will use digital channels to make some purchases220million+

Source: McKinsey Global Payments Practice

Exhibit 1

The U.S. digital payments environment will undergo rapid transformation between now and 2020


with compelling offers, discounts and loyaltybenefits. The ability to craft winning offers atscale also enables them to collect marketingfees from merchants.

To protect their relationships with both con-sumers and merchants, banks and other in-cumbents must adopt personalizedmarketing. In the digital world, buildinghighly relevant and emotively appealing ex-periences is essential to keeping customerrelationships dynamic and profitable. Per-sonalization supports this goal of dynamic

engagement on three levels: functional (ad-dressing specific information and transac-tion needs), emotive (appealing to thecustomer’s personality) and social (support-ing interactions with peers and merchantsas well as with the payments serviceprovider). In addition, the measurable bene-fits of the personalized approach are signifi-cant: increased customer loyalty, lower costsfor new customer acquisition and revenueincreases of up to 20 percent.

To illustrate how the narrow payments of-fering would take shape in a digital bank-ing app, functionality would be limited toprimary deposit and credit card accountsand payments services, including person-

to-person, bill payment, online, in-app andin-store payments. A program of mediumscope would extend to other areas of finan-cial services, including mortgages, insur-ance and investments. Again, the first taskis to define the scope of the digital pay-ments offering (or payments “wallet”). Towhat extent should it be incorporatedwithin a banking app or, alternatively,stand alone as a separate app (e.g., a robustdigital wallet)? As an indication of the im-portance of digital payment capabilities,digital wallets are expected to account forsignificantly higher digital transactionvalue than card-on-file and key-enteredpayments by 2020 (Exhibit 2).

While one-to-one marketing in the narrowand medium programs would enable a bankto anticipate individual customer needswithin a familiar range of financial services(e.g., for credit, investments, mortgages, in-surance), the bank will in all likelihood finditself continually on the defensive, as data-driven challengers constantly attack thepayments offering, seeking to win cus-tomers with stronger, more relevant offersand benefits.

To counter, banks and non-bank incumbentsshould reach beyond the payment and com-pete for a growing share of total marketingrevenue. This means expanding the valueproposition to include both payments andmarketing along the full breadth of thesearch-shop-buy-evaluate continuum. Anumber of banks are repositioning theirpayments offering within the broader retailshopping experience, for instance, by serv-ing as a personalized marketing channel forsellers and a shopping assistant for con-sumers. The revenue gain from this aggres-

Banks should reach beyond thepayment and compete for share of

total marketing revenue. This meansexpanding the value proposition to

include both payments and marketingalong the full shopping continuum.


sive strategy can potentially far exceed the20 percent increase that some companieshave achieved with one-to-one marketing.

Whether an organization’s payments strat-egy is primarily defensive or aggressive, tocompete in the digital ecosystem requiresoptimizing data assets within the “3-D”framework: data aggregation, decisioningand distribution.

Optimize data assets within the 3-Dframework

Banks and non-bank payments organiza-tions have highly valuable data, and theirdata stores are growing exponentially duenot only to more frequent interactionsthrough digital channels, but also to the

steady growth in electronic payments vol-ume. The amount of data appended to thepayments transaction is also growing. Withtheir vast stores of historical data, banks inparticular have unmatched potential to un-derstand how different types of customersspend: where they shop, how much theyspend, how often and how they fund theirpurchases.

However, their ability to take advantage ofpersonalized marketing in a cost-efficientway is hampered by gaps in each area of the3-D framework.

Data aggregation: In the area of data ag-gregation, traditional payments organiza-tions must find ways to gain a real-time view

U.S. consumer digital commerce volume, 2020 forecast$ billion

Total digitalcommerce volume

$1,200- $1,300

In store - proximity In-app and in-app/in store

$450 $25

Browser-basede-commerce

$750

Digital wallets

Card-on-file/Key entered

$425

$250

$500

$100

Source: eMarketer; Forrester; McKinsey analysis

Exhibit 2

By 2020, the primary digital spend battleground will be in-app and e-commerce


of the customer journey from one transac-tion to the next. They can partially fill thisgap by incorporating data from external,third-party sources into their analysis (e.g.,appended data from partnerships and mar-keting technology and data vendors, includ-ing aggregators, social media, searchengines). In addition, banks should increasethe frequency of digital interactions withtheir customers. Digital wallets, as distinctfrom banking apps focused mainly on cur-rent accounts and monthly bill payments,are one way to establish daily interactionswith customers.

Analysis and decisioning: Data analyticsis another area where banks have clearstrengths, for example in credit card fraudscreening, monitoring account activity andknow-your-customer review. But banks areonly scratching the surface and must gobeyond conventional approaches to marketsegmentation (e.g., based on needs andpreferences) in order to recognize patternsthat precede a transaction and identifytriggers that are likely to accelerate a pur-chase. This means using the diverse datapoints (starting with age, income and loca-

tion, but also including spending history,current search history) generated at eachcustomer interaction (search and compari-son, social media, as well as direct interac-tions through the bank’s digital channels)and then crafting the right message to bedelivered at the right time through theright channel.

Distribution: The third area of the frame-work is distribution. The ability to delivermessages (and collect customer feedback)through any channel—tablet, ATM andconnected appliances—is crucial. In addi-tion to familiar channels such as email,text message, Web browser or call centerconversation, customers can be engagedthrough connected TV and even the refrig-erator. Wallets and other digital bankingapps are two-way channels, serving as aconduit for pushing messages and collect-ing data. The acceleration of messages intothe pipeline and the continuous feedbackfrom the customer in the form of searchhistories, response rates for messages andoffers, and purchase behavior results in adigital engagement that is increasingly re-sponsive to individual customer needs.This dynamic interaction gives the cus-tomer measurable advantages: faster,smarter purchase decisions; highly com-petitive pricing (e.g., discounts, loyalty re-wards); as well as security andconvenience.

Complexity and agility

The three “d” framework is deceptivelysimple in concept, but entails complex anddifficult changes in technology, processesand human skills and culture.

Starting within the retail bank, the priorityshould be to establish a holistic view of

The acceleration of messages into thepipeline and the continuous feedback

from the customer in the form of searchhistories, response rates for messages

and offers, and purchase behaviorresults in a digital engagement that isincreasingly responsive to individual

customer needs.

customer interactions across current ac-counts, loans and credit cards. The fastestdata exchange and greatest cost efficiencyare achieved by integrating retail bankingplatforms, from back-office production,middle-office functions such as service andcompliance, and front-office sales and mar-keting. Ultimately, the digitization effortshould span the entire enterprise, includ-ing mortgage lending, investments and in-surance, which pays off not only inimproved cost efficiency but in thestrongest possible understanding of cus-tomer needs and behaviors.

Integration with third-party platforms is an-other important consideration, particularlywhere partnerships are necessary to fill gapsin data stores, performance measurementcapabilities or distribution channels.

With 1,900 companies in 2015 and nearly4,000 today, the vast field of potential mar-keting technology partners can make the re-view and selection of the right provider adaunting project. Some providers specializein familiar but fast-evolving functions suchas CRM, marketing automation and leadmanagement; others deliver more recent in-novations, such as mobile marketing, socialmedia marketing, video marketing, loyaltyand gamification.

In some cases, an institution may choose toserve as a third-party aggregator for other fi-nancial institutions and retailers. Increasedreliance on third parties requires carefulplanning to build automated data exchangewith the proper filters and segregation to en-sure the security of data stores and the pri-vacy of customer information.

The new technology architecture bringschanges in skills and culture as well, as au-tomation frees developers, marketers andsales and service representatives to focus onresolving more complex issues. Digitizationalso allows for an agile approach to productinnovation. For example, a digital walletprototype could be designed to appeal to keypersonae such as “mobile moms,” “mobileexecs” or “tech-savvy Gen Xers.” Live testingin the niche markets allows for the gradualaddition of new functionality as the proto-type passes predefined benchmarks for oper-ational reliability. In the case of a digitalwallet prototype, added features might in-clude hybrid funding options combiningcurrent and credit card accounts, loyaltypoints and coupons—all based on informa-tion from various loyalty programs and fi-nancial services providers stored in thewallet—in order to lower the cost of the pur-chase. Once the prototype reaches scale inthe niche market, the app can be rolled outto larger segments, again with the incremen-tal addition of features designed for differenttypes of users.

* * *

Going forward, digital channels will serve asthe heart and circulation system of customerrelationships, and personalized marketing atscale will be the baseline requirement forkeeping these relationships dynamic and


With 1,900 companies in 2015 and nearly 4,000 today,

the vast field of potential marketingtechnology partners can make the

review and selection of the rightprovider a daunting project.


profitable. In order to maximize the prof-itability of the organization’s marketing andrelationship management activities, banksand other payments service organizationsmust optimize their vast data assets arounddata aggregation, decisioning and distribu-tion. Success depends both on extending au-tomation and digitization to the furthestlinks of the value chain and on developing

human skills and an organizational culturefocused on creativity, innovation and contin-uous improvement. Finally, this digitaltransformation will push bank and non-bank payments incumbents to a crossroadswhere they must define the scope of their of-fering to consumers and merchants.

Jason Heller is a senior expert in the New York office.

At the forefront ofpayments innovation:An interview withSoner Canko, CEO of Turkey’s BKM

Soner Canko is the Chief Executive Officer of Turkey’s In-terbank Card Center, or BKM. BKM was launched in1990 by a group of 13 Turkish banks as a service providerfor clearing and settlement. The organization’s role hasevolved since then, and its primary mission today is tosupport the future of cashless payments in the coun-try, and to add value through seamless and se-cure payments solutions.

McKinsey on Payments spoke withCanko on a range of topics relatedto the Turkish cards market andthe many ways that BKM is help-ing to foster innovation.


McKinsey on Payments: To start, can you talk a bit about whatmakes Turkey’s payments ecosystem unique, and the particularchallenges in the market?

Soner Canko: Sure. Turkey is a heavy cash country, having one ofthe largest shadow economies in Europe. Fifteen years ago, only 9percent of total household consumption was conducted via cards.Today this ratio has almost reached 40 percent, with a dramatic risein recent years. However, cashpayments still make up a greatportion of the economy, with atotal cost of more than 4 billion TL(~US$1.3 billion) per year. Thiscost includes printing and distri-bution costs to the government,distribution and managementcosts for institutions, fraud costs,as well as financial costs. Heavyuse of cash feeds the shadoweconomy, which paves the way forfiscal evasion and reduced taxrevenues. So card payments arenot only practical, but they are away of fighting against theshadow economy. We’re develop-ing a loyal cardholder base thatuses cards habitually and forcesmerchants to accept cards.

MoP: Over the last 10 to 15years, Turkey has become one ofthe top three credit card markets in Europe in terms of total creditcards, debit cards and point-of-service machines. What has beendriving this growth?

SC: I would call it the three “I”s: investment, innovation, inclusion. Tobegin, Turkey’s banking industry began investing heavily in cardsduring the years of hyperinflation, as they were the only retail creditinstrument. During the 1990s, inflation rates fluctuated between 70and 100 percent, and this continued until 2003. This led to immenseinterest rates, especially for long-term retail loans. So retail loanssuch as mortgages could not grow in that period. However, credit

cards are short term and free credit instruments. Banks also offeredfree installments up to 24 months to cardholders. Considering yearly100 percent interest rates, the two-year free funding was a great op-portunity for consumers and a significant driver of growth in cards.

Next, because it has a very young population open to new products,Turkey is a center of innovation for payments. Retail consumptionforms almost 70 percent of Turkey’s GDP, which is growing thanks to

rising consumption.

MoP: What are some of theinnovations that stand out?

SC: Turkey was the first countryto offer totally free installmentoptions for credit cards, the firstEuropean country to offer acontactless card, and to acceptcontactless cards for highwaytolls. Turkey was one of the firstto finalize EMV migration, and,finally, we have the only digitalwallet that covers the wholebanking industry. Every large re-tail bank is a member of BKMExpress. We also have very so-phisticated loyalty practices.

MoP: Can you elaborate a bitmore on innovation in loyalty?

SC: Loyalty programs are a keyfactor behind the dramatic

growth in the business. Banks started to offer free points to theircustomers in the 1990s. The more you spend, the more you get. Per-centage of free points also increases according to the type of card.For example, if you have a gold card, you earn more than a classicone. If you have a platinum card, you earn even more. There are lotsof partnership programs as well. Airlines are the most widely used.You earn miles for your payments and redeem them in order to buytickets from that airline. There are also partnership programs withrailways, bus companies and gas stations.

MoP: What about the third “I,” inclusion?

“Because it has avery youngpopulation, Turkeyis a center ofinnovation forpayments.”

27An interview with Soner Canko, CEO of Turkey’s BKM

SC: Yes. Another reason for Turkey’s rapid growth in card penetrationis that unbanked customers, including students, mostly are intro-duced to banking via cards. As I mentioned, there is still a consider-able part of the population that does not take part in bankingbusiness. This is mostly due to their income level, which makes it im-possible for many people to meet the minimum deposit level forbanks. It is also risky to give loans or offer credit cards to these un-banked consumers. So pre-paid cards become the bridge to inclu-sion. They are often offered as scholarship payments to students,and are also distributed for poverty payments.

MoP: Let’s talk about BKM and its role in the evolution of Turkishpayments market. How did BKM’s role change over time?

SC: Certainly. BKM was founded as a service provider for clearingand settlement in 1990, as a subsidiary of banks operating in thepayments business. Over the years, other services essential for thecards business were added as core functions, such as a nationalswitch system and a 3D secure system.

MoP: Can you briefly explain the 3D secure system for those of ourreaders not familiar with it?

SC: 3D secure means three-dimensional authentication. First is thecard number, second is the 3-digit cvv2/cvc2 code at the back ofyour card, and the last is a one-time password sent to your mobilephone via SMS. This password fully secures the transaction. Even ifyour card is lost or stolen, it cannot be used in an online transaction.

MoP: So how did BKM develop after this point?

SC: In 2010s, BKM changed shell and the company evolved from aservices provider into a market leader. In the first 20 years our visionwas “to be a system-level services provider, aiming at improving thecard payment system infrastructure for the benefit of all memberbanks at minimum possible cost.” Then, five years ago, we embarkedon a restructuring project with the help of McKinsey, and the missionevolved to “powering the future of cashless payments,” meaning thatBKM will develop projects to expand card acceptance and increasecard usage in payments. This was a significant change and it wasnot easy to adapt to such a transformation.

The number of employees tripled in a few years’ time during thistransformation, and this is also when I joined BKM. As we aim toreach our goal of cashless payments in Turkey, and as we develop

new products and functions, we are entering new areas and requireadditional resources. Finding the right talent is always a challenge.We are always looking for people who work with passion and are re-silient. Entrepreneurship and accountability are integral parts ofthese skills as well.

As we progressed we made a number of innovations, some of which

I mentioned earlier. We launched the world’s first national digital wal-

let. Public transport payments started to be made with contactless

cards. We developed several e-government projects and continue to

develop ways to make Turkey a more cashless society.

MoP: Which of these projects was most fulfilling or challenging?

SC: We built a payments gateway for Turkey’s Social Security Institu-

tion enabling collection on their website with banking cards. It is one

of our most fulfilling projects with government institutions. Cardhold-

ers can make payments with their cards, banks can apply surcharges

and government institutions can increase their collections with the

convenience of card payments. Working with government institutions

can be challenging because the terms of the projects are subject to

special legislations. This affects everything from contracting to pric-

ing, and government projects are always more costly in terms of

time, money, infrastructure and operational costs.

BKM builds single integration and infrastructure for government in-

stitutions and banks for card transactions. These projects, such as

contactless banking card acceptance in transportation or online or

offline public collections, connect all banks that are qualified and

willing to participate. And public satisfaction increases as conven-

ience increases.

We’re also proud of the Konya transportation project, which enables

all contactless card transactions in public transport for both domestic

and international cards. Turkish citizens and tourists alike can use

their existing contactless cards for transportation without the hassle

of acquiring city cards and printing transport tickets. Enabling card

payments in transportation also increases cardholders’ daily usage

and frequency.

MoP: And there is BKM Express.

SC: Yes, BKM Express is currently the market leader among the

digital wallets in Turkey, with more than one million members.

There are more than 1,000 merchants, which covers half of the e-


commerce ecosystem. Eighteen banks are members, which means

that 99 percent of cards in Turkey can be used for payments via

BKM Express.

MoP: Why do you think this has been so successful?

SC: There are a number of unique features. For example, interms of security, users never need to enter their whole creditcard number for any transaction, even while registering. Andevery BKM Express transactionis fully secured with OTP au-thentication. Users also gainloyalty points that they can laterredeem for purchases madewith BKM Express. They cansend money from any bank ac-count or credit card to any otherbank account or card at anytime, day or night.

We knew that two of the mostimportant problems for e-com-merce customers are securityand convenience. They buy on-line because they want to buyquickly and at the same timethey don’t want their card datastolen. BKM Express providescustomers with a seamless andsecure payment solution.

BKM Express was built by Turk-ish banks together with theprominent e-commerce brands. We knew that with this level ofcooperation in the ecosystem the venture would be successful.We worked with e-commerce software developers, payment facil-itators, mobile application developers, e-commerce productsearch platforms and e-commerce firms. We explained our goalsto the regulatory agencies and got their support. And thus, everyfeature of our product (which has evolved over time) has beenquickly acknowledged by the industry. BKM Express’ first featurewas e-commerce payment. Then we introduced money transfer,mobile and in-store payments.

MoP: How is BKM different from national payments institutions inother countries?

SC: BKM’s is at the center of all card payment transactions in Turkey.BKM is unique not only in being the national clearing and settlementagency for all domestic transactions but also for being an incubationcenter on behalf of the cards market. We also facilitate governanceof the Turkish payment market through policy-making and rule-set-

ting.

MoP: Can you describe theNational Payments System thatBKM is currently working on?

SC: TROY provides a range ofproducts and services devel-oped specifically for the benefitof the Turkish market. The ideawas to shorten “go to market”time for innovative productsand to enlarge freedom of ca-pabilities. The main drivers ofthe card scheme were thebiggest issuers/acquirers. BKMwas the natural place to assessand incubate this idea.

Our aim is to provide all thelatest technologies in the TROYscheme. Fast, secure, EMV,mobile, online and physicalpayments will be supported.

Building a card scheme re-quires managing a huge ecosystem. You have issuers/acquirers,card manufacturing and personalization companies, POS and ECRcompanies, software development companies and regulators. Everyissuer/acquirer and all regulators are supporting TROY.

We have now completed all technical, functional, governance andregulatory requirements, and have been in the market since April2016.

MoP: How do you see the role of national payments systemsdeveloping, particularly in emerging markets?

“Especially inemerging markets,national paymentsschemes are themost effectivestructure forincreasing financialinclusion amongunbankedpopulations.”

29An interview with Soner Canko, CEO of Turkey’s BKM

SC: The need for alternative solutions, which will also address localrequirements, is growing in emerging markets, and given their

reach and size, global schemes do not necessarily respond to local

needs in a timely way. National payment schemes can better ad-

dress local requirements, and deliver products suited to local mar-

kets faster and integrate with other players in the ecosystem easily.

So I think that, especially in emerging markets, national payment

schemes are the most effective structure for increasing financial

inclusion among unbanked populations.

MoP: Can you describe BKM’s relationship with your shareholder

banks? Do they ever see your activities as competition?

SC: BKM is in a way a collaboration center for banks. Banks both

compete and cooperate within the “borders” of BKM. We use the

term “coopetition” to describe the current structure. Our members

compete for market share gains and to give better service for cus-

tomers. On the other hand, they cooperate to define market stan-

dards, to diminish fraud and to expand card usage.

BKM itself is neither a player in the market nor a competitor for

banks and their products. Even in our marketing campaigns we high-

light the payment systems, digital commerce or card usage instead

of our products because success for us means attaining a cashless

society, not increasing usage of BKM products or services.

MoP: How do you see the future of payments, particularly in

emerging markets?

SC: Cards continue to be a form factor in brick-and-mortar com-merce because of their convenience and security. However, e-com-merce and recently m-commerce are growing, and at a higherpace. I expect we will be seeing more smartphone usage in thenear future. At some stage, smartphones will be used in stores in-

stead of cards. NFC projects and HCE developments will makesmartphones a contactless payment device.

MoP: Do you believe that non-bank players entering the paymentsmarket provide strong competition against banks?

SC: The banking industry has a very strong image in Turkey. Ourbanks provide sophisticated products and services that are viewedas best practices abroad. Particularly in online and mobile banking,Turkey is ahead of many other markets. From this perspective Ithink that banks are likely to keep their position.

However, customers always benefit from competition, and Turkey’sunbanked and underbanked populations provide a significant op-portunity for non-bank players. If these players can bring success-ful new business models to market it could change the dynamics ofthe industry. In this case, banks will need to reassess the valuethey create for their customers and develop new offerings accord-ingly.

MoP: What are BKM’s plans for the future?

SC: Well, every project we have is an ongoing one. So every projectI mentioned will continue to expand. BKM Express will cover thewhole ecosystem and become the payment method not only in digi-tal commerce, such as in-app purchases, but also in store pay-ments via QR code scans, biometric payments, and so on.

We expect that TROY will be the market leader in domestic trans-actions, and that micro payments will be done with contactlesscards and devices.

We will continue to pursue our mission to increase card accept-ance and usage. We believe every mobile phone will be smart andhave the capability to both make and accept payments and we planfor BKM to pave the way.


Opportunities and challenges

APIs are essentially software programs thatfunction as contracts between other softwareapplications, enabling and controlling theways in which those applications can interact(Exhibit 1). Because they are typically de-signed to interact with various types of com-puter systems, databases and Internetcommunications services, they can signifi-cantly ease the task of creating the kind ofbusiness and consumer-oriented apps thatcustomers increasingly demand. GoogleMaps, for example, is a free API that makes iteasy for software developers to incorporateGoogle’s sophisticated mapping capabilitiesinto a diverse range of websites and smart-phone apps. In 2013, the company reported

that more than a million active sites wereusing its Maps API.

APIs have now established a foothold in fi-nancial services. Consumers can use appslike Digit for their savings, Wealthfront forinvesting and Venmo for payments. Each ofthese apps uses APIs that enable the execu-tion of certain types of financial transac-tions without compromising the systemsintegrity of the associated institutions. De-spite the recent inroads of APIs, however,most banks remain hesitant to engage withthird parties that require direct links withthe bank’s customers. To transfer funds orapply for credit cards, for example, cus-tomers often must still visit their bank’sbranch office or website.

Payments and the rise of API-driven banking

An application programming interface (API) is a set of standards designed to

enable computers to communicate across large networks, such as the

Internet. APIs have been major contributors to the success of such companies

as Amazon, Google, Netflix and Twitter. And now, led by the global trend

toward digitization in banking and payments, they are establishing their

presence in financial services. For the banking and payments industry, 2015

was clearly a year of API experimentation, and McKinsey believes that 2016

will be a critical time for banks and payments organizations as they devise

and solidify their individual API strategies.

Vishal Dalal

Grace Hou

Kausik Rajgopal

31Payments and the rise of API-driven banking

Businesses and consumers alike, however,have grown accustomed to the convenienceand immediacy that apps are bringing tomany aspects of their daily lives, from man-aging inventory and security systems to buy-ing concert tickets and making restaurantreservations. And software developers aretaking notice. Yodlee, Xignite and othercompanies now offer financial servicesproviders one-stop-shopping for APIs andother industry-related solutions. Notably,their targets include potential market en-trants as well as established incumbents.

Payments APIs, in particular, are expected tobecome significant enablers of e-commercegrowth. Before their emergence, the only al-ternative for merchants wanting to acceptonline payments was costly integration witha payments gateway, or redirecting cus-tomers to an online payments provider—a

less inconvenient option. With the advent ofpayment APIs, e-commerce merchants canuse industry operating standards to linkwith PayPal and other payments providers,thereby offering multiple payments optionsright on their own websites, without the costof developing systems integration coding.

The emerging developer channel

One advantage of APIs is their ability to fos-ter a unique ecosystem. This means organi-zations that have their own banking orpayments software platforms can provideAPIs that various types of third parties canuse to develop new and innovative applica-tions. Prospective user groups include inter-nal IT and technology-savvy business users,and, increasingly, external developers. Ex-ternal developers are becoming especiallyadept at using core APIs offered by banksand payments organizations. They use them

APIs are used by internal developers within an enterpriseMay include external contract developers but the targeted projects still remain inside

3. Internal

APIs are used by business partners, including suppliers, providers, resellers and othersTighter partner integration for extended market reach

2. Partner/Business-to-Business

APIs are used by external partners and developers to build innovative apps

APIs are programmatic interfaces that expose corporate data assets such as products, prices and availability. Internal or external developers can use the APIs to create websites and apps.For example: If an insurance company exposes an API to get quotes, a developer could write a quote comparison app using that API in combination with APIs from other insurers.

Extended digital value chainReduced partner costEnhanced customer experience

Cost reductionOperational efficiencyInternal cost management

Innovation by inspiring the developer communityMonetizationExtended market reach

1. Public/Open API

Public

Partner

Internal

Three types of API business models

Source: McKinsey & Company

Exhibit 1

An overview of APIs


to design new apps and web pages, some ofwhich can draw data from diverse sourcesand integrate it to provide new services. Of-fering APIs to external developers is gener-ally referred to as having an “open APIstandard.”

McKinsey expects the emerging software de-veloper channel to continue growing and tobecome a leading source of innovation in thebanking and payments industries. The fol-lowing forces will likely drive and shape thatchange:

• Rapidly changing consumer expecta-tions: As smartphones, mobile computingand Wi-Fi grow more ubiquitous, con-sumers are rapidly developing app-orientedmindsets. With thousands of apps literallyat their fingertips, they expect to find appsthat will help them with almost any task—including payments, banking and other fi-nancial services—whether for their own ortheir employers’ needs. And they expectthose apps to operate seamlessly, providinga friction-free user experience. To remaincompetitive, therefore, banks and paymentsorganizations must find ways to deliver thetypes of experiences that consumers andbusinesses now expect.

• High investment costs: Software develop-ment is a highly specialized field thatthrives on innovation while itself changing

at the same rapid pace as technology. No-tably, its very culture runs counter to thatof banks, where hierarchy, systems, proce-dures and controls have been the norm. Al-though it is essential that banks keep pacewith digital technologies, few actually pos-sess the talent, resources or mindset thattechnological innovation demands.

• Ongoing revenue pressures: Banks havebeen under substantial pressure to main-tain and build their revenue streams in anenvironment that continues to grow morechallenging on multiple fronts. Makingbetter use of external developers wouldnot only address the need to handle devel-opment needs in-house, but also couldprovide opportunities to create new rev-enue streams. One well-known example ofthis is the Commonwealth Bank of Aus-tralia, which offered its payments APIs toexternal developers. Among the apps sub-sequently designed by developers is onethat enables users to split a bill at arestaurant or other place of business.

• Strengthening security measures: Fi-nancial institutions are typically com-pelled to implement higher securitystandards when relying on external devel-opers than they might if they developedall applications internally.

• Accelerating API standards: In Europeand elsewhere, governments and other or-ganizations are accelerating industry-levelstandards for banking APIs. The best-known example is the Open Bank Project,which aims to create and evangelize APIstandards across as many banks as possible.

The combination of these forces is likelystrong enough to discourage all but thelargest banks from attempting to develop

Banks have been under substantialpressure to maintain and build theirrevenue streams in an environment

that continues to grow morechallenging on multiple fronts.


APIs internally. This suggests there shouldbe ample opportunity for an embryonic de-veloper channel to grow substantially in thenear future—an opportunity that shouldprove mutually beneficial to both the devel-oper and banking communities. Recent databears this out. PayPal earns more than $2billion a year through API calls. Its transac-tion volumes are just as staggering. AndTwitter sees more than 10 billion API callsdaily, while Salesforce generates half of itsrevenue through APIs.

Three fundamental approaches tousing APIs

As banks experiment with open APIs, theirfirst priority should be selecting the businessmodel that best fits their organization’s long-term strategic plan. A bank could choose itsAPI approach based on who it anticipatesbeing its primary partners in innovation,which could be public or private firms, inter-nal developers or some combination. Alter-natively, it could choose based on what itsees as its core source of value, be it revenue,crowdsourcing of innovation or an internalforcing mechanism for greater discipline inprogramming.

Based on these options, McKinsey sees thefollowing types of business models emerging:

• Public: Public (also referred to as “open”)APIs are those that organizations makewidely available to partners and externaldevelopers, who then use them to createand market apps. When well imple-mented, this approach can lead to a sig-nificant uptick in innovation due tocrowd-sourcing.

• Private: These are APIs that organiza-tions make available on a restricted basisto business partners such as suppliers,service providers and resellers. Thismodel includes most of the benefits ofpublic APIs and is easier to control be-cause management only needs to copewith a limited number of known users.

• Internal: In this model, APIs are pro-vided for use solely or primarily by the or-ganization’s in-house developers. Thesemight include external developers who arecontracted to work on an organization’sprojects. This model has significant bene-fits for banks because it necessarily bringsmore discipline to its software develop-ment efforts.

After determining which business model bestfits the bank’s long-term goals, some technicaldecisions must be made. The most importantof these is choosing an API protocol. Thereare various protocol types, but two account formore than 90 percent of banking and pay-ments APIs. They are known as Representa-tional State Transfer (ReST) and SimpleObject Access Protocol (SOAP). These twoprotocols are currently understood to be thesafest standards for organizations seeking toenter the banking and payments spaces.

Offering APIs to partners and external de-velopers also requires certain technical capa-bilities. Among these are an ability to

A bank could choose its API approach based on who it

anticipates being its primary partnersin innovation, which could be public or

private firms, internal developers orsome combination.


correctly meter API usage and bill cus-tomers accordingly, an ability to ensure thatno individual user is gaining disproportion-ate access to the platform, and an ability tomonitor the well-being of the core plat-forms. These capabilities are commonly pro-vided by a class of applications known asAPI engines, and are available in enterpriseand cloud versions.

Managing risk

Managing an API-driven software develop-ment effort is a sophisticated undertakingwhatever the choice of business model andinnovation partners. It requires substantialinvestments of both time and money. Invest-ments must be made in several key areas:

• Technology: Significant changes in thebank’s technology architecture often mustbe made and implemented. If the institu-tion presently relies on legacy core sys-tems, it will need to invest significantly infacilitating core functionality for APIs.This could be a gradual, medium- to long-term effort. In addition, new softwaresuites might be needed to manage, protectand monetize new APIs. Process disci-pline is also essential for creating anddocumenting programming standardsand checklists, especially if working withexternal developers.

• Security: Banks must of course take carenot to expose sensitive information in thepublic domain.

• Operations: Developers are exacting anddiscerning by nature, and are becomingan increasingly powerful user group.Holding their interest in a given bank’sAPI opportunities requires providing a re-liable infrastructure and some assurancethat the bank is on solid ground. In onerecently documented case, Linkedin wasreported to be finding it difficult to regaindevelopers’ interest in its revamped APIplatform. It is also very important for or-ganizations to take advantage of the “wis-dom of the crowd,” by holding developerforums, hosting developer events and reg-ularly seeking and acting on developers’feedback (when appropriate).

• Economics: Banks must be realisticabout the costs of setting up an API plat-form, especially the public type. Themost important costs are those related totechnology, operations, people and mar-keting. It is also important to be realisticabout the sources of revenue, whichcould include fees for API calls, programreviews, troubleshooting and mainte-nance. A rigorous business case incorpo-rating these and other elements shouldbe prepared and agreed upon.

* * *

Given the time and effort that managingopen API platforms demands, banks andother payments players should embark onthis path only after careful deliberation. Fac-tors that should receive special considerationinclude: institution size, existing technologyarchitecture, the ability to stitch APIs to-

Managing an API-driven software development effort is a

sophisticated undertaking whateverthe choice of business model and

innovation partners.


gether into meaningful services, and thegrowth stages of prospective API partners.

An open API platform model should not beviewed as a way to offload software develop-ment and its associated problems to externalsources, or solely as a revenue source. For in-stitutions that are confident in their ability tomanage their core platforms consistently andreliably on an ongoing basis, the open plat-

form model can work well. For others who cansuccessfully implement the required changes,the rewards can be significant in terms of visi-bility, innovation and revenue.

Vishal Dalal is an associate partner in the Singapore

office, Kausik Rajgopal is a senior partner in the

Silicon Valley office, and Grace Hou is an associate

partner in the San Francisco office.


In the next issueThe next issue of McKinsey on Payments coincides with the 2016 Sibos conference to beheld September 26 to 29 in Geneva. The issue will include articles on the following topics:

Access to account: Implications for banks

Europe’s access to account (XS2A) regulation and the UK’s similar Open Banking Standardcould have an effect on banking comparable to the advent of iTunes in the music industry.Banks are at risk of losing direct access to customers and being relegated to the role of“content provider.” On the bright side, the new regulations could be the spark that motivatesbanks to truly embrace digitization and get a head start on attackers and bank competitorsin delivering new payments value to their customers.

The future of transaction banking

A look at the trends shaping the transaction banking landscape, from advanced analyticsand blockchain technology to new regulations and emerging FinTech players.

mckinsey on payments - bkm

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