New Payments Challenges

Some of the challenges financial institutions faced in 2022—most notably fintech disruptors and cryptocurrency—will carry over to 2023. Unfortunately, new challenges could impact institutions’ payments business in the year ahead. Here are six of the most critical issues credit unions should look to address in payments in 2023. 

1. The Sad Math of Payments Income

With an effective date of July 1, 2023, the newest Fed ruling related to payments (“Durbin 1.5”) won’t create a need for the average institution to make any system changes. But the early October update to Regulation II will still have significant impacts on most credit unions in terms of interchange income, fraud losses, branding agreements and processing expenses. 

The update’s requirement to route card-not-present transactions across a secondary network (not Mastercard or Visa) will most often impact interchange income negatively, as chargeback rights for secondary networks will become much less issuer-friendly. Any bank or credit union with a branding agreement with Visa or Mastercard will also see reductions in the incentives and discounts they receive under these agreements.

For institutions that are not Durbin-regulated (those with $10 billion or less in assets), we estimate an impact of 5% to 20% on interchange alone. Durbin-regulated institutions will not be affected by the changes to interchange but will still experience the significant impact of this regulatory change in the form of increased fraud losses and brand incentive reduction. 

In all, Reg II will result in credit unions doing this sad math: Impact of Reg II = lost interchange + higher fraud loss + brand incentive reduction - lower processing costs. While processing costs are expected to come down, the increase in costs associated with the other factors could be five to 10 times greater.

2. Being Top of Wallet Is Essential

Being top of wallet has long been the most critical part of a successful card program, and it is becoming increasingly essential. Despite only 15% of commerce currently being e-commerce, the mix for card spend is closer to 50/50. E-commerce continues to grow at a significantly faster rate than in-person transactions. An institution that is not primary in the digital space (wallets, card on file, recurring bill-payment) will soon lose its primary wallet position. 

3. Alternate Payments Create Interchange Pressure

Consumers are spending significantly less on their primary credit cards, according to J.D. Power’s 2022 U.S. Credit Card Satisfaction Study. Overall, credit card holders allot 42% of their monthly spending to their primary credit cards, down from 47% in 2021 and 2020. Forty-four percent of credit card holders have considered buy now, pay later as an alternative financing option. Fixed-term and specific payments seem to appeal more to consumers than the perceived risk of long-term credit card debt. 

Of course, non-card payments have been in place for years, with Square offering members a way to make direct payments to merchants. In 2022, Cash App and Venmo aggressively moved into merchant acceptance. For example, Venmo has recently been enabled as a payment option at Amazon. In addition, Cash App’s new partnership with Adyen creates a significantly larger population of merchants that accept Cash App in place of cards.

The reason alternative payments represent a threat to credit unions and appeal to merchants is the number of users on these platforms. The lower fees for processing these transactions don’t hurt merchant adoption either. The only open question is whether consumers will see the value of using alternative payments rather than their cards to make these transactions. If they do, that means lower card interchange income for issuers.

4. The Future of Real-Time Payments

The amount of coverage currently given to real-time payments is ludicrous. Unlike other markets worldwide, real-time payments use cases and benefits are limited. That said, compelling use cases still need to be considered and planned for in 2023. Specifically, consumers and businesses want to receive money as quickly as possible. Whether payroll, reimbursements or invoices, there is a real opportunity for real-time payments to replace traditional checks and, to some extent, automated clearinghouse transactions. Daily payroll, digital reimbursement, and other check and ACH use cases could be replaced by real-time payments. The question is at what scale and what level of priority. 

There is a need to eliminate checks and cash from as much of the payments ecosystem as possible because of the costs associated with processing and storing them, plus fraud losses. Unfortunately, the timing and scale of this migration is an open question. The most likely credit union priority related to this in 2023 will be ensuring members can receive real-time payments into their accounts. Getting money faster is a benefit members want, as anyone who has adopted Chime’s get-paid-two-days-early strategy can attest. 

5. Boomers and Gen X Don’t Matter Anymore

My older compatriots need to come to grips with the fact that new account growth and consumer spending today are all about the transfer of wealth and the increase in spending in the millennial and Gen Z demographics. Chase recently announced that these generations comprise close to 50% of its customers’ card spending. According to a report from Wealth Engine, millennials are set to inherit $68 trillion by 2030. 

When it comes to driving the adoption and usage of cards and payments products, credit unions must be where these customers and prospects live. That is not branches, billboards, cable and radio. Credit unions without a robust digital and social media strategy to grow and expand their member base will be left behind. It is not possible to sustain growth with a population of members whose average age is 55. While they can be profitable short term, targeting them is not a strategy for long-term success. Marketing to younger generations is the only way to stay relevant over the long term. 

6. Durbin 2.0 on the Horizon

New legislation proposed by U.S. Sen. Dick Durbin of Illinois has the potential to eliminate interchange income and credit card rewards. Durbin 2.0 is being sold as a law that would impact only credit card companies with more than $100 billion in assets. In reality, over 70% of the spending on credit cards is at banks with more than $100 billion in assets. Nothing is finalized on how the networks will react to the rule, but it is safe to say they will likely reduce interchange across the board given the volume of spend at impacted banks. The networks will either lower prices across the board given the market share of the large institutions, or merchants will favor larger institutions because the costs will be lower. Either way, everyone’s interchange will go down. Obviously, the offset to this reduction will come from rewards offered to consumers. This will very clearly hurt consumers rather than benefitting them. 

The payments business continues to evolve and change more rapidly than most areas of banking. The biggest issue we see with financial institutions and their payments business is neglect. For years the income from payments was a foregone conclusion that required no time or resources. Clearly, with the challenges ahead in 2023, it is critical that credit unions actively manage and optimize their payments business.  cues icon 

As a senior director and co-leader in Cornerstone Advisors’ payments practice, Tony DeSanctis helps financial institutions develop custom payments plans and strategies. Cornerstone Advisors, Scottsdale, Arizona, is a CUESolutions provider.