This article was produced in collaboration with Knowledge@Wharton.
Instant payment systems are transforming banking and retail, especially with the rapid rise of e-commerce amongst consumers. And these new technologies can offer a huge competitive advantage to organizations.
Juan Giraldo, PhD fellow in the department of digitalization at the Copenhagen Business School, says it is important for executives to keep pace with these new systems and the implications they hold for various sectors. In a conversation with Knowledge@Wharton, Giraldo talks about different aspects of the payment infrastructure, the current research in this area and what more needs to be done, Giraldo will be speaking about instant payments at SWIFT’s annual Sibos Conference in Australia later this month.
Knowledge@Wharton: How did you get interested in instant payment infrastructures?
Juan Giraldo: I first became interested in payments in 2010 while I was working on a remittance platform. Then, in early 2013, I became interested in blockchain and started studying the payment infrastructure as a whole. After my academic studies at LSE it morphed towards instant payments with a study on remittances, and now, with my doctoral studies, it is one of the areas I’m looking at.
Knowledge@Wharton: Why is it important for executives in banking and retail industries to understand these technologies and their implications?
Giraldo: It’s very important for executives in the banking and retail industries because, in the banking sector in particular, these technologies contribute to run the payment infrastructure. This push towards instant payments, coming from the banking and the infrastructure side, is a great opportunity for banks to maintain a competitive advantage within the payments market.
Knowledge@Wharton: Can you summarize your own research, as well as some of the other studies such as the one by the European Central Bank, on instant payment infrastructures?
Giraldo: For my research, I’m looking at the architecture of these infrastructures from two perspectives. One is the supply side — banks providing the infrastructure to smaller companies. And then there is the demand side — companies sitting on top of the banking infrastructure providing further payment options to end users. I’m reviewing the changes in the payments infrastructure from these two angles, and how centralized or decentralized architectures might enable higher accessibility which seems to be a key feature for allowing more efficient payments at a global scale.
Interestingly, studies such as the one by the ECB and by Zhiling Guo and his team in collaboration with the SWIFT Institute have highlighted the relevance of regulatory authorities in pushing towards instant payments. These studies also emphasize the strategic benefits of adopting instant payments, as well as the need for further access to the infrastructure. Behavioral changes from end users, especially with the increase in e-commerce transactions and adoption of mobile technologies, are also driving the research agenda.
Knowledge@Wharton: Could you explain the different models of instant payment infrastructures? I understand that there’s a centralized model and a decentralized model. What are the pros and cons of each of them? Which model is more efficient, and why?
Giraldo: The discussion between centralized and decentralized payment infrastructures is an ongoing one that can be traced back to the House of Medici in the 1300s. One of the approaches is a centralized and closed approach. For instance, a payment platform such as MobilePay. In this case, the service is controlled end-to-end which enables greater efficiency but constrains accessibility and reachability. A second approach is a centralized infrastructure that’s more open and reaches different platforms. This enables reachability in terms of payments and transactions but with less control over the service. An example of this would be a real-time gross settlement system offered by a central bank and the different banking platforms using it to support other payment services.
Recently, we have also seen open, decentralized and synchronized payment infrastructures supported by blockchain. I think these infrastructures can provide high value in places where there are high transaction costs and no trusted institutions. But of course, being decentralized constrains efficiency. This blockchain-like approach has also been used in more closed environments but at this point it becomes a question of either operational risks or governance and power in running the infrastructure.
Knowledge@Wharton: Could you share some examples or case studies? I believe you’ll be presenting three case studies at Sibos in Australia about instant payment infrastructures and how they enable value creation in the payment ecosystem. Could you preview some of them?
Giraldo: MobilePay is a good example coming from the demand side of the market. It’s reaching end users and supporting low-value, high-volume payments. A good example on the infrastructure side is the TARGET Instant Payment Settlement (TIPS) service by the European Central Bank, which is to be launched in November. These two cases offer a good overview of centralized payment infrastructures that approach the market from different perspectives. What’s interesting about the infrastructure change from the European Central Bank is that it not only enables high reachability, but it also improves efficiency on the supply side. It enables low-value, high-volume transactions at cheaper costs which are normally supported by platforms on the demand side of the market.
Knowledge@Wharton: Looking at the global landscape, what does the scene for instant payment infrastructures look like? Where do you find the most innovative work being done? How does Europe compare with the U.S. and Asia, especially China? Also, are there any companies that you are paying attention to, and why?
Giraldo: I’ve heard that China is heavily investing in payment infrastructures and also in the implementation of blockchain within the finance sector. So, China is an interesting place to keep an eye on. I think Europe and the U.S. are pushing forward, but if we look at other places like Africa, they have been using a mobile based payment infrastructure for a while, whereas Europe is still catching up. However, I believe that at this point, it’s not about which places are pushing forward, but how these places are looking to each other to be able to offer high reachability at a global scale.
Knowledge@Wharton: Absolutely. Are there any companies that you think are doing interesting work in this space?
Giraldo: I think TransferWise is very interesting. They fit within the infrastructure offered by banks and offer very efficient cross-border payments. Revolut is also very interesting. They are building a diverse platform and offering low fees with a good user experience. I think these platforms and developments on the supply side that bridge country level payment systems such as the ECB TIPS service are good cases to follow.
Knowledge@Wharton: What do you think are some of the biggest obstacles to the implementation of instant payment infrastructures, and how can those be overcome?
Giraldo: For banking institutions, the risk is mainly operational. Because once we move towards an instant payment infrastructure, there is a shift from having credit risks to having greater liquidity risks. This means maintaining a higher level of liquidity for the payments that are expected. That’s one interesting challenge on the operational side, but of course moving towards an instant payment infrastructure will also demand further operational changes. On top of that, there is also a regulatory challenge.
Knowledge@Wharton: What are some of the main regulatory issues that bankers and retailers should keep in mind as they think about instant payment infrastructures?
Giraldo: Well, it depends on the region because some countries are driving the adoption and development of instant payments with different regulatory approaches. But generally speaking, I would say that new regulations such as PSD2 (Payment Systems Directive) and GDPR (General Data Protection Regulation) are covering some of the aspects of instant payments, especially regarding accessibility to the infrastructure and user data.
Knowledge@Wharton: As you were conducting your research into instant payment infrastructures, what has been the biggest surprise for you?
Giraldo: The high involvement of authorities has, in a way, surprised me. I think it is a good thing. [It helps] in developing an instant payment infrastructure at a faster pace which is good for the end-users. The discussions of some of the industry players to push towards a global instant payment infrastructure that communicates different payment infrastructures and enables higher reachability and cheaper payments have also surprised me.
Knowledge@Wharton: What are some aspects of instant payment infrastructures that need further research but it’s not happening at present?
Giraldo: I think researching how to enable an open infrastructure that allows for further participation and innovation in the payment industry in a way that maintains accountability needs further research. Because one aspect is opening up, or releasing control, and another is keeping accountability if something doesn’t work, which can become quite difficult. I think those two aspects are interesting and should be further researched. Also, from a regulator’s perspective, an interesting area to keep working on would be the balance of power in the payment infrastructure. Because, somehow, owning or running the infrastructure enables some parties to have more power over the payment ecosystem.