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Does anyone have a P&L for payments?

So the week ends with another wide ranging conversation about new business models and new ways of banking, although I still have one question that no-one seems to be able to answer: how much profit does a bank make from payments, and how has that changed over the last twenty years?

This question came up because I saw that one of my twitter friends, Daniel Gusev, had posted a comment from today’s Financial Times that: “banks in the European Union alone spend an estimated €50bn-€70bn a year moving and storing physical banknotes”.

Why estimated?

Because no-one knows how much banks spend or make from payments.

McKinsey claim that 25% of bank revenues are from payments in 2007, comprising an industry worth almost $1 trillion a year.

2007 McKinsey

That’s revenues by the way, so the $10 billion that Citigroup’s Global Transaction Services generate or $4.2 billion that PayPal will generate this year gives you an indication of the players and their relative market shares.

What is interesting is that this is more than the amount of revenue estimated to be made by banks a decade earlier. From the Federal Reserve Bank of Chicago, Q4/2004 journal:

“Rice and Stanton (2003) updated and expanded Radecki’s study by estimating the volume of payment driven revenues at the top 40 bank holding companies in 2001. In order to obtain a larger sample of banking companies, Rice and Stanton drew their data from the financial reports (call report and Y9) that U.S. banking companies file with their regulators, rather than relying on banking company annual reports, which do not offer consistent information on payment-driven revenues in several important categories. In addition, these authors adjusted some of Radecki’s approximation methods, which may have over-allocated some bank revenues to payment activities. They conclude that payment revenue accounts for 16 percent to 19 percent of operating revenue—a substantially lower estimate than Radecki’s but still a surprisingly large contribution to the overall revenue streams of banking companies.”

Back in 1999, completely disagreeing with this research, my friend David Birch claimed that “the top 25 retail banks in the US derive only around 7% of operating revenue from payments”, and recently stated that revenues from payments have halved over the last two decades in the banking community.

So who do you believe and what is the truth?

Answer: no-one knows.

McKinsey, the Chicago Fed and David Birch have no idea how much money banks make from payments.

A bold statement and a provocative one, but it’s a very basic question: how much money do you make from a payment, by payment type?

It’s a simple question.

But it is completely unanswerable.

You know why it’s an unanswerable question?

Because most banks don’t know how much revenue they get for each of the payments instruments they process, versus the cost of processing that instrument.

Without that granularity of information, they cannot work out their profit from payments.

Without knowing their profit from payments, they have no idea how much money they make from a payment, let alone by payment type.

And even if the bank does have an idea of such costs and revenues, they have no idea how much is generated by tertiary products, such as deposit accounts, that drive these payment revenues.

Payments in and of themselves are not the sole revenue generator, as much of the payment process is cross-subsidised by other bank products.

All in all, payments is a great industry to be in, but show me an accurate breakdown of a banks P&L for its payments business, and I’ll show you a little bit of creative accountancy.

Now I hope this blog entry gets some real pushback, as that’s what it’s meant to do, as anyone who can point me to a clear analysis of the costs, revenues and profitability per payment type within a bank will be my friend for life.


About Chris M Skinner

Chris M Skinner

Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here…

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  • Jim Ford

    The key challenge in estimating the revenue from payments is the indirect costs, ie the technology and people costs. Any bank can calculate the revenues themselves from the fees that they charge. Such fees are usually split between STP and repair. Also in FI payments there is usually a split between bank to bank payments (SWIFT MT202) and bank to customer payments (SWIFT MT103).
    In terms of the internnal costs the basic challenge I would argue is to calculate the cost of a manual payment since that involves staff time. I would suggest the best approach is to look at the total number of payment clerks you have on the manual team and estimate an average salary. Then use those figures to work out what the total number of manual payments costs the bank each day. The STP payments are not really a cost since the cost of the system that processes them becomes a sunk cost after a while.
    The problem is that you need to put a system in to calculate that or do it manually. This as with all things has data capture challenges and I suspect it is quite far down the pecking order in terms of priorities.

  • Banks need to examine payments profitability beyond a time & motion study and allocation of IT costs. The focus on liquidity by global regulators means that the cost of liquidity required to make payments will have a direct impact on bank balance sheets.
    It is inevitable that correspondent banking relationships will factor in increased balance requirements in relation to payments volumes. In effect to secure collateral for the liquidity required for processing another bank’s payments. I think intra day credit lines will surely diminish and more likely will only feature in reciprocity agreements.
    These hitherto unmeasured costs will have to be allocated to product lines whether banks like it or not. Two fundamental questions that will be asked of banks by the regulators will be:
    1) Who uses the bank’s liquidity?
    2) How is the cost of your liquidity allocated?
    To not know the answer to either of these questions will not look good in the bank’s audit report.

  • Unfortunately, there is no way to provide such an answer, because payments are an essential component of the industrial structure of banks. Payments are not an optional extra that can be independently costed or monetised.
    The core of the question circulates around the subsidy of payments granted to banks. Payment services are preserved as a subsidy to banks so as to ensure their command of the lending function.
    In order for banks to attract demand deposits, they need to offer something more attractive that the 1609 Amsterdam idea of a secure vault in the town square. That something is the ability to move value from one customer to another in a relatively convenient fashion (insert here long rant about cost of walking to the vault, the evolution of cheques and digital payments and so forth and so on).
    People deposit money in demand accounts because the banks make it easier for people to pay their bills. Beginning and end of the discussion — without the payment, banks cannot attract demand deposits.
    If banks cannot attract demand deposits, we aren’t talking about banks any more, we’re talking about something else entirely. Regulators have to some extent recognised this two-edged sword over the last decade (PSD, MTA) and they have now come to grips with the concept that payments can be divorced from banks.
    But, they have not mandated it. Nor could they, but the point is that banks still hold the lion’s share of payments. Given that this is a subsidy, and given that the payments subsidy is a necessary factor in keeping the current structure alive, however we view that structure, there is no way to cost the subsidy in an accounting sense.
    Traditionally, management accounting will give you some numbers, but you have to first state what it is you want to get from those numbers. And it will be exactly that — whatever you want; thus justifying the tag “creative accounting.” The numbers are only useful for comparing to similarly calculated numbers, internal metrics if you like.
    A more on-point question might be — how much do you want to pay to keep the subsidy?

  • Boston Consulting Group define payments revenue as direct and indirect revenues generated by a payments service, including transaction-specific revenues, card and account maintenance fees, and spread income generated from current accounts….so payments make up approximately one-third to one-half of most banks’ revenues. They estimate that the global payments market will be $492 bn in trn revenue by 2020.
    A bank last week at a conference stated that they typically cross-sell up to 8 financial services to customers initially seeking p2p transfers. Does that count?

  • Björn Flismark

    The article in the FT actually describe that there is something banks can do about the cost for cash handling. They can start using the cash recyling machine developed by Mr. Lundblad. By doing that they will reduce their cost for cash handling and ATM replenishment.
    The pilot in Stockholm shows that the concept works, the cash in circulation is reduced by 50 % which leads to substantial savings. And on top of that the depositing customers are very satisfied. The deposits are credited to their accounts immediately! The machine accepts all denominations and there is much less need to transport cash.
    The big difference between this solution and other recyclers is that it is a combination of deposit machine and ATM. What is deposited is authenticated and quality checked and can then be withdrawn in one of the two ATM. No need for a CIT company to count the money and fill up the ATM. All that is done by the machine.

  • cardsgeek

    There are a number of challenges with trying to build a P&L for payments. I am speaking here from a consumer payments perspective – I suspect that on a corporate / commercial level the picture is even less clear…
    1) While direct revenues relating to payments are often very clear (fees to consumers, card interchange etc), indirect revenues (e.g. float) can be much more difficult to break down and allocate
    2) Payment processing costs are bundled as part of the operating costs of the bank and are almost impossible to break down and allocate
    3) The individuals within a bank responsible for the revenues and costs relating to payments are almost never the same person, and their individual targets will be related to revenues or costs relating to a specific product line (e.g. current accounts) or business unit , so there is no drive to improve the understanding of the payments element of this
    4) Payments are often bundled with other banking services (a good example would be small businesses, who often receive x cheques per month free and are then charged for the rest as part of their banking package)
    5) Revenues relating to consumer payments are very different in different countries. In much of Europe, consumers expect to be charged for making payments, while in the UK almost all everyday payment types are free. In the US, card interchange is significant enough on debit cards to build sizable reward propositions, while the income received from this in Europe is much less significant
    Overall, it is not possible to pull out a P&L for payments because the banks do not treat payments as a standalone business line. To a previous commenter’s point, payments are completely intertwined with other services and there is so much cross-subsidisation going on that it is impossible to get a clear view. Payments are a hygene factor for doing lots of different sorts of business. And the impact of legacy systems don’t help either, making it very difficult to understand costs at a granular level.
    Simple question, impossible answer. Much like “why did the chicken cross the road?”…