The Middle East payments matrix

Technological innovation in the financial services industry is the cornerstone of fintech development and will continue to drive disruptive business models in the payments space globally

Digital payments are gaining popularity as cash usage wanes around the world. Though debit/credit card payments still dominate in several countries across the Middle East region, digital products like payment apps, digital wallets, buy now pay later (BNPL) and account-to-account payments are gaining traction.

The digital payments space had been gaining significant traction in the region before the shift to the “digitalfirst” approach that gained prominence after the outbreak of COVID-19 two years ago. However, the onset of the pandemic saw the volume of digital payments soaring to record highs and generating as much as 10 years’ worth of growth in just 24 months.

Globally, payments remain among the best-performing financial services product segments but unfortunately for banks - traditionally the main providers of payments services—this momentum is no longer extending to most of them especially under the current operating conditions. “Fintech firms are the primary innovators in the payments space and banks are struggling to keep pace,” said EY.

For financial institutions in the region to maintain a competitive edge in the payment ecosystem, success will depend on how they thoughtfully assess capabilities, determine the role of payments in market strategies and appropriately align payments operations to achieve the required performance improvements.

The surge in global payments volumes is also being driven by the growth in e-commerce as the pandemic is pushing more shoppers online and changing customer preferences and demands among the young tech-savvy customer base.

“Leading e-commerce and technology companies have set a high bar for the financial services industry to create better experiences and simple, seamless integrations that can make traditional banking, digital payments, and other related activities easier to accomplish,” said Deloitte.

The payments sector is also benefiting from the ongoing shift towards subscription-based billing—a boon for the region’s payments-as-aservice (PaaS) and software-as-a-service (SaaS) solution providers. McKinsey said that open-source software, serverless architecture, and SaaS have become must-haves for technology players and traditional financial institutions launching new fintech businesses.

Meanwhile, the ongoing digital transformation initiatives that are being implemented by regional governments are also driving the growth in the payments industry as banks are leveraging these adoption rates to advance their digital transformation strategies.

Innovation in payments

Technological innovation in the financial services sector is the cornerstone of fintech development and will continue

to drive disruptive business models in the payments space globally. “Driven by changes in digital technology, consumer demand and competitive forces, the way people make payments is evolving faster than any other area of financial services,” said EY.

The last two years have undoubtedly seen an acceleration in a string of existing trends in both consumer and business behaviors while introducing new developments that saw the use of digital payment methods surpassing the use of cash and debit cards.

Open banking

Open banking is playing a significant role in the rise of the open data economy as it makes payments easier and more transparent while loosening incumbent banks’ tight control of customer data and their near monopoly over payment services. The European Union’s revised Payment Services Directive (PSD2) and open banking make it much easier for new entrants to launch new products and services while transforming the ways certain banking propositions work, according to global management consulting firm Kearney.

The GCC region is one example of an emerging global open-banking microcosm. Bahrain is implementing a European-style regulation-driven approach and the UAE has adopted an American-style market-driven approach under the guidance of the Abu Dhabi Global Market and Dubai International Finance Centre.

Saudi Arabia is also implementing a market-driven strategy, but the kingdom’s approach is inclined towards a more formal regulatory framework though its regulations don’t follow Bahrain in requiring the opening up of APIs which facilitate data sharing, or in mandating security standards.

With open banking coming into effect in the first quarter of 2022 in Saudi Arabia, Strategy&, part of the PwC network, said that legacy banks may lose their dominancy in the payment services sector.

Outside the GCC region, several countries including India, Japan, Singapore, and South Korea are implementing a market-driven approach. These countries do not currently have formal or compulsory open banking regimes, but their policymakers are introducing wide-ranging measures to promote and accelerate data-sharing frameworks in the financial service

SaaS

The fact that payments represent the most frequent touchpoints between banks and their clients makes investment in the sector more important than ever. SaaS allows banks to use the software as needed without having to own or maintain it themselves, while serverless architecture removes the need for financial institutions to run their own servers, freeing up time and resources for customers and operations.

McKinsey said that serverless architecture fosters flexible scaling that avoids idling and loss, improving development efficiency. The adoption of open-source software is a godsend for Middle East retail banks that are looking at scaling up their digital transformation as it provides free-to-use source code that gives developers a head start in programming their own applications.

The collaboration between paymentsas-a-service (PaaS) solution providers and banks is also crucial for the financial sector as it allows players in the industry to calibrate their business models while enabling them to bundle some of the solutions available on the market to meet customers’ demands. PaaS players operate cutting-edge cloud-based platforms to provide specialized services, such as card issuing, payments clearing, cross-border payments, disbursements and e-commerce gateways.

The innovative technologies offer resiliency, cost-effectiveness and accelerate customer onboarding, allowing organizations to focus their operating and business models while meeting customers’ demands.

Leveraging the cloud

The emergence of new technologies is offering retail banks a window to be more innovative and efficient in-service delivery, but it is also opening up the industry to new entrants such as fintechs, global retail giants as well as card networks and neobanks.

Cloud computing offers a dynamic platform to develop, trial and offer innovative services, driving operating and business model transformation. The cloud has been driving innovation across the payment services sector enabling high data security, cost-effectiveness on the part of banks and it also drives innovation as financial institutions keep on introducing new services and products to maintain their market position and meet customers’ evolving demands and expectations.

Trends in MENA

The changing customer behaviours and reimagined customer experiences, marked by an increasing desire for frictionless, more seamless and intuitive value-added banking experiences, are driving incumbents to develop open, collaborative financial ecosystems.

Several regional banks are leading or participating in several accelerators, incubators and training programs to advance their access to instant payment technologies to enhance service delivery. For fintechs and start-up’s, such partnerships provide easy access to resources, data, funding, space and networking opportunities to test and showcase their prototypes.

Last March, Buna, the cross-border and multi-currency payment system owned by the Arab Monetary Fund, said that it is considering launching instant payments at a later stage, in addition to trade finance solutions, securities settlement and ATM/ POS processing service. The move is expected to complement Buna’s current offering of multi-currency cross-

border interbank payments, commercial payments and consumer remittances.

Meanwhile, treating payments as a stand-alone entity for example in the case of Emirates NBD’s Network International and First Abu Dhabi Bank’s Magnati allows for the expansion of services across the financial services sector and opens the service to a broader array of customers. FAB spun off its payments unit into a stand-alone operational entity called ‘Magnati’ in April last year. Aside from its payment services, Magnati seeks to provide enhanced capabilities to partner with fintechs on product and service innovation.

“Carving out the payments business allows a more flexible approach to growth while also establishing a currency that makes subsequent consolidation possible, as carve-outs can tap into the higher valuation afforded payments companies,” said McKinsey.

The ongoing shifts toward e-commerce, digital payments (including contactless), instant payments and cash displacement have all been significantly boosted in the last two years as support from governments is making it imperative for banks to provide frictionless payments solutions.

Commercial Bank of Dubai (CBD) signed a debt financing agreement with Postpay in January, a deal that will see the bank supporting the BPNL solutions provider on several fronts including transaction banking, debt funding and e-commerce solutions. The debt financing deal between CBD and Postpay is an example of how fintech and incumbent banks are partnering to enhance digital payments and the entire suite of financial products offered in the market.

Gulf region countries are spearheading different digital payments initiatives such as Oman’s Mobile Payments Clearing and Settlement System, UAE’s e-Dirham, DubaiPay, BenefitPay in Bahrain and Saudi Arabia’s Sarie – all of which are meant to enable service providers and government entities to offer payment facilities around the clock.

FINTECH FIRMS ARE THE PRIMARY INNOVATORS IN THE PAYMENTS SPACE AND BANKS ARE STRUGGLING TO KEEP PACE

– EY

Challenges faced by banks:

Regulation & competition

The rapid pace of change in the digital payments sector, which includes innovative technologies, entry of nontraditional payments providers into mainstream markets and the rise of digital currencies, is causing an untenable shift to operations and risks within compliance departments.

McKinsey said that for financial watchdogs weighing digital payments’ benefits and risks, the challenge is to find the right balance between supporting innovation and protecting consumers. Regulators are often perceived as innovation killers by several players in the financial services industry in their quest to strike the right balance between protecting customers’ interests, financial institutions’ risks and other policy objectives to enhance sustainable growth.

The UAE central bank last July unveiled the Retail Payment Services and Card Schemes Regulation, the regulator’s fourth regulation, as part of its broader strategy to prepare the Gulf state for a new era of digital payments.

On the competition front, the wave of digitalisation in the financial services industry following the outbreak of the pandemic is driving corresponding shifts in customer demands that have upended service delivery for most retail banks globally. KPMG said that as financial institutions across the payments value chain seek to adapt to the winds of change, they find themselves in increasing competition and in shifting partnerships with fintechs, non-banks as well as some of the world’s leading retailers.

Network International joined forces with Amazon to provide merchants across the UAE with access to Amazon Payment Services gateway and payment solutions and enhanced fraud monitoring. Amazon Payment Services’ merchants are also set to benefit from Network’s acquiring and settlement solutions.

Security concerns

The entrance of technology superpowers and fintech into the payments space is driving competition, lowering transactions costs and enhancing product offerings but its integration with a variety of consumer services that rely intensively on user data has raised security concerns.

The increase in digital payment options together with skyrocketing adoption rates are being met with a surge in cybercriminal activity as hackers are becoming more sophisticated and aggressive, making it imperative for banks to invest in cybersecurity. KPMG stated that the proliferation of digital channels following the outbreak of the pandemic has also led to increased cyber-risk exposure. Cybercrime and malicious hacking cases have also intensified since the outbreak of the pandemic.

However, retail banks are investing in the next generation of digital payments vehicles that will not only be embedded within smart devices but will also have to offer increased securitization, such as tokenization and strong authentication. The growth of instant payments services in the Middle East region is being driven by several factors including their popularity among SMEs and start-up’s. Digital payments are expected to revolutionise the payments sector and its application into the retail industry and standard B2B transactions.