By: Dan Frechtling, SVP of Marketing and Chief Product Officer
India’s demonetization announcement is causing a shift away from cash and in favor of card and digital payments. Yet India is only the latest sign that card payments are growing globally. The decline of paper in favor of card payments creates opportunity and vulnerability for incumbent financial institutions and new fintech entrants.
Consumer card transactions overtook cash payments for the first time in 2016, according to Euromonitor. The gap will widen over the next five years, as card payments are projected to grow five times as fast as cash. CapGemini estimates the fastest growing regions are emerging Asia, followed by Central Europe, Middle East and Africa. But noncash payments in all regions are growing at a healthy rate, yielding global annual growth of between 8% from 2011-2014 and 10% 2014-2015 (see Figure 1 below).
Figure 1: Growth drivers of card payments. 2011-2015 data courtesy of CapGemini
Moving away from cash and checks is a signal of modernizing economies, more efficiency and less fraud — in a conventional sense. But as card payments grow, so do card crimes.
In some cases, the growth of card use is good news for fraud. Fewer paper payments mean fewer checks. Fewer checks means less check fraud. Checks are the most popular payment method targeted by fraudsters: 71% of companies experienced check fraud in a 2016 study by the Association for Financial Professionals (AFP). Card and digital payments also can make it harder to hide ill-gotten gains. In fact, eradicating “black money” was one of the key reasons for India’s de-monetization.
But with the good news comes some bad news. Looking at two of the drivers of increased non-cash transactions, e-commerce and intermediaries, shows us that for all the positive velocity, there is drag as well. (see Figure 2 below)
Driver #1: E-commerce eases business development yet vexes bank compliance
Card payments and e-commerce grow together, in a symbiotic way. But card payments and card fraud also grow together, in a parasitic way. Underpinning this is overall e-commerce growth, and specifically, the lowering of barriers for entrepreneurs to set up storefronts.
First, e-commerce is growing at a healthy rate throughout the world, with 23.7% growth forecast by eMarketer for 2016. The next two years are expected to surpass 20% growth as well. During the next five years, e-commerce will rise from 8.7% of retail sales to 14.6%. E-commerce is a significant catalyst for non-cash payments because of the inconvenience of cash on delivery for e-commerce purchases. Cash is inefficient, and dangerous to stockpile. Cards do away with that. This is the good news.
The bad news is that illegal goods and services are moving online too. The Global Drug Survey, which queried 101,313 self-identified drug users from over 50 countries, found online sales surpassed street sales for the first time. That means drug users trust the internet more than their dealer or their friends. Drug industry experts say online purchases are more efficient and more consumer-oriented than offline. Online drug peddlers offer consumers promotions like buy-one-get-one-free, repeat-buyer savings, and money-back guarantees. Tom Wainwright, author of Narconomics: How to Run a Drug Cartel, writes:
“I dealt with a trader of crystal-meth pipes who was as attentive as any Amazon representative. (Actually, I take it back. He was far more helpful).”
These payments do not always use crypto-currencies like Bitcoin. They often use conventional card payment rails. The implication: law enforcement will be extending more investigative resources to the internet, and holding financial institutions accountable when they enable online crime. Payments companies that rely on banks, and vice versa, will need to be a step ahead.
Figure 2: Pros and cons of alternative aggregators
Financial inclusion complicates financial risk management
Second, it’s easier than ever for anyone, especially those previously excluded from entrepreneurialism, to set up new storefronts and establish merchant accounts. There are many resources for merchants to launch online storefronts that include hosted and self-hosted ecommerce platforms. Using online store builders (e.g., Shopify, BigCommerce, Weebly, Magento) and even selling directly through Facebook make it an easy process.
Securing a merchant account has gotten easier, and there are even more options for processing transactions. In addition, many payment gateways also offer various kinds of integrated merchant accounts to help ease the process of getting set up online. This form of entrepreneurial “inclusion” is a very positive development.
The bad news is it’s easier than ever to abuse these online entry points to conduct transaction laundering. New storefronts and web services also bring new points of entry for suspicious transactions. Shopping carts, hosted payment forms, gateways and virtual terminals represent more places to hide. This makes it extremely difficult to accurately and consistently identify transaction laundering. In fact, transaction laundering is starting to displace cash-based money laundering. Money laundering, which serves to conceal the origin of illegal proceeds, consists of three steps: placement, layering, and integration. Transaction laundering facilitates the first step, placement.
Past methods utilized smuggling, briefcases of cash, asset purchases, and other cumbersome methods. Transaction laundering sidesteps these and moves funds electronically by blending them with valid purchases or utilizing front businesses. Often, the criminal operation uses a dozen or more nodes spread across different banks so that when one is shut down, the other is immediately activated.
Implication: Transaction laundering is no longer a “wait-and-see” until it happens problem for acquirers. It’s a case where an ounce of prevention is a pound of cure — be sure your portfolio is being monitored.
E-commerce represents a wave of growth that propels card payments. But, looking closer, there is a rip tide of risk in the form of illegal or prohibited goods and services. Thus concludes part 1 of the cash-to-cards story. In the next two installments, alternative aggregators and payments will be examined as both catalysts and hazards for card payments.
Next, in part 2: How “nonbank” intermediaries benefit the payments chain, but are only as safe as their weakest link.
G2 will be hosting a webinar next week covering the rise of card payments this year as well as other trends, please join us for: Threats and Trends Dominating Risk and Compliance in 2016: A Year in Review.