You have had a long and respected career, consulting in financial services for more than 15 years. How has the industry changed since you first became involved in the field of payments?

The payments world has gone through a total transformation in this time period. Let me highlight just a few of the momentous changes we've witnessed.

Fifteen years ago, paper checks were the most common non-cash payment instrument in the U.S.; today, very few consumers write checks and business check writing is also declining rapidly. The passage of Check 21 has had an even more radical impact upon check processing: just under half of all checks are imaged (and 90 percent of these are processed electronically end-to-end). The Federal Reserve used to operate 45 check processing sites across the country; in a few months this will be down to just one.

The ascent of debit card transactions has been just as dramatic. Fifteen years ago, debit cards were in their infancy, generating about 0.5 billion transactions per year. Today, there are 37 billion debit transactions annually worth $1.5 trillion. Debit has surpassed credit cards and checks as the most popular (non-cash) payment vehicle in terms of the number of transactions. And, despite all the rhetoric, both PIN debit and signature debit continue to thrive.

Visa and MasterCard have been at the heart of many of the critical changes throughout the payments business, including as defendants in the major merchant class action lawsuit challenging the Honor All Cards rule (and subsequent $3 billion settlement), as subjects of a Department of Justice investigation (leading to the entry of American Express and Discover into the third-party network business), and most recently in taking their organizations public (with Visa as the largest IPO ever).

These industry shifts have spurred important changes within financial institutions. Fifteen years ago, payments tended to be regarded as part of a bank's "plumbing" — it was a back-office operational function and was managed based on efficiency (check throughput, cost per transaction, error rates, etc.). Today most organizations recognize the critical strategic and financial importance of payments: payments fundamentally define the customer experience and generate 30 to 40 percent of bank revenue. Accordingly, financial institutions are putting senior executives in charge of their payments strategies, leading cross-enterprise initiatives, and actively shaping the evolution of their payments businesses.

We are working with our clients to consider what the next fifteen years may bring. If history is any guide, we're in for considerable change!

If you would have been told five years ago that mobile phones were going to be an area of strategic focus for payments in 2009, would you have believed it? Should we have seen this coming?

No one fully anticipated the convergence between mobile phones and banking or payments, largely because it is so difficult to grasp the phenomenal rate of change within the mobile phone industry. The fact of the matter is, given the complexity of the payments ecosystem and its fragmented nature, the rate of change tends to be fairly deliberate. By contrast, many people buy new mobile handsets — with new technology — every two years.

We are very bullish on the future of mobile. The phones are getting better: 50 percent of all new phones sold are smart phones and the processors inside these handsets are equivalent to a supercomputer 20 years ago. And the networks are getting better: 3G is widely deployed and the mobile network operators (MNOs) are beginning to roll out 4G, enabling far superior applications.

Consumers are rapidly embracing mobile banking, with the introduction of the iPhone in June 2007 as an important inflection point in the product's adoption lifecycle. Bank of America's numbers are striking. After introducing the service in the second quarter of 2007, it took 13 months for the bank to attract its first million users, nine months for the second million, and just six months for the third million.

USAA's mobile phone application to allow customers to take a picture of the front and back of their checks, and transmit the electronic image for deposit, could be the start of a game-changing way to bank. In the service's early days, 40,000 customers had used the software to deposit more than 100,000 checks worth a total of $61 million (peaking at $2.2 million of deposits in one day). If — or more accurately, when — other banks roll out this capability, some of the core service functionality provided today by branches and ATMs will be called into question.

Mobile payments is a much more tricky proposition. The vision of a mobile wallet replacing consumers' traditional leather wallets is very compelling, but getting from here to there is remarkably complex. It's not so much technically complex but rather the challenge lies in finding a business model that will work for all parties: merchants, issuers, networks and consumers, and also the MNOs, the handset manufacturers, additional service providers (for tasks like over-the-air account provisioning) and so forth. Considerable effort is being spent on this task and I am hopeful that an effective model will emerge.

What do you see as the future of debit? Can you tell us the trends that have unfolded over the last year and what you see on the horizon?

The biggest issue facing debit issuers right now are the new Reg E requirements. On November 12, the Federal Reserve announced new limitations on how financial institutions can allow their customers to overdraw their accounts. Specifically, customers — both new and existing — need to explicitly give their bank or credit union permission to allow overdrafts ("opt in") on ATM cash withdrawals and one-time debit card payments (recurring debit card payments, check and ACH payments are excluded from these new provisions). And, issuers need to comply with these requirements by July 1, 2010.

This rule change creates significant technical, financial and strategic questions for FIs. Technical: Opt-in communications and processes need to be developed and implemented, and new transaction authorization parameters tested and introduced. Financial: Up to $30 billion of non-interest revenue will be impacted by this regulatory change; how will debit card managers and/or retail banking heads make up this shortfall? From new revenue sources or cost cutting? Strategic: Recognizing that these fees helped subsidize banking services for different customer segments, will banks seize the initiative to develop new product propositions for targeted customer groups?

I believe that the future outlook for debit remains very bright. First, in terms of numbers, between Q2 2008 and Q2 2009, Visa and MasterCard's credit volume declined by 12 percent, while their debit volume increased by 5 percent. Second, while the majority of the adult population now has a debit card, on average, only 56 percent of these cards are used to make a purchase in any given month, suggesting that there's still considerable upside. Third, and perhaps even more important, the opportunity for debit to continue to eat into cash payments remains large, be it taxis, transit payments, quick service restaurants, toll roads, vending machines, iTunes and other micropayment sites, and a whole host of other venues. Additionally, the universe of potential debit transactions is expanding as things like card-to- card money transfers take hold.

Success in debit remains an execution game. In our work, we find that best-in-class debit issuers have an intense focus on card penetration, activation and usage — and, as a result, generate revenue per cardholder that is more than 30 percent higher than the industry average.

I'm glad to hear your positive thoughts on debit. What is your outlook for the credit card industry?

This is much tougher. Issuers have been hit by the one-two punch of dramatically rising chargeoffs and tighter regulation in the form of the CARD Act. As a result, the credit card industry had aggregate profits of zero in 2009. Zero! That's down from a peak of $26 billion just two years earlier.

As consumers deleverage and restore their household balance sheets, total credit card outstandings will shrink. This is already underway — and occurring at quite a rapid pace. 

Looking forward, we see a smaller market (in terms of spend and outstandings) and a bifurcation within the competitive set. Some issuers are clearly hampered by the current environment; they will be dealing with collections and will be internally focused for some time to come. Other issuers, on the other hand, are already plotting new customer acquisition approaches and new product designs to gain share.

But look, it's all too easy to get caught up in the negative news and poor earnings of credit card companies when, in reality, there are a number of very positive developments. In our experience, among well-run issuers, profit margins — pre charge-offs — are actually improving. Issuers have better pricing strategies and are being more disciplined in their approaches to portfolio management than before the downturn.

We are working with banks on what we call "Next Generation Customer Decisioning," where we supplement credit bureau data with new data sources and new analytical techniques to create new decisioning algorithms. In our testing, this new approach is 27 to 38 percent more effective in identifying "bad" customers than traditional bureau data alone. And, with better predictive capabilities, issuers can capture emerging profit pools and lower their risk profiles.

I've been told you graduated with First Class Honors from Oxford University. What brought you to consulting? Can you tell us what you're working on now?

After Oxford I spent a year teaching economics at Warsaw University in Poland, funded by the Soros Foundation, and wanted to continue pursuing my passion for economics. This led me to the economics PhD program at Harvard. However, I quickly realized that I was much more interested in applying my training in economics to real-world business problems, which is what led me into strategy consulting.

About the Author

Tony Hayes is a partner in Oliver Wyman's North American Retail & Business Banking practice, working out of the firm's Boston office. Hayes specializes in strategic questions related to electronic payments and retail delivery channels.

His expertise spans payment types (credit, signature and PIN-debit, prepaid, check, ACH and cash), payment constituent groups (consumers, issuers, networks, processors, merchants, mobile network operators) and themes (industry structure, pricing, rewards, competitive landscape and strategic alliances). He can be reached at tony.hayes@oliverwyman.com.