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Analysis: Modernisation under way

The accession of transition economies to the EU will have a big impact on European payments sectors, reports Michael J McEvoy.
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As the former eastern bloc nations continue their transition to market-based economies, their respective payments sectors generally lag behind those of the more advanced economies in terms of infrastructure and sophistication. There are grounds to believe this will change in the period ahead, especially for the transition economies that comprise eight of the 10 countries that have acceded to the EU.

Relative to GDP, banking assets among the transition economies are about one-third the level of banking assets in the euro countries. Domestic credit, which includes credit card borrowings, is also about one-third of eurozone levels. Therefore there must be a question over the ability of the banking sector to bring to bear the resources that will be needed to support a modernising payments sector.

Offsetting this, the banking sectors in central and eastern Europe (CEE) have undergone a decade or so of restructuring and privatisation. As a result, foreign investors own more than two-thirds of banking industry assets among the accession countries as a whole, compared with about 20% in the eurozone. Foreign ownership can be accompanied by the necessary expertise and resources to modernise. Entry to the EU will probably hasten the desire among banking institutions to do so.

Cash in decline

Even in the absence of a strong banking sector, in the past decade much has begun to change in how payments occur in the CEE region. Although cash remains a key means of payment, measures of cash in circulation suggest its use is in decline.

There is still a big disparity with more developed regions, however. During 2001, consumers in the accession countries made an average of 30 payments each that did not involve cash. That pales in comparison with the 137 cashless payments made by each EU citizen or the average of 278 non-cash payments made by each American in the same year (see graph 1). Although some of the difference may be attributed to lower spending power relative to consumers in the US or the EU, the predominance of cash in the accession countries is also a significant factor.

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Helping to close the gap is the trend for increasing numbers of employers to pay their staff by direct deposit, using credit transfers. The significance of this is hard to overstate. In many of the accession countries, a considerable segment of the population is unbanked and so effectively excluded from non-cash payment options. With direct deposit, this is changing. Workers are opening bank accounts to receive their wages and banks are taking the opportunity to bundle their account offerings to include debit cards and access to other services, such as ATMs.

As a result, there has been an explosion in the number of debit cards in circulation, as workers access their wages with debit cards that double as cash cards at ATM machines. In Poland, which is by far the most populous of the accession countries with 38 million citizens, debit card penetration and usage have grown in tandem (see graph 2). A similar picture has emerged throughout the region.

If recent trends continue, debit card adoption and use in many of the accession countries’ economies in the next few years will begin to resemble that of much of the EU.

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Electronic alternatives

Other payment alternatives to cash are also being adopted in the accession countries. In Poland, for example, the use of direct debits has begun to take root. In other economies, such as the Czech Republic, Estonia and Slovenia, direct debits have been around longer but are only now becoming mainstream. Despite being relatively new to the payments environment, consumers in the accession countries make more payments by direct debit than they do using cards (combined, debit or credit).

Also, by both value and volume, credit transfer is by far the most important payment instrument in the region as a whole.

A modern, electronic payments system is emerging that is, to a large degree, by-passing outmoded paper-based instruments that are still in use in western economies. Cheques are almost non-existent in the accession countries and will remain so.

Overall, transfers and debit cards are the dominant payment instruments that are replacing cash in the settlement of debts in the accession countries. The changes already under way will probably accelerate post-EU membership integration, with greater movement of people into and out of the region and a potential for enhanced competition in financial services.

There are challenges ahead, however. These include issues concerning Credit infrastructure, technology and merchant acquisition.

  • Credit infrastructure. A lack of supporting infrastructure means that credit cards are a niche product throughout much of the region. The availability and use of quality credit bureau data is not yet widespread, and even the largest banks in the region do not deploy the kinds of advanced statistical modelling to assess customer risk that are typical of major card issuers in western markets. The presence of western-owned banks and the prospect for increased competition in financial services following EU entry may encourage efforts to modernise the credit infrastructure.
  • Technology. Banks and other financial institutions will have to invest considerably more in technology to support broader access to the payments system. Delivery channels – including branches, the internet and ATMs – are improving but remain under-developed relative to much of the EU and the US.
  • Merchant acceptance remains a problem in expanding the use of cards. Among the EU accession economies, only Slovenia has an installed base of point-of-sale (PoS) terminals on a level par with the EU and the US. The challenge will be to convince a wider base of retailers to accept PoS terminals, particularly given that cash is the preferred means of payment in the CEE.

Impact of accession

The impact of the accession countries on the EU payments sector will be felt in a number of ways.

In the payments sector, banks and others that are seeking scale advantages may decide to concentrate back-office and call centre activities in lower cost centres operating in the accession countries.

Western businesses may also benefit from upgrades to payment systems in the accession countries. Software and hardware firms, along with consultants and marketing firms, among others, stand to benefit from accelerated efforts to modernise payments systems in the transition economies.

Longer term, the anticipated movement of people from the accession countries to other parts of the EU will have an impact on payments. Their combined population of 74 million citizens represents an increase of about 20% on the current EU population. This is significant given the fact that migration has become so critical to the EU’s well being. In 2002, net migration of almost one million people accounted for more than 75% of the EU population increase (see graph 3).

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In time, migrants – including those from the accession countries – will become a growing segment of the younger demographic groups in the existing EU countries. Migration gives rise to an increased need for remittance services because migrants are likely to send funds to relatives in their home country. This can be significant business for banks: Latin Americans working abroad last year sent home an estimated $38bn.

Migrants are also likely to be more receptive to offers of credit and, more generally, to be a new source of business to financial institutions as they establish themselves in their new homes. Recent migration levels to the EU have been about one million people, net, annually and this is likely to increase (relative to the existing EU members) as the accession countries gain entry to the current 15 EU members’ labour markets.

It is clear that the accession countries and their peoples will have some impact on the payments sectors in the existing EU region. It is equally clear that payments in the accession countries are starting to resemble those of advanced economies elsewhere. EU entry will probably expedite modernisation that has been under way since the late 1990s.

Michael J McEvoy is founder of Nechtain, LLC, and conducts payments-related research on behalf of Purchase Street Research, a unit of MasterCard International

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