The document discusses the challenges facing retail banks as the payments industry undergoes disruption from new entrants and changing regulations. It argues that banks must reposition themselves to remain central to the commerce value chain by leveraging their customer assets and relationships. Specifically, the document suggests that banks create a collaborative framework where they facilitate connections between merchants and consumers to enable targeted offers, driving engagement for both groups and positioning banks at the center of the future of commerce.

1. 1
Operating under new interchange
regulations: New models for driving
consumer and merchant loyalty
The key opportunity for retail banks

2. 2
Summary
Catalyst
The retail banking industry is facing unprecedented disruption. New entrants, the convergence of
activity on mobile devices, and rapidly rising consumer expectations are creating a huge customer
engagement challenge. At the same time, interchange regulation has removed the revenue used to
fund many loyalty offerings. Despite this, retail banks have huge customer assets at their disposal.
The way these are leveraged will be critical in determining the competitive landscape of this industry
in the future. This white paper, produced in partnership with Global Loyalty (www.globalloyalty.com)
outlines the strategic opportunities for the retail banking industry in this evolving marketplace.
Ovum view
The challenges facing the industry are clear, and retail banks must respond by driving new sources of
value for both consumer and merchant customers. To a great degree, the solutions to these problems
lie within. The customer assets that retail banks have are powerful but remain under-exploited. The
breadth of relationships with consumers and merchants, the high penetration of mobile banking
services, and the high level of trust placed in the industry are critical here.
As commerce, marketing, and payments move increasingly mobile, bringing together these customer
assets into a mobile-led proposition creates the potential for banks to drive deeper customer
engagement and reposition at the heart of the future commerce value chain. There is a clear
opportunity to create collaborative frameworks in which banks facilitate access to the retail customer
base for merchant customers to position offers and marketing content. By becoming hubs through
which consumers and merchants transact, the industry can deliver a counter-proposition to the group
of non-bank entities looking to achieve the same.
Key findings
 The traditional models used by banks to drive customer engagement are breaking down. New
entrants are taking customer mindshare, while interchange regulation has removed a vital
source of funding for loyalty offerings. European banks will lose over €3 billion a year as a
result of the interchange cap, leaving the industry in an even weaker position when it comes
to competing with new entrants.
 The industry must re-position to remain at the heart of the future commerce value chain.
Banks should consider building collaborative frameworks across their customer relationships
and position themselves as hubs for marketing and commerce activity, to act as enablers
between their customers and merchants.
 The payment schemes are actively adding new commerce-enabling services, such as
card linked offer solutions. Omni-channel marketing/campaign management frameworks,
data intelligence, content marketplaces and commerce solutions are additional areas
where schemes can further differentiate and provide additional support.
 A convergent mobile strategy is crucial. A wide range of mobile financial service solutions are
currently available to consumers, including card linked offers, proximity/location apps,
NFC/contactless payments, and mobile wallets, but the customer experience is fragmented.
Consolidating these initiatives into single applications presents a clear opportunity to drive
revenue growth.

3. 3
Creating deeper customer engagement is vital for
retail banks
Once a bank-centric and supply-led business,
the payments industry is now experiencing
huge disruption. The old value chain, in which
consumers and merchants transacted using
only the payment tools and acceptance
services that banks gave them access to, is
breaking down in the face of rapid changes in
the competitive landscape, consumer
expectations, merchant priorities, and
regulation. At best, retail banks risk losing
some of their traditionally high share of
customer wallet. At worst, they could lose
almost all of it.
Banks’ relationships with their customers are fragmenting,
requiring urgent action
The challenges facing banks over customer
engagement are not limited to dated loyalty
models and loss of revenue. Rapid and
sustained changes in the operating
environment are placing even greater strain on
the ability of retail banks to retain customer
mindshare.
Commerce is changing rapidly. Mobile
technology in particular has dramatically
expanded the ways in which merchants can
engage and transact with their customers,
while it has also driven customer expectations
to new heights. This has already had a major
impact on the payments industry, and the rate
of change will continue to grow over time.
The threat of disintermediation hangs over the industry
The rapid pace at which consumers are
turning to mobile devices in particular for
commerce has already changed the game.
Digital transactions need solutions that are fit
for purpose and the last five years have seen
a range of new entrants coming into the
payments value chain at both ends, from
Apple, Samsung, Google, Amazon, and telcos
looking at enabling consumer payments
through to Square, iZettle, and the like looking
to take a share of the payment acceptance
business.
Simplification of the customer payment
experience has been a key driver of activity
here. The inability of the incumbent industry to
deliver payment services fit for this new
transaction model created the space for new
players such as PayPal to flourish. Since then,
the number of wallet platforms aiming to
improve the consumer experience has
increased rapidly, while many large merchants
have taken the opportunity to use card vaulting
to speed up their own digital checkout
processes.
There is an argument that, so long as payment
cards remain the funding source behind digital
wallets and other third-party payment tools,
then issuers see little or no loss to card
revenues. While this is true in the short term,
the longer-term ramifications strike at the heart
of the issue at play, which is the question over
the future role for retail banks in the payments
value chain.

4. 4
The real risk facing the banking industry is that
of disintermediation. The threat from third-
party entry to the payments space is that
banks become the funding source – in effect a
processing function – for brands which seek to
own the customer relationship. This risk is
even greater for banks in Europe, which are
subject to the access to account (XS2A)
provisions of the PSD2.
The weakening of brand attachment this
brings has long-term ramifications for
customer retention, with implications that cut
beyond payments and across the whole
product suite. Also, at a time when many
banks are seeking to use their data assets to
enrich the customer experience, the loss of
transactional data will restrict their ability to
deliver on the aspirations many hold.
Technological convergence has changed the nature of commerce, and
merchant requirements with it
The digitization of commerce has
fundamentally changed the management and
initiation of the entire customer journey. The
route to a purchase can start and end on any
channel, be it online, mobile, or in store, and
this has driven rapid changes in marketing
strategies and engagement models. At the
same time, the ability of mobile devices to
receive or download marketing messages,
show location information, and also be the
device through which purchases are
completed has significantly enhanced the
range of options available to marketers.
The convergence of these factors, alongside
the changes in the payment space, has led the
key battleground in the payments industry to
gain a position to influence the customers’
buying and browsing behavior. Payments will
always be a low-margin business, but
delivering customers to a merchant is
considerably more lucrative. The opportunity
to profit from sitting between the customer and
the merchant, and delivering value to both
audiences, is the key to what is drawing
mobile device and OS/ecosystem owners,
online players, social media brands, and telcos
into the value chain.
Merchants on the whole are embracing these
changes, and are actively investing in new
capabilities around both payments and the
wider ecosystem. Ovum’s 2015 program of
merchant research found that 56% of
merchants globally are planning to increase
their investment in payments technology over
the coming two years, and enhancing the
customer experience is the leading ROI
expected from these investments in most
merchant sub-categories.
This is the driver of take-up for new payment
services, as when merchants expand their
capabilities, they will look outside their current
providers. Figure 1 focuses on the UK market,
and shows the responses to the question
“Which of the following types of organization
would you go to for help in delivering new
payment services?”
Across the whole merchant panel, 50% would
look for an alternative acquirer, but 47% would
look to an online payment brand such as
PayPal and 44% would look to the telecoms
industry. The largest merchants are most likely
to avoid their acquirers altogether and talk
straight to the emerging payment brands.

5. 5
Figure 1: Merchants would look to new providers to deliver new payment services
Source: Ovum Global Payments Insight Survey 2015
Interchange regulation has exacerbated the wider customer
engagement challenge facing the industry
The retail banking industry is facing a major
customer engagement challenge. At the same
time as technology is enabling ever more
sophisticated means of building and growing
customer relationships, the traditional model
banks have used to build loyalty in the
payments business is breaking down. At the
same time, the competition from third parties
for customer mindshare has never been
fiercer.
Card-based approaches have failed to deliver genuine customer engagement
While often effective at driving customer
acquisition, the card-based models of bank
loyalty fail at driving genuine customer
engagement. Many of the card-based
programs available are passive and built on
rewarding historic customer value (such as
card transaction volumes), offering little
beyond that in terms of personalization or
interaction and creating few engagement
points beyond an annual update or a mention
on statement. Consequently, the impact these
programs have in terms of changing behavior
and driving attachment to the bank brand is
equally limited.
Card-based programs typically fall into one of
the cashback, loyalty point or ‘club’ model
categories. These models have been around
for many years and, despite a number of
variations on these themes, consumers
understand the essence of the deal: Use my
card and you will receive a benefit at some
point in the future. With the majority of credit
card issuers offering at least one product with
one cashback or points-based loyalty
12%
11%
11%
14%
20%
15%
15%
10%
13%
15%
17%
12%
12%
20%
14%
15%
13%
12%
12%
20%
15%
Card/payment scheme
Consumer tech company
Online payment gateway
Current bank/acquirer
Telcos
Online payment provider
Different bank/acquirer
Percentage of respondents (sample: 296)
Top Second Third

6. 6
constructs attached, these models have
become largely commoditized and as a result
do little to inspire customer engagement with
the issuer brand. Co-branding has proven a
more successful model, although engagement
tends to be with the partner brand (commonly
an airline or large retailer) rather than the
bank.
The use of ‘club’ models, in which customers
receive offers and promotions content through
their relationship with the bank, also exist and
enable a breakaway from the purely price-
based competition of cashback and points.
The premise is sound: Merchants are able to
reach a captive customer base, while the bank
benefits from delivering this value to the
customer. However, weak deployments, in
which static and blanket offers are
downloaded from a website, have failed to
deliver value to any party and resulted in
limited customer take-up.
Interchange regulation has removed the key source of funding
To say that interchange fees are a contentious
issue is an understatement. The fee, which is
paid by merchants as a portion of each card
transaction made in their outlets, is designed
to cover both the services they receive (such
as a payment guarantee for card present
transactions) as well as some of the card
benefits enjoyed by the consumer. This
includes both the short-term credit aspects of
a traditional revolving card as well as loyalty
benefits. The rationale here is that merchants
benefit from additional business where
consumers are induced and able to spend.
However, merchants have long viewed this
model as unfair and this has ultimately proven
to be a view shared by regulators in many
markets. The fallback rates, which are used
when no bilateral agreement exists between a
merchant and the issuer (and are therefore
used in the majority of cases), are regulated in
many markets now with the most recent
changes occurring in the US and at European
Union level.
In Europe, fallback rates will be capped at 20
basis points (bps) for debit cards and 30bps
for credit from December 2015. In the case of
revolving credit cards, this will mean
interchange falling by over 50bps in most
markets in the region, with even greater falls
for premium cards and at higher-risk merchant
types.
Ovum analysis of ECB data suggests that, for
credit card purchase transactions alone, this
means interchange revenue for issuers across
the EU-30 will drop from €5.4bn to €2.3bn, a
reduction of €3.12bn per year. At a customer
level, this is just under €29 per card account.
Issuers in the UK will be the hardest hit, losing
€813m in revenue as a result of the capping of
interchange.

7. 7
Retail banks must reposition to remain at the heart
of the future commerce value chain
Ultimately, the challenge facing the industry is
a clear one: Invest to deepen existing
merchant and consumer relationships or risk
ceding the central role in the commerce value
chain to third parties. Underlying this is the
need to find ways to create new sources of
value for both consumer and merchant
customers. To a great degree, the solution lies
within. Retail banks have a number of key
assets that, if brought together in a
collaborative framework, can deliver enhanced
services to both customer groups, driving
deeper engagement for retail banks in the
process.
At the heart of this approach is the opportunity
to change the dynamic of the bank’s
relationship with its merchant customers, away
from being a provider of services and towards
becoming an enabler of sales growth.
Incumbency and trust are powerful but underexploited assets
While there is a popular view of retail banks as
sleepwalking towards disintermediation, the
industry continues to hold an extremely strong
position. High levels of customer and
merchant penetration, coupled with the
inherent trust placed in the industry to deliver
secure transactions, are powerful assets that
new entrants and other competitors cannot
easily replicate.
Incumbency and scale remain the industry’s key advantages
Perhaps the most important advantages that
the industry holds are its scale and
incumbency. Banking penetration in developed
markets across both consumer and merchant
customers is high and growing, and these
existing relationships with both ends of the
commerce equation (buyers and sellers in
effect) represent the largest single asset the
industry can leverage. This is also a stable
position; despite the hype, we are a still a long
way from consumers handing their income and
finances to a social media or online brand to
manage.
The World Bank estimates that over 80% of
adults in almost all developed markets had
access to a bank account in 2011. Alongside
this, the adoption of digital banking and mobile
in particular sees many customers interacting
with bank services very regularly.
In Ovum’s 2014 Consumer Insights study,
which surveys 15,000 customers across 15
countries, 32% of all respondents reported that
they log into their mobile banking app on “a

8. 8
frequent basis”, while the British Bankers
Association’s World of Change report (June
2015) revealed that the UK’s 22.9 million
banking apps downloaded to date are driving a
combined 10.5 million log-ins per day.
Next-generation banking services aim to deepen these relationships
While it has undoubtedly increased the
amount of contact that customers have with
the bank over a given time period, the growing
use of digital channels has created its own
problems over how to enable effective
marketing and product origination in what have
to date been largely transactional channels.
Digital channel investments are top of mind for
many banks, with Ovum’s ICT Enterprise
Insights survey showing that 48% at a global
level have online banking projects as a top-
three IT priority for 2016 and 42% have mobile
in the same bracket. One of the key areas of
investment within these developments is
customer analytics, specifically how
generating customer-level insights based on
the demographic and transactional data that
the bank holds across its different channel and
product systems can be used to deliver more
responsive communications and greater
personalization in the UX.
Retail banks remain the most trusted providers of payment services
In addition to the high degree of customer
interaction with banking services, the use of
payment cards and other bank instruments
accounts for the majority of retail payment
volumes. A key reason for this is the high level
of trust placed by consumers in the ability of
retail banks to provide secure and effective
payment services. Ovum’s Consumer Insights
study found that consumers at a global level
see retail banks as the single most trusted
provider for payment products, with a rating of
3.9 on a 5-point scale, compared with online
payment providers (3.4), mobile operators
(2.9), and social networks (2.3).
A collaborative framework which brings merchants into the
equation can drive value for both customer groups
The future of retailing will increasingly revolve
around mobile devices for both discovery and
payments/completion. At a time when
competition and regulation (notably the PSD2)
are changing the operating landscape for retail
banks, the decision that many institutions have
to make is how to respond to these changes.

9. 9
There is a clear opportunity for the retail
banking industry to derive new sources of
value for both its consumer and merchant
customers. At the heart of this is the potential
for a collaborative framework in which banks
facilitate access for merchant customers to
position offers and marketing content to
targeted groups within the retail customer
base. This creates new sources of value for
both groups, and the bank benefits from
deeper customer engagement as a result.
This is very much a case of evolution rather
than revolution. There are, and have been,
many instances of merchant-supported
promotions content delivered through banks,
although weak deployments have often limited
the impact of these programs. In addition, the
ability to target offers content at specific
segments based on the demographic and
transactional information (such as the data
held in card management systems) that banks
hold on customers is not new either, as this is
the essence of the card-linked offers model.
The opportunity for the industry is a variation
on both of these models; to provide a
framework for one group of customers within a
bank to interact with the other. While there are
technical hurdles to overcome and commercial
agreements that would need to be put in
place, this leveraging of the core assets of a
bank will provide a mechanism for it to deliver
greater value to its whole customer base.
It also changes the nature of the merchant-
bank relationship to one in which the bank can
play an active role in generating revenue or
leads for the merchant.
Large merchants would benefit from greater ROI from digital marketing
There are clear benefits of this approach for
medium-sized and larger merchants. As key
parts of the consumer purchasing journey go
digital, a growing proportion of advertising and
offers content has also moved into these
channels. However, the difficulties of ensuring
that offers reach the right audience and are
visible to them create problems in driving
results from any given campaign.
Careful targeting of offers, to the customer
level where possible, is increasingly the
priority for marketers when designing and
evaluating campaigns. The growth of online
offers, daily deals, and mobile coupons means
that it is increasingly difficult for an individual
merchant to be heard above the noise. The
ability to target specific customer profiles,
which are refined using the bank’s
demographic and transaction data, and
delivered to a channel that the customer
accesses several times a week can provide a
solution and deliver improved results for
merchants.
Smaller merchants would benefit from accessing a new marketing channel
This model also has benefits for smaller
merchants. The ability to offer independent
stores and small chains the ability to target
local customers with dedicated digital offers is
a method of marketing that few currently have
access to. For the bank then, this may create
opportunities to provision simplified campaign
management solutions alongside acquiring or
banking services, representing an additional
revenue opportunity for the bank.

10. 10
The real opportunity for banks is to reposition as
hubs for future commerce
Ovum believes that there is a clear strategic
opportunity for retail banks to reposition and
remain at the heart of the future commerce
model. By becoming hubs through which
consumers and merchants transact, the
industry can deliver a counter-proposition to
the group of non-bank entities looking to
achieve the same.
Convergence across channels and devices requires a rethink of
current mobile strategies
Consumer activity is converging on mobile
devices (see Figure 2). Holding and use of
these devices continues to grow at a rapid
pace and anyone born after 1980 (the so-
called ‘millennial generation’ and that which
follows) has effectively grown up with
smartphone technology. Across all
demographic segments, but particularly this
group and post-millennials, consumers are
increasingly centering their daily activities on
smart devices.
This white paper has already discussed the
impact this is having on commerce and
payments, but the implications go far wider
and create a clear need and opportunity for
the retail banking industry to re-consider their
current mobile strategies.
The investments that retail banks have made
in their mobile banking services have focused
on the (quite necessary) need to enhance
functionality and the customer experience.
What has yet to be addressed is the
opportunity arising from this wider
convergence on mobile. The payment product,
customer and data assets banks have across
their portfolios leave them uniquely positioned
to act as more influential enablers to
commerce than they are today. Banks have
these assets, but few are actively leveraging
them and those that are do so in a fragmented
way. This approach leaves room for non-bank
entrants to thrive.
The industry should strongly consider bringing
together existing services into a converged
solution. This will create opportunities for new
areas of service delivery to be included in the
platform, encompassing loyalty, greater use of
digital ticketing, m-wallets, and augmented
reality.

11. 11
Figure 2: Consumer activity across all aspects of banking and commerce is converging on
mobile devices
Source: Ovum
Collaborative models built around a content marketplace can
ensure banks remain central to the future value chain
In the future retailing environment, providing
payment and banking services will continue to
be important commodity services but revenue
will increasingly be driven by added value
services. It will be those providers that are
central to the purchasing journey that are
successful. The ability to have ownership – or
at least influence – on customer decision-
making will be the revenue driver for any
player in the future value chain.
As noted in the previous section, the data and
customer relationships that banks have are
key assets to be leveraged and one potential
model for the industry to pursue is illustrated in
Figure 3.

12. 12
Figure 3: Through focusing on enabling merchants to push promotional content to
consumers, retail banks can remain central to the future commerce value chain
Source: Ovum
There are four elements to the transaction
flow:
1. At the center of the model is the
Content Marketplace, the repository
into which the bank accepts offers
content of any kind from its own
merchant customers, non-customer
merchants, payment schemes, and
any platform for generating and
aggregating promotional content such
as card-linked offers providers.
2. Sitting alongside the Content
Marketplace are a combination of
CRM, marketing, and loyalty engines,
which position the content to
customers based on the criteria set
out by the providing partners. This
could be based around specific
purchasing preferences, location, or
one-off events, but the aim is to
provide an experience tailored to the
needs of individual customers. More
sophisticated implementations can
involve near real-time and offer
delivery when customers enter a geo-
fence or check-in with a BLE beacon.
3. The content reaches the end customer
via the bank’s engagement layer,
principally the online and mobile
platforms, and is then used as part of
the purchase process. The fulfilment
of offers will naturally differ depending
on the merchant and type of content,
but the most sophisticated will bridge
to digital wallets or merchant app
estates directly.
4. To close the loop on the provision of
offers content, the customer
completes a purchase with the
relevant merchant. From the bank’s
perspective, this delivers value to both
merchant and consumer, but drives
additional benefits where the payment
tool being used to complete the
purchase is issued by the bank.
Through this transaction flow, consumers
interact with the bank to begin or conduct a

13. 13
stage in their purchasing journey, centralizing
the bank in the value chain.
In the case of the largest merchants, it is
unlikely that this model would replace existing
marketing and engagement strategies, but it
can certainly complement what is there
already. In the case of smaller merchants
without their own marketing and loyalty
engines, a bank could license or provide a
managed service from its own platform as an
additional value-added service. In this
scenario, as well as having the option to push
offers content to the Content Marketplace
directly, a merchant could also push its own
promotions to its customer by leveraging a
bank-provided loyalty platform. In addition to
driving deeper engagement with merchant
customers, this also provides a new revenue
stream for the bank.
This approach can also be used to defend market share in the
retail payments space
The final element of this model is the ability for
banks to use third party offers content to drive
the take-up and use of new payment tools.
The failure of many new payments services to
ignite the public imagination has demonstrated
one critical factor in the launch of a new
payment tool: consumers need a compelling
reason to change from the tools they are
comfortable with. Payments are, after all, the
final step in a transaction and no consumer
makes a payment for the sake of it.
Assuming that broad merchant acceptance is
a given, these reasons will fall into one of
three camps: The tool must either be faster or
cheaper than alternatives, or offer some kind
of additional benefit. The concept of using a
payment product simply because it is provided
by Apple will never be enough to drive mass-
market acceptance; even Google failed with its
first Wallet incarnation in 2011 (and has had
limited success with further incarnations since
then). The market is now rapidly adapting to
this with key players developing their value-
added service capabilities to their mobile
payment offerings.
The payment schemes are actively adding
new commerce-enabling services, such as
card linked offer solutions, to supplement their
core payment processing capabilities. Omni-
channel marketing/campaign management
frameworks, data intelligence, content
marketplaces and commerce solutions are
additional areas where schemes can further
differentiate and provide additional support.
Retail banks are also investing heavily in new
retail payment services directly to compete
with third-party offerings. Just over 46% of
banks surveyed in Ovum’s 2015 ICT
Enterprise Insights survey reported that online
payments are a top-three investment priority
for 2016, and these new services will enter
what is an increasingly fragmented market.
Positioning offers content around these
payment tools can act as a clear incentive to
make them ‘top of wallet’, while a digital wallet
platform can also be the channel through
which consumers receive, select, and then
redeem promotional offers.

14. 14
Appendix
Author
Kieran Hines, Practice Leader, Financial Services Technology
kieran.hines@ovum.com
About Global Loyalty
Global Loyalty is a UK based technology group that offers solutions encompassing
marketing/campaign management, B2C Omni-channel commerce and life cycle loyalty management.
We are driving new levels of customer loyalty and sales growth to our clients across financial
services, retail and marketing sectors ranging from SME’s through to top 20 Fortune 500.
Ovum Consulting
We hope that this analysis will help you make informed and imaginative business decisions. If you
have further requirements, Ovum’s consulting team may be able to help you. For more information
about Ovum’s consulting capabilities, please contact us directly at consulting@ovum.com.
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15. 15
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