The European retail payments market: Fundamentals and trends (Note)

Purpose of the article: This note aims to describe what retail payments are today (first section), before discussing the trends shaping the European market (second section).

Summary:

• In the European retail payments market, cash is losing ground, mainly to cards

• Traditional payment infrastructures continue to dominate in the European Union (EU), accounting for more than 96% of transactions in 2019.

• Instant payments, which appeared in 2017, are experiencing significant growth despite some structural obstacles.

• Retail payments are becoming increasingly international, even though more than 90% of transactions remain domestic.

• EU members have very diverse situations in terms of retail payments, but are converging in the long term.

In its conclusions of March 22, 2021, on the European retail payments strategy[1], the Council of the European Union highlighted the progress made in the European retail payments sector in recent years, thanks in particular to efforts by Member States to harmonize the various national markets and the adoption of European legislation (Payment Services Directive (PSD2)[2], the SEPA Regulation[3], and the Interchange Fee Regulation[4]). Europe has thus established a system that allows for the emergence of a true European retail payments market.

Nevertheless, there are considerable cross-border disparities in the use of payment methods in Europe[5], with some countries still using cash extensively in everyday life (Germany, Italy), while others make extensive use of bank cards (France) or mobile applications (Sweden), despite the introduction of a European legal framework.

On the other hand, the European market is experiencing various trends, with their own national variations: overall decline in cash, digitization, instantization, etc. In this context, this note first describes what retail payments are today (first section), before discussing more specifically the trends that are currently shaping these markets (second section).

A second note will focus more specifically on the future of the European retail payments market.

1) Retail payments

1.1 Definition

Retail payments are « small-value » transactions[6] involving consumers, businesses, and public authorities. They can include everyday transactions as well as the payment of salaries and taxes by businesses and households[7]. They mainly concern transactions between households and businesses (B2C, C2B, etc.), between businesses (B2B, B2B2B, etc.), and transactions between households and businesses with public authorities. They can be carried out at a point of sale, peer-to-peer, or remotely.

1.2 Retail payment solutions

Retail payment solutions include retail payment methods and initiators. A payment method can be a payment solution in itself, but a payment initiator requires a payment method to form the basis of its solution. Companies offering payment solutions are called payment service providers (PSPs).

Retail payment methods are mainly cash, bank cards, transfers, direct debits, checks, and electronic money[8] (which includes many different payment methods, generally based on ad hoc payment infrastructures—PayPal, cryptocurrencies[9], etc.). Other means of payment exist on a marginal basis: vacation vouchers, restaurant vouchers, etc. Abroad, highly innovative means of payment are already in use: QR codes, facial recognition payments, as offered by Chinese payment companies such as AliPay.

Retail payment initiators are therefore developing an interface for using the above payment methods that is both effective and easy to use. This is the case, for example, with many digital solutions for households (Google Pay, Apple Pay, Lydia) or for businesses (Stripe, Klarna). Current innovation in the payment sector mainly concerns this segment[10].

Different payment solutions can rely on the same payment infrastructure via the payment method they use (for example, Lydia and Google Pay both use the banking system via card or transfer). Conversely, it is also possible for a single payment solution to offer consumers several payment infrastructures (for example, an e-commerce platform offering a banking system via transfer and card, or PayPal).. There is a real disconnect between the initiation of payment—either directly through a payment method or a dedicated initiator—on the one hand, and the management of settlement and clearing risks—managed by retail payment infrastructures—on the other.

1.3 Retail payment infrastructures

Retail payments are characterized by a very high transaction volume (1,822% of GDP in the EU for non-cash volume) and therefore require very robust and scalable payment infrastructures. Due to the network effects involved in the payment market in general, only a few infrastructures coexist in the market. In addition to the cash management network operated by the Eurosystem and private banks, certain infrastructures are integrated at the European level for credit transfers and direct debits within the Single European Payment Area(36 countries), and coexist with national infrastructures (such as CORE in France).

Card systems, which use the banking infrastructure, operate very differently from one European country to another, with some countries having well-established national players (Carte Bancaire in France, Girocard in Germany) and others relying exclusively on international reference systems (mainly Visa and Mastercard)[14].

Other infrastructures managing retail transactions are emerging (decentralized cryptocurrency exchange systems based on blockchain, PayPal, etc.), but their share of total exchange volume has remained marginal in recent years (see section 2.1).

1.4 The objectives pursued by companies in the retail payments market

PSPs have three objectives in the retail payments market:[15]

Ø Efficiency. PSPs want to provide fast, easy-to-use, and inexpensive payment services for both consumers and merchants.

Ø Security. One of the big questions when introducing new payment services is whether they will be secure enough to prevent online fraud.

Ø Inclusiveness. The biggest challenge for PSPs is to be available « everywhere » and to cover different realities, both physical (via ATMs for cash, for example) and virtual (via digital or e-commerce solutions).

While security is essential for public payment service providers to deliver their services, their market power will ultimately be determined by the efficiency and inclusiveness of services for consumers.

It should be noted that these three objectives can only be achieved through cooperation between payment solutions, which focus more on efficiency and inclusiveness, and payment infrastructures, which focus more on transaction security.

1.5 Retail payment habits

Retail payment habits are generally changing slowly, as most consumers find it difficult to assess the efficiency, security, and inclusiveness of emerging payment methods and therefore prefer to continue to trust the payment methods they use (lock-in effects).

Nevertheless, the emergence of payment methods offering a more enjoyable payment experience, a phenomenon linked to the digitization of the sector, is stimulating consumption, trade, and therefore the creation of national wealth.[17] This explains why there is both public and private willingness to accelerate the transition of the retail payments market from time- and energy-consuming solutions (cash in particular) to simpler and more efficient solutions. At the same time, retail payments are increasingly seen by users as a « commodity » for which they would like to obtain the best possible quality, which is encouraging the emergence of « frictionless » payment solutions. These two simultaneous phenomena are creating an environment in which many players are emerging, even though the sector is characterized by « low margins » and, therefore, rationalization is expected[19].

2) Trends in the retail payments market in the EU

2.1 Growth of card payments at the expense of cash[20]

Figure 1: Use of cash at points of sale in the euro area (quantity and value of transactions, %)

Source: ECB, SUCH studies, 2017 and SPACE, 2020

In the euro area[21], cash remains the main means of retail payment. In 2019, 73% of point-of-sale (physical point of payment between a customer and a seller) and peer-to-peer payments were made in cash[22]. These cash payments represent 48% of the value of total payments. However, the importance of cash has declined in recent years: in 2016, 79% of retail transactions were settled in cash, representing 54% of the value of transactions.

Chart 2: Number of transactions by retail payment method in the EU (in millions of transactions)

Source: ECB, Payment Statistics. The « cards » category only includes cards issued by national issuers.

Between 2016 and 2019, card use increased significantly in the EU, both in terms of transaction volume and value, at the expense of cash. The growth of cards is most significant compared to other non-cash retail payment methods (+55.6% of transactions between 2015 and 2019, compared to +25.8% for transfers and +14.2% for direct debits). Traditional payment infrastructures, on which cards, bank transfers, direct debits, and checks are based, continued to dominate in 2019 in the EU, accounting for more than 96% of transactions. Nevertheless, electronic money, including cryptocurrencies, experienced significant growth over the period (+95.4%) despite its small market share.

On the other hand, the COVID-19 pandemic has likely accelerated the decline in cash use and thus the rise in non-cash payments, starting with cards. Forty percent of a panel of euro area citizens said they were using contactless payment cards more often, and a similar proportion said they were using cash less often. Eighty -seven percent of these citizens said they would continue this practice after the crisis—46% of them said they were certain they would.

2.2 Digitization of payments

As shown in Figure 2, retail payment solutions that rely partially (cards, transfers, direct debits) or entirely (electronic money, others) on digital technology are growing rapidly in the EU. This digitization implies a change in the nature of payments made: while cash guaranteed the anonymity of transactions (it was impossible to identify the payer directly or indirectly once the transaction had been made), digital payments challenge this assumption, either by deliberately removing anonymity (transaction made from an account identifying the payer)[24] or by introducing « pseudonymity » (transaction made from an account that can only be identified by a key)[25]. This should reduce the proportion of illegal transactions, even if unregulated pseudonymity offers a sufficient alternative for this type of transaction.

2.3 « Instantization » of payments[26]

In recent years, two retail payment infrastructures dedicated to instant payments have emerged: TARGET Instant Payments System (TIPS)[27] —developed and managed directly by the European Central Bank since 2018— and RT1, developed and managed by the clearing house specialist EBA Clearing since 2017.

Both TIPS and RT1 enable participating PSPs (i.e., credit and payment institutions) to make payments within the EU in less than 10 seconds. TIPS and RT1 are used by PSPs that have joined the instant payment scheme designed by the European Payments Council, SCT Inst. In August 2020, 62.4% of all PSPs in the SEPA zone had joined the SCT Inst. scheme, with large intra-European disparities (87.5% in Germany versus 47.1% in France).[28] Nevertheless, the vast majority of large European credit institutions participate in it. In addition, on July 24, 2020, the ECB decided that all PSPs offering instant payments by bank transfer must be accessible via TIPS.[29]

Thanks to these infrastructures, 7.8% of SEPA transfers were instant payments in December 2020, up 2.1 percentage points since December 2019. This segment is growing, particularly due to the increased accessibility of instant payment solutions, such as Paylib.

2.4 Internationalization of payments

Retail payment transactions are becoming increasingly international. In France, between 2015 and 2019, international transfers increased from 1.8% to 3% of the total (+63.8%), direct debits from 0.1% to 3.7% (+2,994.8%) and cards from 5.2% to 7.1% (+37.3%)[31]. There is therefore a real trend towards the internationalization of payments, which is also visible in Germany (where the share of international payments rose from 4.3% to 6.6% between 2015 and 2019)[32]. Finally, as highlighted by the Bundesbank, more than 8% of card payments in the EU were already cross-border transactions in 2019[33]. The internationalization of payments, particularly intra-European payments, is likely to continue, given their current marginality (more than 90% of non-cash payments and financial companies remain national for the time being) and European integration projects in the field of payments.

2.5 Fragmentation and European convergence[34]

Retail payment habits vary greatly within the EU, and differences in appetite for non-cash payments will pose a challenge to the establishment of a common European payment solution. To illustrate this point, let us take the French, German, and Italian retail payment markets. While Germany and Italy are still markets where cash remains the most widely used means of payment at points of sale (77% and 82% of transactions respectively, compared with 59% in France in 2019), card payments play an important role in France (35% of transactions, compared with 21% and 16% respectively in 2019). The German and Italian markets therefore remain less receptive to changes in point-of-sale payment methods, given their populations’ continued strong attachment to cash. This situation, together with the disproportionately small size of the Italian non-cash retail payments market (503% of GDP compared to 1,167% in France and 1,757% in Germany), may explain the difficulties Europeans are experiencing in further integrating their retail payments market.

Nevertheless, in the long term, European retail payment markets are converging. According to a study by Martikainen et al. (2015)[35], convergence in terms of volatility in the use of payment methods is strong within the EU and has been accelerating since the introduction of the euro. Convergence in terms of payment method usage levels is significant in terms of card payment volumes and the value of remote payments. Convergence is therefore likely to continue and could be accelerated by the introduction of innovative pan-European payment solutions, given the growing importance of remote payments, particularly since the COVID-19 crisis.

Conclusion

More than ever, the European retail payments sector is experiencing a proliferation of new infrastructures and solutions. While the payment experience has long been perceived as a « necessary chore, » technological progress now makes it possible to turn retail payments into a « commodity » whose « quality »—i.e., efficiency, security, and inclusiveness—is promoted. The speed of change in the European retail payments market will depend on the strength of all the trends outlined in this note.

Other emerging phenomena, which are set to become trends, will also play a role, such as the rise of blockchain-based retail payment infrastructures and solutions such as Diem and Lugh, and the ongoing creation of a European retail payments giant with the  » European Payments Initiative.  » The trends outlined in this note could experience further disruption once these phenomena gain momentum.

The note « What future for the European payments market? », also published on the BSI Economics website, will address these issues.