Digitizing retail transactions

It’s a no-brainer that digitizing economic transactions will have multifaceted benefits. As per SBP data, total banking transactions (excluding PRISM) stood at Rs205 trillion in FY19. Out of which mere Rs366 billion was spent on point of sale (POS) machines. In 2019, store-based retailing in Pakistan was estimated at Rs7.1 trillion by Euro monitor. Looking from any lens, the digital gap is huge. SBP is cognizant of the fact, as it has issued a circular on 31^st January on improving payment-card acceptance infrastructure in Pakistan.

There are two issues at hand. First, that supply-side infrastructure is not robust, and second, that incentives are misaligned. POS-machine number has been hovering around 50,000 for past 10-12 years while unique locations of machines are mere 20,000. SBP is targeting to increase it to 500,000. The need is to have buy-in of acquirer of POS machines and merchandizers to enhance the footprint.

SBP, in the first wave, is attempting to incentivize acquirer. There are five banks in Pakistan in open-loop POS acquiring business (HBL, UBL, MCB, Alfalah and Keno/BAHL). Their business lines are not making enough money to drive expansion. The juice is being squeezed by card-issuer (debit and credit cards) while the switch-fee is charged by players such as Master Card, Visa and Union Pay.

It’s a four-party model operating in Pakistan. The debit/credit card is issued generally by a bank (issuer) to a consumer, who charges through a POS machine (provided by acquirer) at a merchant. The switch (Maser Card/Visa) charges a fee for the transaction. The amount distributed between acquirer, issuer and the switch is charged to merchant and is known as MDR (merchant discount rate).

The MDR in Pakistan averages around 1.5 percent per transaction. Bulk of MDR (around 1.15 percent) is taken by the issuer, the switch fee is around 0.1 percent, and the remaining 0.25 percent is the acquirer’s margin.

For example, if a consumer buys a cup of coffee from a high-end café such as Mocca at Rs500 by swiping a Standard Chartered credit card on an HBL POS machine, SCB will charge the consumer Rs 500, and after deducting its issuer fee (Rs5.75) and switch (50 paisa) share, transfer the remaining amount to HBL in 2-3 days.

While it sounds simple, there is a time lag that the acquirer is exposed to. In the example above, HBL will independently transfer Rs492.5 to Mocca Café in 1-2 days, whereas SCB will send Rs493.75 to HBL in 2-3 days. HBL incurs the funding cost of Rs492.5 for the duration in which it makes payment to Mocca and receives the amount from SCB. If the gap is one day, the funding cost (at 13.25%) is 18 paisa for the above transaction. Hence, HBL effective share is reduced to Rs1.07 from Rs1.25.

So, it is clear that the incentive structure is skewed towards issuer. That is why there are more cards and less POS machines. There are around 25 million debit cards and 1.6 million credit cards while around 10-11 million cards are being used at POS machines operating at 20,000 merchants. SBP’s idea is to tweak the policy to enhance POS footprint and to have higher volume of transactions.

The latest SBP circular has capped the issuer margin at 0.5 percent while the MDR limit is set between 1.5 - 2.5 percent. The switch-fee is likely to remain the same. At 1.5 percent MDR, share of acquirer is to increase from 0.25 percent to 0.9 percent. This will be enough for acquirers to expand. According to one acquirer, this business line’s annual cost is Rs 80-100 million while the revenue hovers around Rs60 million. With new structure, the acquirer revenues could increase to Rs200 million. So, it will make commercial sense to expand.

The new terms will be for 3 years. In that time, acquirers may expand aggressively to bring more merchants on board. Right now, banks are in acquiring business, but it is too small a size for a big bank. Third-party operators need to be encouraged. A company that makes this line of business its core focus area can add more value. SBP must issue licenses, just as license is being issued to an independent ATM operator.

At this point, acquirers are fighting within a low base. For example, in a small Mocca outlet, there are two POS machines installed – HBL and Alfalah. In case of supermarkets such as Al-Fateh, there are 1-2 machines at each counter and there are numerous counters within one store. The fun is in installing POS machines with virgin merchants. SBP perhaps feels that there are enough card holders, and the challenge is to bring those cards to swipe on POS machines.

The story does not end there; as it’s not only debit and credit cards that can be used for digital transactions. There are emerging products, such as mobile wallets, but right now, the money is topped up in wallets through consumer bank accounts, at a charge of Rs100-150 per transaction. Moreover, it’s not a good experience for consumer.

Then there are issues of interoperability. Micro-payment gateway may help in resolving this issue. Domestic payment schemes – mainly PayPak – need to be encouraged. Settlement cost must be minimized, and settlement be made real time. This kind of infrastructure is imperative for a digital payment ecosystem to grow.

The transactions are not limited to retailing. Government payment is a big market to capture. This will help in enhancing financial inclusion under the National Financial Inclusion Strategy (NFIS). The idea is to bring into the digital economy consumers who do not possess debit or credit card. There are other issues in customer acquisition. Banks, the SBP and other players must run awareness campaigns. There are issues of connectivity in remote areas. And then there are issues of documentation.

The first leg is to enhance the supply side. At some point, the SBP must incentivize demand by luring merchants. In mature markets, MDR is usually low. Many merchants have thin margins, such as electronic goods sellers and petrol pumps. The MDR has to come down in the second leg to incentivize merchants. Besides, to tackle the fear of documentation, there should be tax incentive for merchants having higher ratio of cashless transactions. Good luck, SBP!