Consumer Adoption of Mobile Payments

In one of our first posts, Channel Shifts, we noted the projected rapid growth in mobile banking. A recent study by the Federal Reserve confirms this trend with nearly 21% of mobile phone users reporting they have used mobile banking in the past 12 months.  Another 11% think they will probably use it within the next 12 months. 

While mobile banking appears to be taking off, the Fed study suggests that consumers may be slower to adopt mobile payments. The Fed reports that only 11% of mobile users have made a mobile payment over the past 12 months. Primary barriers to adoption of mobile payments include security concerns, lack of perceived benefit of mobile payments and ease of use of cash or credit cards (see below chart).

Source: "Consumers and Mobile Financial Services", Board of Governors of the Federal Reserve System, March 2012.

McKinsey’s recent “Global Mobile Payments Survey”, which polled consumers who access financial services via their mobile device, also shows limited adoption of mobile payments.  Of those surveyed who use a smartphone, 24% report using their mobile device to make a remote payment, but only 15% have used their phone to send personal payments or to transact at the point-of-sale.  This limited adoption of mobile payments appears to be linked to consumers’ lack of enthusiasm for key benefits offered by mobile payments as depicted in the following chart.

Source: "Understanding Consumer Adoption Drivers: Insights From the McKinsey Global Mobile Payments Consumer Survey", McKinsey & Co., May 2012.

Both the Fed and McKinsey studies suggest that certain consumer segments are leading the way in terms of mobile payments adoption. According to the Fed study, 73% of mobile phone users who made a mobile payment in the past 12 months were younger than 45 years old.  McKinsey’s study supports this finding – segments most receptive to mobile payments have substantially lower average ages than the least receptive segments. Hispanics and the underbanked are two additional demographic groups that currently use mobile payments at higher rates than the general population.

Despite the modest consumer adoption of mobile payments to date, a widely cited Pew Research Center study reports a majority (65%) of industry experts believe mobile payments could replace cash and credit cards both online and in stores by 2020. Their position is best summarized by a quote from John Pike, Director at GlobalSecurity.org:

“So many people are already accustomed to buying a cup of coffee with a credit card that smart device swiping is only a very small next step.”

A number of these experts also cited the explosive growth of smartphones and other mobile devices and the potential for greater security as reasons why mobile payments will replace established payment methods, such as cash and credit/debit cards.

How realistic are these predictions of the demise of cash?  According to the Cleveland Fed, cash is the single largest payment method with nearly one-half of total transaction volume being paid using cash. The use of cash has been growing at an average annual rate of 4% since 1990. The number of banknotes in circulation has grown from just over 20 billion in 2000 to over 30 billion in 2011. Given the ubiquity of cash today, a near-total shift away from this payment method by 2020 seems improbable.  It also seems clear some segments will increasingly rely on mobile payments while others will continue to rely on cash or other payment methods.

To remain relevant, financial institutions will need to monitor the changing payment preferences of the segments represented in their customer base to ensure that their future payments capabilities are aligned with their customers’ needs.

Is the Provision Coaster Losing Steam?

Before the recession, year over year increases or decreases in the provision for loan loss had little impact on the overall returns in the system, accounting for a de minimus portion of ROA. As you can see from the chart below, from 2005 through 2007 provisions only had an impact of +/- 6 basis points on ROAs that ranged from 94 to 75 basis points. However, as the economic crises took hold, the influence of provision changes increased dramatically. For example, by the forth quarter of 2009, the year over year increases in provision expense had an impact of -45 basis points causing the industry ROA to be only 18 basis points. Without the increase in provision expense, 2009 ROA would have been 63 basis points. The latest numbers are an encouraging sign of improving system financial health with both an improving ROA and declining provision impact. At the end of first quarter, the system had an ROA of 84 basis points, 10 of which is driven by reduced provisions.  

The election year has inspired us to try our first blog poll and we want to know what you think the future impact provisions will have on the system. Will the volatility continue or are we entering a relatively stable stretch? Let us and other readers know what you think by answering our poll question on the right hand side of the screen. Answers will not be individually identifiable and we’ll share the results next week in the comments section.

Interest Rates – Going Up or Going Down and the Impact on Credit Unions

Historically low interest rates, especially mortgage interest rates, are great for those looking to finance a major purchase or refinance existing debt, but make it more difficult for credit unions to grow their bottom lines and thus support future growth.

The impact of this low rate environment on credit unions’ bottom lines is felt in two ways. First, low short-term rates make it relatively inexpensive for product-sponsored finance companies to buy down rates, for example 0.0% auto financing. This unmatchable rate caused the credit union industry’s new vehicle loan portfolio to contract in 55 of the past 64 months. That portfolio is off 35% ($32 billion) its early 2007 peak. Fewer loans imply reduced spread income.  Second, many credit unions are choosing to not hold newly-originated, fixed-rate 1^st mortgages in their portfolios. They see the interest rate and duration risks outweighing the extra spread potential.

So Where are Interest Rates Going?

If anyone tries to tell you they know exactly where interest rates are going, RUN. The old adage, when interest rates are this low there is no where to go but up, is very compelling. Equally compelling is the list of events likely to hold interest rates down, e.g.:

• Federal reserve statements and monetary policy actions
• Flight to safety of U.S. as reserve currency
• Equity market volatility and boomers nearing retirement moving assets into instruments with more certainty of principal
• Higher rates could trigger double-dip recession  as in:
• Rate resets trigger delinquencies and defaults by households already on the edge. Much of the same can be said for small businesses.
• Higher rates imply higher debt service costs and to meet budget constraints, government entities at many levels would have to reduce labor costs and programs

Another alternative is for rates to move sideways for the next two or three years. This is likely the best course for a sustainable recovery.

The factors noted above translate into slower loan growth, a larger share of credit union assets in cash and lower yielding investments. Investments as a percent of assets hit its low point of 26% in early 2007 and it now stands at 39%. Thus, 13% more of credit union assets are earning lower investment returns. Q1 2012 NCUA data shows the yield on average investments is 426 basis points below the yield on average loans. Bottom line growth through spread improvements is very unlikely in this low interest rate environment.