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The why, how and what next of digital wallets

Card-services providers have no choice but to create their own wallet product

In the simplest sense, a digital wallet is a facility to store and transfer money in an electronic format in a convenient manner.

The key aspect to be highlighted here is the convenience, as the owner of the digital wallet could even otherwise have accessed this money through other conventional channels available to him - a bank account, a debit card, a credit card or a prepaid instrument.

The convenience element is accentuated in situations where either the "sender" or the "receiver" or both do not have access to conventional mechanisms of funds transfer.

The digital wallet is just an application which resides in the smartphone and has been allotted dedicated funds through any of the conventional payment products.

When we "add funds" to the wallet through a particular means, we are actually effecting a withdrawal of money exactly akin to any other transaction using that means.

For example, when the digital wallet owner debits his credit card to add funds, the wallet service provider (WSP) acts like any other merchant establishment to the credit-card issuer where the cardholder would have swiped the card.

The WSP incurs the charge which the card issuer charges any merchant establishment, which could range from 1-3 per cent.

Hence, if the added value is 100 units of a currency, the wallet shall receive, say, 98 units.

Since these are nascent businesses, many wallets continue to show full value of 100 as these companies fund the discount themselves.

The physical funds seen as the digital wallet balance continue to lie in a bank account that the wallet maintains - albeit in a fiduciary capacity.

The WSP has only a restricted access to those funds, which can be used only for the purpose that the wallet holder directs the services provider to. The WSP is actually required to be licensed by the regulators in most jurisdictions.

The WSP maintains a ledger account, in its own books, of all the entities that have opened accounts with them.

When a transfer is made, it just transfers the funds, in its ledger, from the payee's account to the recipient's account and reflects this in the wallet that each sees on his respective smartphone.

As the WSP holds a very large number of wallet accounts, it maintains what in banking parlance is termed as a "float" - cheap funds that are available to the bank with which the WSP maintains its account.

For maintaining this float, the bank might reward the WSP with some complimentary services which offset some of the costs that the WSP incurs, including the discount it has to pay upon receiving funds from a credit/debit card.

In addition, the WSP's revenues arise from the fee that it charges for the transfer of funds out of the wallet.

When the wallet holder wishes to transfer funds from the wallet out into his own bank account or any other instrument, then there is an actual flow of funds from the WSP's bank account into that instrument.

FAILURE TO INNOVATE AND READ THE MARKET

The card-issuing companies have a very long presence in the payments space. However, in the view of this writer, the emergence of digital payments and wallets is the direct outcome of the smugness and lack of innovation in these enterprises.

While the need to make payments and transfers pervades across all segments of social strata and across geographies, these organisations continued to focus on the market segments that were relatively economically advanced, urbanised and savvy enough to afford the plastic and to understand its working.

Until the wallets started eating into their space, they seldom made efforts to extend themselves lower down the rungs and actually try and reach the bottom of the pyramid.

"The card-issuing companies have a very long presence in the payments space... The emergence of digital payments and wallets is the direct outcome of the smugness and lack of innovation in these enterprises."

They remained content with maximising the various types of charges which their customers - the cardholders and merchants - incurred.

As with most businesses intermediating between two counterparties and charging a brokerage or seeking "rent" (on point-of-sale real estate), the card providers have also had their moment of reckoning with the new breed of entrepreneurs and innovators seeking to eliminate all such opportunities.

It has now reached a stage where each of the card-services providers has had no choice but to create its own digital-payment and wallet product.

It is too late - and unless these companies undergo a complete overhaul in their mindset, they have very tough challenges ahead.

Overall, wallets themselves shall continue to evolve until they can offer a seamless transfer to anyone across geographies. Until then, this is a space to watch out for.

The writer is managing director of Engee Advisors

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