The banking industry is under siege; a suboptimal macroeconomic environment combined with increased regulatory governance has resulted in EU banks being unable (on aggregate) to generate returns above their cost of equity since the financial crisis.
However, despite the emergence of ‘omnichannel capability’ (Telephone and Internet Banking), low interest accounts (lower for longer) and increased competition from FinTech companies, the traditional retail banking sector has remained resistant and relatively unchanged. The vast majority of retail customers remain with their bank of choice and ‘switching’ remains an ostensibly arduous and uncommon process. However, the European Union’s Second Payment Services Directive (PSD2) and the UK’s own Open Banking are in the process of bringing about what some are calling a financial services revolution. With Saturday the 13th marking the 10-month anniversary of the imposed implementation cut off, it seems opportune to assess the What, Why How and Who’s of the legislations along with discussing what the future holds for them.
Before defining the legislation, let us first examine the main differences between the UK’s Open Banking and the EU’s PSD2. Firstly, the scopes of the respective standards differ; the UK’s Open Banking regulator; the Competition and Markets Authority (CMA) requires only the top 9 banks to adopt the standard, whereas PSD2 applies to all EU payment account providers, regardless of size. The requirements relating to Application Programme Interface (API) infrastructure also differ between the EU and UK; within the UK, the 9 banks have implemented a pre-defined API, whereas the EU has decided to leave the technical details of PSD2’s API to be defined by the market. The key differences that are developing between the two API standards are that in the UK, due to a pre-defined system, corporates can benefit from a centralised platform which will provide more convenient payment management, whereas in the EU there has been an emergence of various standards defined by different consortiums of EU Banks and Payment providers. One example of these ‘syndicates’ is the Berlin Group, which is comprised of 40 organisations which have defined a common API standard called NextGenPSD2.
Essentially, the regulation aims to ‘level the playing field’ by opening up consenting customers account and transaction data to authorised third party providers, and in turn granting these parties the ability to authorise payments directly from their account.
As pre-mentioned, there is a shared view amongst many that innovation in the banking sector has been fairly limited, Paul Volcker, former head of the US Federal reserve famously said that “The ATM has been the only useful innovation in Banking for the last 20 years” (2009). PSD2 and Open banking are aiming to redefine Banking across the EU and UK by:
- Taking steps to level the playing field for new and emerging payment service providers
- Increasing customer security and protection
- Lowering the price of payments and encouraging innovation
- Increasing, improving and integrating payment efficiency across the EU
- Providing clarity on the use of emerging payment methods
How? (Customer and SME)
So how is this affecting the customer and SME; the answer in short is that it is drastically increasing efficiency, primarily in three categories; Money management, Payments and Lending.
Money Management: Thanks to the implementation of PSD2 and Open Banking, it is now possible to view all your finances in one place: apps such as Mint and Yolt (ING) offer this, and we are starting to see more and more banks develop their own ‘open’ applications.
Payments: There has been a ‘cutting out’ of the middle man which has made payments vastly more simple and cost efficient. The customer, who consents to third party providers accessing their data, can complete a transaction whereby the money is taken directly from their account, without contacting ‘acquirers’.
Lending: The process of securing a loan, which includes proving to the company or investor, whether it be institutional lending or P2P, is becoming a lot straighter forward. The lender, for example can be given one off access to the income and expenditure data for the party they are investing in.
Apart from the obvious benefits to the customer and SME, the incumbent banks are facing a threat in the form of commoditisation, as third parties are now capable of owning the primary customer relationship via a separate single interface (other than that of the incumbent). There is also an increase in competition due to the emergence of more personalised and in-depth price comparison between account providers. However, banks can take advantage of data ubiquity by building more personalised customer experience and by developing new and innovative products.
How will the market react over the coming years?
As is the same with any legislation; its success will depend heavily on how well it is regulated and enforced, but a recent report by PwC predicted that by 2022, £7.2bn revenue will have been created by open baking and 71% of SMEs and 64% of adults to have adopted the legislation. The opening up of data will lead to an increase in the number of financial institutions ‘in the game’ which will in turn increase competition, meaning the customer will benefit from cheaper, safer, more efficient and more personalised services.