An analysis of banks’ threats and opportunities after the introduction of the PSD2

Laura Kaiser, Allard Lubberdink, Giulia Monaco

February 2017

Introduction

In the digital age, the European financial service environment is continuously changing due to the rising importance of the internet. Increasingly new market participants enter the market of financial services. Customers are no longer solely dependent on banks, since non-banks offer financial services via digital channels that are less costly, more efficient and convenient, than banks’ services used to be. Despite the large number of benefits, that the data and algorithm based financial services offer, they also face several problems. For instance, their product portfolio is relatively one-sided, they indicate high rates of failure and normally do not remain in the long-run on the market. Nevertheless, banks’ original benefits such as financial expertise, risk assessment, crisis experience, evaluation and management are threatened by the changing consumer behavior and the stringent regulatory and budget constraints, that hinder banks a lot to catch up with their online services.

The introduction of the revised payment service directive (PSD2) requires that banks, and especially non-banks in the field of digital financial services, provide more transparency and have to face new legal regulation.

Payment service directive 2

In January 2016, the legal framework for payment services, PSD2, entered into force and by 13th January 2018 all European and European Economic Area member states have to fully implement

the directive. The PSD2 is the revised directive of the PSD that was implemented in 2009 after the EU commission’s review of the first PSD in 2012.

The second PSD leads to an obligation for banks to allow third-party providers access to their customers’ accounts through open application program interface (API). This disclosure only covers clients’ information about their transactions and balance data. Customer information such as age, gender or other information acquired by the bank are not included in the directive. That means, that banks are not obliged to expose these data. Nevertheless, thanks to the PSD2,

Third Parties Provider (TPP) will be able to build services on top of banks’ data and infrastructure, enabling bank customers, both consumers and businesses to manage their finances.

One of the main aims with the introduction of the directive is to foster innovative and new types of payment as well as financial services by increasing the competition in the market.

Another reason is to improve the consumer protection and securities that is especially for online payments and account access important.

The directive introduces two new types of financial services: the payment initiation service providers (PISP) and the account information service provider (AISP). The PISP initiates a payment order at the request of the payment service user with respect to a payment account held at another payment service provider, mostly used in the field of online selling alternatively to card payments. The AISP is an online service that provides consolidated information about one or more payment accounts held by the payments service user with either another payment service provider or with more than one payment service provider in order to manage and analyze his transactions and spending pattern. As a result the originally monopolist position on their customer’s transaction data and payment services of banks will diminish, due to the rising meaning of non-banks and its increasing market shares.

The PSD2 comes along with several changes in the European landscape for financial services. Noteworthy are the traditional payment value chain, the use of account information, customer expectations and the profitability of business models that will be affected and transformed under the new directive. Consequently, banks have to seek for relevant strategies to remain their strong positions in the market. Namely, the value of data analytics and customer experience in banking,

innovative financial service products and banks’ potential first-mover advantage over non-banks, become more and more important

Present and future threats

The competition of external players to the traditional banking sector is getting stronger every day. This a threat that can become a great opportunity of diversification and development with large advantages for customers. The entrance in the financial sector of these non-banks organizations and technology giants is subduing the banking under an unpredictable stress test.

The introduction of Payment Services Directive (PSD2) is now going to quicken payments’ innovation and advance everyday payments to a new stage of progress. When companies like Amazon, Facebook, Google, or the large-scale retail are managing hundreds of millions of customers, ready to control growing volumes of financial transactions, banks have no other alternatives than to react or disappear.

Accordingly, PSD2 and the combined effects of other regulations (e.g. SCT Inst, e-identity) increase the regulatory and competitive pressure on payments market. Such as they support a reshaping and create opportunities for the development of new business models. Banks offer more evolved financial services than the new competitors, but the market is soliciting for different services, more adequate to the developing behavioral cultures. A digital-divide is emerging and it raises two issues: the care of the traditional client and the achievement of new users.

David Gyori, CEO of Banking Reports, defines the Innovation Paradox[1] as the contradiction between the main message from regulators after the financial crisis of 2008 about reducing risks and the main message of innovation from the public. As the fast-evolving financial landscape with increasingly digital customer expectations and the threat of disruptive, FinTechs requires banks to innovate to survive.

We can see this in the form of FinTech companies and traditional financial services providers supplying new digitally-enabled services or forming unconventional partnerships in an expanding payments ecosystem. They are taking advantage of banks’ technological backwardness and operational slowness, but at the moment they don’t have that credit specialization that is the core asset of banking.

PSD2 brings substantial economic challenges for banks. Due to new security requirements and the opening of application program interface, IT costs are expected to rise. Banks will need more experimenting with their APIs in order to face the changing customer expectation and increasing digitalization. Accenture estimated that 9 percent of retail payments revenues will be lost to PISP services by 2020[2]. Relationship banking will become increasingly difficult due to the fact that non- bank organizations will be taking over the customer interaction through the API’s. As a result, it will become much more difficult for banks to differentiate themselves.

As PSD2 will increase the opportunities for companies without a banking license to enter the financial market, it is likely that the trend of amplified consumer trust in non-banks will continue to grow. Following Evry A/S[3] analysis, customers’ trust in Fintech companies will probably lead to an open domestic market in the near future, with mostly national providers (banks, Fintech and other non-bank companies) that will compete to provide the best and most specialized solutions to consumers. Eventually, that would create the appropriate environment (with fewer barriers and

uniform regulations) to allow the banks with the strongest position to grow bigger and take a large share of the European market. So that it would turn into a unified

European financial market, accordingly to the changes in the consumers’ habits and introduction of new EU directives. Indeed, a European financial market is one of the desired outcome of both the first and the revised PSD.

But also opportunities

According to Cortet, Rijks and Nijland (2016) banks should consider the two following questions with regards to their position in the financial services industry in the post-PSD2 era: What position is my company going to take in the payment value chain? And which types of transactions will we be offering in the future? In other words what will be the use of banks in the transactions of consumers in response to PSD2? The business model of banks should definitely change in order to keep up with the accelerated competitiveness, transparency and digitalization.

Light, MacFarlane, Barry and Ruotsila (2016) have provided some insights into which strategies might be worth pursuing for banks in the post-PSD2 era. The first of these options is to comply with PSD2 without the implementation of any further options for customers. If banks choose this option they actively narrow their focus on their core business, that is mainly the provision of liquidity and infrastructure services (Cortet et al, 2016). In that case, a Third-Party Provider (TPP) offers the remaining services like the supply of the entire customer experience (Light et al., 2016).

The second opportunity for banks is to facilitate and monetize access to additional customer information. PSD2 requires banks to give access to transactions and balance data, however it does not require them to hand over all customer information they possess, such as age, gender or other information acquired by the bank. These datasets are very valuable to TPPs and therefore provide an opportunity for future sales. Banks could create new services and products in collaboration with third parties, using these datasets to speak to the more specific customer needs of the future (Light et al., 2016). For example, if someone has recently bought a car, the bank could allow access to their data to an insurance provider, given that the customer agrees on this.

The third strategic option that Light et al. identify, is that the business and market insight the bank has, could be leveraged. By aggregating all transaction data, the bank receives over all consumers, market and performance trends can be identified and pin-pointed to different groups of consumers. If, for example, a company is planning an expansion, but does not know the direction in which to expand, the bank might be able to provide support and insights. Their insight originates from the transactional data they receive in combination with all the other data banks, that are not required to expose as a result of PSD2 (Light et al., 2016).

A fourth, more extensive, strategy is the investment in and partnership with these third parties that are threatening the banking business model. It could take the form of the creation of new services and products that would be owned by the third parties but would be accessible for consumers through the bank’s API’s (Light et al., 2016). This implies a partnership regarding the services provided for longer periods of time. Or it could take the form of a consolidation of financial and non-financial data of the bank and several third-parties to create a new portal that helps consumers with all their everyday needs, as well as all their transactions for an extended period of time. As a result, the bank establishes a position at the center of everyday life of the

customer and is able to give customized advice on what to buy and support all purchases of consumers at any time (Light et al., 2016).

The strategic options identified by Light and his team can all provide some future profits for the bank. However, not all options seem to be equally profitable in the future. The alternative to simply comply with PSD2 without the introduction of any new strategy, will result in considerable downsizing and profit loss. Nonetheless, the upside of this option will be a more solid position in the market. The sale of data and the sale of market and business insight as suggested in option two and three respectively, are more future oriented and seem to be more viable options that shift the focus of the bank. The last option provided by Light regarding the investment and collaboration with new competitors seems to be the strategy with the best future perspective, because the bank is able to remain in the center of the ecosystem. However, this possibility might not be as easily realizable as suggested, because most FinTech companies are not willing to collaborate with banks as this would result in an enormous inflow of regulations and bureaucracy.


Footnotes

[1] David Gyori (September, 2015), The Banking Innovation Paradox
[2] Accenture (May, 2016): Seizing the Opportunities Unlocked by the EU’s Revised Payment Services Directive. Everyday bank research series.
[3] Norwegian information technology company operating in 16 countries that supplies services relating to computing, including operation, outsourcing and online banking.

References


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