PSD2 Opens New Doors for European Banking
13th, January 2018 was a red letter day for the European financial services industry when the long-overdue Payment Service Directive 2 (PSD2) regulation came into force. PSD2 has authorized an entity called Third-Party Provider (TPP) approved by the regulators (FCA in UK or other competent authorities in the rest of Europe) to make payments and use customer data with consent. Banks are expected to provide required access to their core systems through APIs to TPPs for efficient execution. The macro objective of PSD2 is to fuel innovation in banking services through effective use of technologies.
Traditional Banking Model – A Walled Fortress
Traditional banking model was built on trust with banks adopting a closed wall policy and a strong compliance culture. They often operated product-centric business units independently with minimum interaction among them. This has led to inefficiencies and poor customer experience. However, in the last few years, digital technology revolution has been sweeping the marketplace which sensitized the consumers to the experience they receive from service providers. While most of the industries are keeping pace with technology and changing customer experiences, the banks have been slow to change due to lack of collaboration among internal functions and external parties. PSD2 disrupts this scenario with a mandate to banks to be sensitive towards the experience demanded by new generation consumers.
Embracing Open Banking Business Model
The primary focus of any financial regulation is to minimize systemic risk and promote retail consumer protection. However, PSD2 unlike most financial regulations strives to create a competitive environment based on customer service innovation. In that sense, PSD2 is being viewed by some banks as an existential threat. Hence the banks are in a hurry to adopt a new "Open Banking" business model. This is the biggest change in retail banking industry since Automatic Teller Machine (ATM). Though PSD2 is currently focused on payment accounts, it is going to expand into a comprehensive Open Banking model transforming the entire banking industry. In the UK, competition and market authority (CMA) has already directed the largest nine banks to come up with an open banking standard.
The initial phase of the PSD2 implementation journey will need to focus on modernizing the back-end systems into micro services-based architecture and developing an integration layer that wraps around them. In the next phase, the banks will need to focus on developing new value-based APIs which can be accessed by various internal business functions as well as third-parties through rigorous authentication. As most of the countries are working towards implementing digital identification of their citizens anyway, potential security risks can be effectively managed by requiring authentication through digital identity. In the UK, HSBC is leading the pack by implementing Mule ESB (Enterprise Service Bus) for total service integration and API management. In the final phase, banks are expected to build new business models that encourage collaboration with end consumer, third-party technology firms and/or their banking peers.
Collaboration with Consumers
A typical consumer initiates several financial and non-financial transactions daily. She most likely works on disparate platforms serviced by different institutions in executing those transactions. As the consumers are shifting towards hyper-personalized services, artificial intelligence (AI) based technologies are making it possible to service these next generation services effectively. The Open Banking standard will enable these kinds of collaboration technologies on top of the existing banking platforms. On the other hand, today’s tech-savvy consumer can readily develop his/her own self-service channels by using bank-provided APIs. It will enable a holistic view for the consumers through a single platform of their choice.
Collaboration with Third-party Technology Firms
Competition from third-party technology companies has been fierce even before PSD2 as they employed technologies such as screen-scraping to integrate disparate platforms that included legacy applications in the mix. However, with the advent of PSD2, most technology companies are expected to access customer data using APIs. While banks have a vantage point with respect to managing risks, compliance and customer needs, third-party financial technology (fintech) firms will be spurred by service innovation on their platforms. Hence, collaboration between banks and third-party tech firms will provide a new fee-based revenue opportunity for the banks. For example, banks can market specialized services such as credit check service and proof of income service to fintech firms. Open banking model will breathe new life into products like mobile wallets and personal account aggregation from third-party fintech companies. As a survey by Accenture indicates, ninety percent of bank executives think that open banking will boost their revenue by ten percent.
Collaboration among Banking Peers
Consider the case of a typical customer who prefers different banks for different products. She may have a savings account in one bank, but loan, credit and investment accounts in another. In such a scenario, Open Banking will greatly ease the process of dealing with multiple processes such as client onboarding, Know Your Customer (KYC), fraud monitoring and over-draft by enabling stronger collaboration among peer banks. Having a complete view of the customer's financial position will also help them in developing highly personalized products and services. Overall, this type of a collaborative environment will help banks in expanding their market share and shedding redundant practices. In the US, for example, a new peer to peer (P2P) payment application, Zelle® stands as a great example of what can transpire when nineteen leading banks join ranks.
PSD2: The New Frontier – Unlocking Innovation and Growth
Consumer is at the core of the new collaborative frontier sparked by PSD2. The Open banking model will help in balancing risks and opportunities. Consumers will be able to receive substantial benefits from the banks and other firms without taking undue risks. On the same token, banks will be able to add to the topline by building a new partner-based ecosystem. In the next ten years, Open banking is going to transform the entire European banking landscape by promoting stronger business collaboration between banking and non-banking institutions.