Whitepaper – How PSD3 Could Close the Gap Between Implementation and Actual Adoption

11 December 202311 December 2014 | Insights

The EU’s Second Payment Services Directive (PSD2) represented a turning point for the payments landscape in Europe. The primary goal of the directive was to enable a single integrated market for payment services through the regulation of banks and fintech payment service providers. Customers could benefit from enhanced transparency, ease of entry, and fair competition among brands.

The directive meant that banks would lose their monopoly over customer data. For years, banks have maintained the custody of customer data and set up investments and infrastructure to protect them. Third-party providers could now procure permission to retrieve account data of bank consumers (both business and retail) directly from them. Bank customers could use third-party developed apps to manage and make payments from their accounts.

For traditional banks, this meant losing a large part of their customer interactions. This led to banks becoming hesitant regarding implementation, partly due to business risks and partly due to security concerns.

APIs are the technological medium that allows banks to connect their payments and data services to third party providers (TPPs). This underlines the importance of APIs in fulfilling the core intent of PSD2.

While PDS2 clearly defined and regulated the “what” of open banking, it did not regulate the “how” of customer data being shared by banks with TPPs.

PSD3 a potential upgrade

The upcoming update to the Payment Services Directive, or PSD3 as it may be called, could address the regulation issues and other concerns associated with PSD2 and amend them to better suit the needs and capabilities of the various participants in the payments industry. The more streamlined sharing of customer data with TPPs could enable traditional banks and all involved parties to embrace the many opportunities offered by an open banking system. This will enable them to serve their customers in ways never imagined previously.

How Does Your Customer Benefit?

The PSD2 directive, introduced in 2018, was meant to drive innovation and competition in the market. It was in response to rapid technological developments that had already disrupted traditional banking systems with the proliferation of smartphones, data analytics, and the Application Programming Interface (API) economy.

There has been a huge proliferation of open banking APIs across the world. Globally, by 2020, open banking API products had seen a 381% annual growth rate. While banks are still lagging behind in shifting to new business models and opening their data up to third parties, they have also been laying the digital rails for future partnerships. In terms of the regulatory framework, Europe has led the world through its PSDs.

The exact nature of these open banking products is complicated, however. After all, who could have foreseen UBER when Google introduced its Maps?

Three distinct benefits to customers have emerged:

Money Management Tools: Firms that can access customer data can provide money management tools that collate financial information from multiple bank accounts and present it in one place in an easy-to-digest way, making it simpler for people to have a quick view of their financial status, create budgets, and monitor their spending via accounts prioritization settings.
Payments: The current payment system revolves around too many cards, user IDs, and passwords. The cards act as the primary channels between payers and recipients. With open banking facilitated by APIs of TPPs, people can skip past these systems and spend money directly from their accounts. The use of QR codes and barcodes can make transactions more secure. This would be quicker and cheaper, with the absence of middlemen. In fact, if open banking had been in place from the beginning, by exposing data in the same way, aggregators might not have been needed in the ﬁrst place. For instance, in June 2019, Mastercard launched its Open Banking Connect Hub, which enabled European PISPs and AISPs to connect to multiple banks via a single API.
Lending: To obtain a loan today, consumers have to provide the details of their finances, such as credit history and income, to qualify. Open banking allows them to provide that information online, where an investor can get one-off access to a year’s data on income and spending habits. On the other hand, a customer may be one click away from opportunities from different banks (already in place in some countries, which understood the benefits of exposing their data along with their attractive offers). Access to financial data can help in automating mundane tasks, such as tax reporting. SMEs can gain insight into their finances. An example of this is a start-up called Fluidly, which has developed an “intelligent cashflow engine,” to predict a business’s financial future, based on past transactions. Recently, Virgin Money announced a partnership with Fluidly to use the company’s scenario and cash-flow planning tools in helping businesses track their performances.

PSD2 Points of Failure and How PSD3 Can Help Overcome Them

PSD2 is an amazing concept in spirit and could have fostered competition if it had worked as intended. In reality, it is hard to set up and fragmented. Integrators, therefore, face massive challenges, which limits opportunities.

In Europe, PSD3 will need to simplify the process and address the following challenges.

Banks Approaching PSD2 Only from a Compliance Perspective

For banks, it has largely been a compliance and risk mitigation challenge rather than a serious business opportunity. They are developing expensive infrastructure and making it available for third parties, who in turn take over the primary customer relationship. They are positioned to make the most of this opportunity, yet they largely view it as a threat.

On the other hand, how many consumers are willing to share their data with third parties? An ING Survey on consumer attitudes towards open banking revealed that only 30% of the people across Europe were comfortable with the idea of sharing their data. Much remains to be done in reassuring customers of the advantages of open banking.

Is it a Directive or a Regulation?

Being a directive, PSD2 is open to interpretation in Europe. The realization of the directive has been largely left to individual banks. In this respect, the UK Competition and Markets Authority (CMA) has made matters easier by establishing a central Open Banking Implementation Entity (OBIE), supported by the 9 largest banks in the country.
The OBIE maintains API standards and provides relevant information, providing solutions and actions in disputes. For this reason, the core of TPPs, digital ideas, and open banking real benefits started and matured there; more than 50% of FINTECHs started their business in the UK.
PSD3 needs to create an EU-based hub that directs all banks on the continent in matters of compliance and mitigates hurdles.

Problems for Global Brands

More and more countries, including Australia, Brazil, Hong Kong, Japan, and the UAE, are now carving out their own open banking regulatory frameworks. However, the lack of a single unified global API standard gives rise to complexities in processing transactions between nations.
Banks will have to acquire licenses and permissions to operate their APIs in these countries. Moreover, different regions vary in terms of local market forces, technical abilities, and support structures.

The role of financial aggregators

Financial aggregators are paving the way for the future of open banking, as they form a crucial bridge between banks and consumers’ financial data by linking bank APIs with TPPs. Data aggregation service providers can use consumers’ financial data to provide them with relevant summaries of their finances in one easy interface. Financial aggregators offer benefits to banks as well, allowing them to offer more relevant and personalized services to their customers, including personalized financial wellness advice and wealth management. Due to the large number of banks and their changeable APIs, a fintech may call multiple aggregator platforms (BMPI) to cover all its banking needs. By leveraging these platforms, in exchange for a subscription fee, fintechs can focus on their core business.

Have Banks Been Looking at it Wrong?

By significantly reducing interest rates, central banks globally aimed to stimulate economies back on track from the pandemic-led collapse. However, this has led to a reduction in banks’ net-interest margins. Economists and business analysts expect this squeeze on margins to continue until 2025 and probably beyond. In the Eurozone, bank margins could decline by 8 basis points going forward.

Banks have been looking at PSD2 as a compliance requirement, rather than a revenue-sharing opportunity. They need to tap into the consumer demand for accessibility, speed, and convenience in payments and banking services. The pandemic has only exacerbated these needs, as most people continue to work from home.

Reducing Friction for Customers by Establishing a Holistic Ecosystem

Banks could have the opportunity to act as platforms for multiple services across a wide range of areas. These services previously included multiple steps. Providers (including banks) can bundle them together into a single point of contact with the bank. For instance, banking customers tend to invest in various financial products, like insurance, loans, pensions, and more. For them, these products are not independent of each other, but rather a set of tools that enable them to lead their life comfortably.

By establishing a single interface, banks will be able to provide customers a seamless and holistic view of their financial products. They will be able to understand customer needs in a better way and develop products and services accordingly.

Even within the EU’s most advanced markets, several banks still do not have clear open banking strategies and view it from the regulatory compliance perspective rather than recognizing the commercial benefit. The quality and reliability of APIs differ significantly too, depending on whether open banking is perceived as a regulation or a revenue-generating opportunity.

Apart from the UK and the EU, other major countries, like the US and China, have their own aggregators to offer better customer experience. The true potential of open banking can be reached if PSD3 is really able to link customers across the world. However, for this potential to be realized, an international body needs to ensure the directive is implemented correctly. On the other hand, lawmakers are mostly not technologists, which may limit the progress of such regulation.

Nonetheless, we look forward to PSD3. It will not only promote a level playing field for all market participants but will likely also explain technical specifications and requirements in greater detail.

Conclusion

Open banking is still in a nascent stage, and the implementation of PSD2 has been patchy at best.

Some countries, like the UK, Germany, France, Sweden, and the Netherlands, have achieved substantial growth in the TPP ecosystems since 2018, while other countries are tech laggards.

Europe recorded 450 TPP registrations as of December 2020, with 200 of them in the UK.