Will open banking really breathe new life into banking?

Pick up an article on PSD2 and you’ll be told that the world of banking is about to be transformed. Doubters are hard to find, yet:

• There doesn’t appear to be a consensus on the exact date you need to be ready.
• The definition of products in and out of scope is vague.
• Consumer awareness remains low.

Behind the optimism, individuals and organisations are still struggling to make sense of PSD2. What’s going to happen? And when it does, what will it look like and how can your organisation move to take advantage?

Recap: What is PSD2?

On 8 October 2015, the European Parliament adopted Directive (EU) 2015/2366, the revised Directive on Payment Services (PSD2). The regulation requires Europe’s banks to give third party payment providers access to their payment infrastructure and the customer data they hold.

The UK government has confirmed that Brexit will not affect the commencement of PSD2, and that PSD2 will be transposed into UK law alongside the rest of the EU in January 2018.

How does it work?

European banks will be required to provide so-called ‘open banking’. Licensed third parties will be able to access a bank’s data and infrastructure using standardised APIs (Application Programming Interfaces). There are two types of licensed third party:

1. PISPs (Payment Initiation Service Providers) will be licensed to use the APIs to initiate payments on accounts held by a bank’s customers.
2. AISPs (Account Information Service Providers) will be licensed to use the APIs to access and analyse balance and transaction data on accounts held by a bank’s customers.

Why was it created?

The FCA describes the aims of PSD2 as:

• Fostering more integrated and efficient European payments market.
• Improving the level playing field for payment service providers.
• Promoting innovation in online and mobile payments.
• Making payments safer and more secure.
• Encouraging lower prices for payments.
• Protecting consumers.

McKinsey describes the potential benefits of open banking as substantial, with “improved customer experience, new revenue streams, and a sustainable service model for traditionally underserved markets”.

The risks and opportunities of PSD2

An invitation to rethink banking

The open banking component of PSD2 is nothing less than an invitation to rethink banking. The walled gardens that banks have built around their customers’ data will start to crumble. The customer loyalty that banks have spent fortunes to build could be challenged. Traditional banks are in the driving seat, but if they hesitate, technology heavyweights such as the GAFAs (Google, Amazon, Facebook and Apple) – organisations that have globally recognisable brands and years of experience in API-driven businesses – are well placed to take advantage of PSD2.

Opportunities

The most impactful aspect of PSD2 seems likely to be open banking (it’s certainly the most eye-catching). If customers allow it, licensed AISPs and PISPs will enjoy unprecedented access to a platform on which they can develop entirely new kinds of products, services and experiences.

“Open banking is paving the way for an entirely new end-user experience in digital financial services, one in which the customer will call all the shots.”

Maikki Frisk, executive director, Mobey Forum

Open banking turns banks into data providers. New products and services built upon aggregated data could take many forms, but we see opportunities, and expect to see products emerge in the following areas:

Price comparison

By looking at customers’ actual spend on everything from insurance to energy, AISPs will be able to suggest better deals proactively, helping customers save money and undercutting passive price comparison websites.

Tailored offers

AISPs with access to a customer’s transactional statement data will be well placed to offer tailored products and offers, or to recommend, resell and broker access to the most appropriate products on the market.

Savings support

Compiling transaction data from multiple sources will give AISPs the chance to build sophisticated savings goal recommendations and tracking.

Debt managment

Greater visibility will allow AISPs to assess a customers’ entire income and expenditure, spot problems earlier, identify missed opportunities or suboptimal products and behaviour, provide new interfaces and identify and recommend the most appropriate consolidation packages.

User experience

By building on other banks’ technology, AISPs will be able to focus their resources on winning profitable customers with a superior user experience in channels such as web, mobile and chat.

Risk management

A better view of a customer’s financial habits will help lenders fine-tune their risk assessment and offer better deals, particularly for those without much (or any) credit history.

The field is open to any organisation that acquires the appropriate licence, but recent research by Accenture suggests that traditional banks that take a bold step could enjoy some first-mover advantage. It found that, six months before PSD2 has come into effect, 69% of UK consumers aren’t ready to share their bank account information with third parties. In other research by the same company, 76% of respondents had picked out traditional banks as companies they would trust to initiate transactions on their behalf (online retailers were a distant second with just 7%).

Risks

Because of its open-endedness, open banking comes with substantial risks, too. There is a risk of banks failing to embrace the opportunities of PSD2, and seeing other banks, retailers or tech companies eat their lunch. Equally, there’s a risk of overestimating the impact of PSD2 and wasting resources on it to the detriment of some other left-field advance such as machine learning.

New competitors

PSD2 opens the door to online retailers, fintech companies, technology companies and other trusted brands from outside the financial services sector. Banks have been looking over their shoulders at Apple, Amazon, Facebook and Google for years, and this may be the tech giants’ moment.

According to PWC, one UK retail bank thinks it could lose £20m of revenue per annum if the 10 biggest retailers become PISPs.

Customer attitudes might also indicate a readiness to embrace new payment and service providers from outside the financial services sector. The use of alternative payment services such as PayPal is already widespread, and people routinely entrust sensitive data to large technology companies.

“85% of respondents rate the security of these alternative payment services as ‘high’ or ‘very high’, and 82% ‘agree’ or ‘strongly agree’ that companies such as PayPal and Amazon can handle cash transfers as reliably and safely as their banks.”

PWC

Hesitancy

A lack of clarity around how PSD2 will change things may be fostering a defensive mindset among bankers. Interviews with senior banking executives conducted by PWC showed that almost all expect PSD2 to affect their business. Two thirds expect to be weakened by it, but “substantially fewer” than half of the executives “have a clear sense of what role PSD2 could or should play … and how it might support new business models”.

It might not work

Perhaps the biggest risk of PSD2 is that it won’t work, and that banks that jump in with both feet will overcommit.

Customers may not want it

Some consumers like to compartmentalise their financial interests, particularly their debts. For some, this is a matter of security or an insurance against fraud, while for others it’s simply because they don’t want their bank (or anyone else) to have a full picture of their financial lives. Services built on the back of PSD2 will have to overcome these concerns to succeed.

The precedents aren’t good

Midata is a ‘portable data’ initiative with similarities to open banking launched by the UK government in 2015. The purpose of Midata was to encourage competition in the banking, mobile phone and energy sectors, but the expected benefits simply haven’t materialised.

One of the expected benefits of open banking is the ability to provide consumers with personalised spending offers, but here too, the precedents aren’t good. In 2013, Halifax (Cashback Extras) and Lloyds (Everyday Offers) launched schemes offering personalised cashback offers to its online customers, but judging by the volume of participating retailers four years on, they can’t claim to have been a runaway success.

PSD2 business models

As well as ushering in new products and services, PSD2 could also lead to new business models.

1. The marketplace bank is the most full-throated expression of the openness of PSD2. The model imagines a service that has little or no banking infrastructure of its own, but acts as a gateway to everyone else’s. Users can mix and match products from the entire financial services marketplace, but access and manage those products through a single marketplace bank’s interface.
2. The fintech integration model sees banks expanding their offering beyond traditional banking products by cooperating closely with one or more fintech solutions. Starling Bank’s partnership with TransferWise, an arrangement that gives Starling customers the ability to make in-app transfers into 35 currencies, is an example of this kind of focused expansion.
3. PFM (personal finance management) provides an overview of an individual’s banking portfolio and tools to understand, manage and optimise it. Broader, easier access to customer data will make PFM solutions more useful and easier to put together. Some banks may choose to provide partial PFM solutions, simply being happy to let accounts held with competitors appear in their apps and websites, for example.
4. PFM middleware. Environments with lots of APIs tend to spawn middleware that simplifies the complex ecosystem of APIs into something more easily consumed by other services. PFM providers will face a sizeable challenge when developing systems that can handle all possible APIs. Instead, they may prefer to focus on user experience and offload that challenge to a third party, creating a potential entry point for big technology companies with deep pockets and considerable expertise in this area.
5. The Banking as a Service (BaaS) model sees banks leveraging their investments in technology and regulatory compliance to provide a banking back-end for organisations that want to focus on branding and customer experience. Being the opposite of the marketplace bank, BaaS has no customer-facing aspect at all and is only accessible to computer systems, via open banking APIs.
6. PSD2 opens the door for payment brokers that can make smart payments on a customer’s behalf. Access to customer data (and perhaps other third party data sources) will allow payment brokers to determine the most beneficial way to make a given purchase – choosing the appropriate credit card, store card or bank account based on interest rate thresholds, overdraft limits, promotions, reward points, cashback offers, user preferences or other data.
7. Security is a huge concern for users, and authentication is a complex operation that’s reinvented by virtually every provider in the financial services sector. There’s a clear opportunity for consolidation, and open banking may see the emergence of third party authentication providers that can provide strong, PSD2-compliant security and single sign-on services.

Who’s doing what?

PWC research suggests that 65% of banking executives intend to integrate foreign products and functionality into their services following the implementation of PSD2, while 44% plan to integrate their own functionality into foreign ecosystems. By 28 September 2017, a total of 17 organisations, including Barclays Bank, Danske Bank, Lloyds Bank and RBS, had listed APIs with the Open Banking APIs Dashboard.

Barclays is investigating what’s possible with PSD2 under the umbrella of its Rise innovation programme. In 2016, it collaborated with over 20 tech partners – including Microsoft, Amazon, IBM, Twitter and Google – in a global hackathon designed to “reimagine banking products and services in a post-PSD2 world”.

BBVA uses acquisitions to bring in digital expertise, and its purchase of Finnish startup Holvi points towards the kind of integrated services PSD2 could usher in. Holvi provides its customers with a range of business services such as online sales platform, an invoicing facility and a cashflow tracker. Those services will now enjoy “a two-way flow of knowledge” with BBVA.

Santander’s investment in Kabbage is another signpost for how aggregating data from multiple sources could change banking. The bank plans to offer working capital loans to small businesses, and will draw on multiple external sources, including credit ratings, social media, payments providers, online marketplaces and bank account history, for its credit scoring.

HSBC UK’s recently announced Beta platform takes a bold step into PSD2-enabled PFM territory by allowing customers to add current accounts and credit cards (and in some cases loans, mortgages and savings information) from 21 different banks, including Santander, Lloyds and Barclays. Features include Safe Balance, which shows how much disposable money you have before your next payday, and Spend Analysis, which categorises your spending patterns.

Smartphone-focused bank Monzo is trialling a feature that lets customers change their energy providers from inside its app. By working with price comparison site Energy Helpline, and partners Octopus Energy and Bulb, Monzo hopes to help you find a better deal and switch energy contracts with just a few clicks.

Conclusions

Open banking is a revolutionary concept in financial services, but not in the technology sector. Open APIs are the driving force behind IoT (internet of things) and an essential feature of almost all successful online platforms, from Twitter and Expedia to Amazon and Uber. Those businesses succeed in large partly because of the access they provide to third parties. By 2015, for example, Salesforce.com was generating 50% of its revenue through its APIs: eBay 60% and Expedia 90%.

As banking goes digital, an API-driven future is as inevitable as the internet-driven present that precedes it. The question isn’t whether open banking is the future, but whether PSD2 will be the catalyst that ushers it in. It’s the opinion of ieDigital that PSD2 could sustain entirely new business models, but that regulation needs to ultimately go further, encompassing all account types and financial data to make open banking the revolution it could be.

Banks should:

1. Understand the threats from inside and outside the banking industry.
2. Recognise the opportunities that access to other banks’ data will bring.
3. Embrace customer concerns about privacy and security with data guarantees.
4. Optimise the customer experience before hitting home the commercial opportunity.
5. Examine alternative business models.
6. Think big, but start small.

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If you would like to read what Briony Richter said on the topic, click here

Further analysis of this topic was also done, as Retail Banker International interviewed some of the 2017 Power 50 award winners, which took part while discussing this topic in October 2017. Read more of this analysis here.