Technological innovation has always had an influence on banking. The scale and pace of technological developments in recent times, however, has the potential to drive change at unprecedented levels, with many commentators suggesting that we are witnessing the early stages of a digital transformation of the industry. For instance, the beginning of next year could see the start of what some anticipate as the ‘open banking revolution’ – where retail banking and the wider financial services sector embraces the full dramatic potential of technological change and where consumers could expect to benefit from a range of new providers and services.
A key driver for this new change is the upcoming implementation deadline for the second Payment Services Directive (PSD 2), widely regarded as a fundamental and comprehensive piece of EU legislation. PSD2 is designed to create a common regulatory framework that facilitates a more integrated and efficient payments market and will encourage the emergence of new payment service providers (PSPs), including fintech companies and other payment institutions, to provide new payment services to consumers and businesses, through utilising shared data. Crucially, this legislation will force banks to allow third parties to access the data of customers who authorise it. This is expected to facilitate innovations and developments in mobile and internet payment services, such as new smartphone apps that can manage customers’ personal financial data and identify suitable products across a range of financial services providers. For consumers, it could include a range of benefits, such as access to better value and more suitable products and the ability to gather consumer financial information from multiple sources into one “head-up” display. For the industry, this has the potential to cause significant disruption to the retail market and threaten the dominance of established players.
The deadlines for implementation are tight and could represent a challenge for banks to ensure that their internal systems are ready to facilitate the new system of open banking. This Directive requires that all Member States implement these rules as national law by 13 January 2018. The UK, of course, remains an EU member state until 2019 and HM Treasury is currently undergoing a consultation on the Directive’s implementation into UK payments regulation. Many of PSD2’s technical standards and guidelines are being determined by regulators at the European Banking Authority (EBA), who will set out regulatory technical standards (RTS) covering aspects concerning customer authentication and secure communication. Resolving issues around the use of personal data among PSPs will be complex, specifically with regards to the introduction of the new EU General Data Protection Regulation (GDPR) – which is also due to be implemented in 2018. There will be restrictions on what customer data PSPs use, how they use it and, in particular, what they store. As with many regulations, the devil is in the detail and we would expect some considerable debate as to whether the EBA’s approach to technical standards and guidelines are consistent with the stated aims of the Directive.
There are many, including new entrants and fintech providers, who see PSD2 as exciting opportunity to change the face of banking and address the high barriers to entry that has traditionally existed within the industry. There is, however, some scepticism about the benefits of the new regulatory framework and its ability to deliver the desired change. A number of concerns and reservations exist, which present risks to new market entrants.
Firstly, in terms of the sharing of customer’s financial data, security and trust remain a big concern for the industry and consumers alike. The Directive itself contains enhanced security requirements for payments institutions and in exchange for access to consumer core banking data, many PSPs would face much tougher regulation, notably over data protection. Whether these measures would be enough to provide sufficient user confidence in the legitimacy and reliability of new PSPs in handling financial data is largely unknown at this stage – although there is a degree of scepticism. Increasing levels of fraud and cybercrime in banking are only likely to fuel consumer distrust and put off those in ‘ticking the box’ that will authorise data sharing among banks and PSPs.
Secondly, there is no conclusive evidence that there is sufficient consumer demand for open banking or that it would drive the desired behavioural change among customers. It is no secret that there is considerable consumer inertia in retail banking, particularly in terms of current accounts, with levels of switching remaining incredibly low despite many Government and regulator-led initiatives to promote greater competition in the industry over the years (eg the Cruikshank Inquiry in the late 1990s or the latest CMA Retail banking market investigation). Indeed, statistically, a UK adult remains more likely to get divorced than change bank. It is clear, therefore, that a change in consumer culture would need to take place, alongside the necessary regulatory framework, to truly deliver the ‘open banking revolution’.
Despite these barriers and reservations, the potential for PSD2 to deliver industry change is significant. The emergence of new PSPs and fintech providers may see a more consumer-focused approach to banking, with the usability and functionality of new smartphone apps likely to prove an important competitive battleground in winning new customers. Many have considered that open banking will facilitate the entry of ‘tech giants’ into the financial services market – with the likes of Apple, Google, Amazon, Facebook and others having the necessary resources and brand recognition to overcome many of the concerns that may affect smaller players.
In terms of how PSD2 will drive price and product differentiation or facilitate innovation in the market in financial products, we may expect this to be limited at first, but there certainly is potential. A key question to consider is what are the situations that are compelling enough for the sharing of data to have a meaningful impact on consumers? One area would possibly involve mortgage applications – given the size of transactions and scale of lending involved in residential mortgages, the ability of payment providers to identify the most suitable product at the most competitive rate, becomes a very useful service. Another area could involve specialist forms of consumer credit, particularly those aimed at consumers who struggle to obtain finance from mainstream sources or ‘prime’ lending. For instance, while the payday lending market was widely seen as exploitative and was ultimately subject to regulatory intervention, it nevertheless provided a service to a portion of the market where there was considerable demand. With increased levels of access to personal financial data, it may be possible for specialist lenders to provide new types of ‘smarter’ lending products to these consumers, that are better catered to their needs, less risky and less exploitative.
Whether these limited changes prompt a wider cultural change in retail banking remains to be seen. The implementation of PSD2 is potentially one of the most significant regulatory and market developments in retail financial services, although given the challenges involved the ‘open banking revolution’ may not take place overnight.
Written by Mark Somers, Chief Operating Officer at 4most.