PSD2: A threat or an opportunity for incumbent financial services providers?
Innovation and regulation have traditionally been positioned within the financial services market as opposing concepts. Indeed, regulation has been seen as being one of the main barriers to new entrants in the market and, when asked what looking for when investing in FinTech startups, venture capitalists have actively stated that they look for teams that have experience of dealing with financial services regulation. However, it would seem that this is changing.
The regulators around the globe are beginning to realise that the reactive rather than proactive approach taken to regulation in the past is no longer appropriate. This backwards approach means that regulation is often one step behind the latest innovation. This can either lead to negative unintended consequences, such as mis-selling crises and sub-prime mortgage lending, or drive entrepreneurs to countries where regulation is more facilitative, which ultimately drives profit away from the economy. But we have recently witnessed a shift in attitude. The UK FCA has introduced a regulatory sandbox, which allows startups to experiment in a regulation-free zone for a limited period of time and the regulators in both Singapore and Australia are looking to follow suit. The Singaporean MAS will also host the world’s biggest FinTech convention in October – but all of this, whilst an important step, is fairly small-scale in comparison to EU-wide legislation due to be implemented in early 2018.
The Payments Services Directive II (PSD2 or PSDII) is legislation designed to increase security and competition in the payments market; however, it has far broader implications for those operating in the industry. This is because one of the main requirements for compliance is that financial services providers open their back office up so that third party providers can access customer data directly when customers give them permission to do so. From a payments perspective, this means that a customer could hold their current account with NatWest but have all of their transactions conducted by FinTech Revolut, for example. However, it could also mean that ecommerce platforms, such as Amazon, take payments directly without having to go via a bank, or that mortgage brokers could automatically gain access to data on income and general spending habits of mortgage applicants rather than relying on customers having to submit this data themselves.
For incumbents this provides a number of challenges, not least from a technical perspective. Financial services providers of old will have to undergo significant tech upgrades to make their core operating systems compatible with the API technology that will be required to make them compliant. More concerning is the challenge that these traditional providers will also face of keeping their brands in the forefront of customers’ minds. There is a risk that, with the opportunity to have all transactions conducted by faster, cheaper FinTechs, that customers will simply see the high street banking giants as storage units for their cash kept in the background like a safe in a basement, and only interact with younger ‘flashier’ brands.
The scale of this challenge is so great that is difficult to see how PSD2 could be positioned as anything but a major threat to the likes of Barclays, Lloyds and RBS – yet it is possible for these big-name brands to treat it as an opportunity. For one, it will give them a chance to differentiate themselves from their competitors. Customers often find it difficult to distinguish between conventional providers. With the introduction of PSD2, incumbents will have the chance to partner with various FinTechs to offer their customers a far wider range of services than their counterparts. This in effect presents them with the chance to create an active loyalty with their customers, rather than the passive loyalty (where consumers stay with their current account provider because they have not pushed them away) that typifies consumer/financial services provider relationships today.
Furthermore, from this perspective, PSD2 actually releases the pressure on incumbent providers to compete from a technical perspective. Very few FinTech start-ups currently have business propositions that will be sustainable over the long-term (see the recent decision taken by Number26 to close accounts); instead, they will become profitable by acting as tech vendors for established providers looking to extend their current services – which is exactly what PSD2 will facilitate. With the technology provided by agile FinTechs, incumbents will be able to refocus resources on competing on product as they always have in the past. In other words, it will give both parties the freedom to focus on what they do best rather than focus on out-competing the other.
This dream will only be realised, however, if incumbents don’t wait too long to act. Challengers such as Fidor already know what they stand to gain from PSD2 and have actively begun their campaign to become leaders in the post-PSD2 world with their login with Fidor function in development and their current account features marketplace. In contrast, the fact that PSD2 does not have to be implemented until 2018 and the technical specifications have not been laid out yet seems to have given incumbents the impression that this is not a pressing matter. We at Mapa believe that this complacency is what makes PSD2 a threat to retail banks. Whilst it may not be possible to start outlining the exact specifications from a technical perspective yet, incumbents should be starting to look at what features and functionalities digital challengers are providing customers and how these features could be incorporated into their offering so that customers don’t choose to use other brands to conduct the associated transactions. Mapa can and wants to help with this.