March 17, 2017
Banking has always been a very conservative industry. If liquidity drops too low, entire markets can grind to a halt. Open yourself up too much and you become susceptible to fraud and theft. Striking the perfect balance is difficult. In every economy, one of the government's primary concerns is securing a steady flow of money in the door, while trying to ensure that it doesn’t fly out the window.
This is why it is rare to see dramatic changes to the banking industry. But that promises to change as a result of Europe’s recent guidelines on banking standards received a massive overhaul in 2016 in the form of PSD2 or the Revised Payment Service Directive. Once implemented, the new directive promises to remove the current monopoly that banks have on their customer’s account information and payment services. Banks will be required to provide services to facilitate these functions to any company that is interested in competing with them.
Customers and businesses will soon be able to use third-party providers to do everything from checking their account balances, to making money transfers and payments. This means that it is only a matter of time before you will be able to pay your bills directly through Facebook or Google, or download third-party software to do your online banking without having to set up a separate account outside of your bank. To accomplish this, banks are required to provide access to their customers’ accounts through open APIs (application program interfaces.)
APIs have been in use in other industries for decades and are a staple of any major application. At their core, they are a way for one program to talk to another without having to share their source code, or give access to all of the data that they are holding. This allows programs to communicate with each other simply and securely.
Banks have also been using APIs, but usually, they are for internal use only. For example, when you want to check your bank account balance online, you first log in to your bank's website. Then you authenticate yourself using a password and click on the account that you want to check. This is all done using private APIs that the bank has created to link their internal account data to their public website. But if another company wanted to access that account data directly, they could not do it. They would have to go through the bank's website or make a request to your account through more formal means. This is why when you want to log in to your bank’s website, you can only see the data from that bank. The banks fully control who can access it, and how.
Open APIs will change this by forcing banks to give the same access to your banking information that their website has. Banks will still be required to authenticate users and provide the same level of security that they do now, but they will not be allowed to restrict account owners to accessing it only through their services.
This will allow third-party financial service providers to build services directly on top of banks’ data and infrastructure. This means that banks will no longer be competing just against other banks, but against everyone who wants to offer financial services.
The European commission hopes that PSD2 will change the payment value chain by driving innovation, protecting customers’ privacy and opening up account access directly to each account holder. The two roles that third-party service providers will try to fill are the Account Information Service Provider (AISP) and Payment Initiation Service Provider (PISP). AISPs will provide read access to bank account data, while the latter will be able to initiate payments on behalf of users. At this point, P2P transfers and bill payments will mostly likely to be the first PISP services that developers focus on.
This will obviously affect banks bottom line. Increased IT costs and lower revenue from retail payments are going to be a reality. Banks know this and have already started experimenting with their own APIs, working with FinTech companies and trying to predict the desired customer experience.
One of the key problems facing European banks today is that despite being a heterogeneous continent, people are very loyal to products and services from their home countries. This is especially true of financial services. In 2015, as few as 3% of European consumers had used banking products from another EU country.
Maybe you think it is because all financial services are the same, so it doesn’t matter where you purchase them? This doesn’t appear to be the case as mortgage rates and interest on car loans varies widely throughout the region. While there are reasons for these differences, there are also opportunities that are being missed by both consumers and banks.
The primary barrier for banks is obvious: The costs related to following the regulatory requirements and compliance for each new jurisdiction are often higher than other opportunities that can be pursued at home. PSD2 hopes to open up European markets to banks by only requiring third-party financial service providers to follow the regulations of their home state while allowing them to operate anywhere within the EU. This would allow far broader access to a unified set of financial services than even the largest multinational banks currently have.
This would also effectively allow banks to operate in several countries through third-party service providers, all while reducing compliance costs. Consumers will enjoy the increase in transparency, making individuals more likely to trust cross-border service providers and make purchases in foreign currencies.
Conservative banks have long dominated the financial services market, but in today's mobile world of instant rewards and limited options, they will need to innovate quickly to hold their sway in the customer service department. Once the APIs are made public, any startup can focus on improving the customer experience while letting the banks do all the heavy lifting in terms of compliance and infrastructure.
Banks traditionally focus more on security, and that means controlling every aspect of the money flow. Giving up that control can be scary and risky. But considering that 37% of European consumers would be willing to change their bank if they felt that it was not using up-to-date technology, taking the risk seems to be the safe way to go.
What will the services of the future look like? No one knows yet. The first steps will be to digitize and streamline existing services such as amalgamated online banking applications, the expansion of contactless payment solutions, and the centralization/decentralization of all banking services. The adoption of APIs also will lead to several niches that will be filled by developers who focus on a single service to connect two parties, making banking and future development easier.
Consumers today are looking for services that faster, less formal, and more personalized. This is a difficult enough challenge in any market, but one as diverse as the European banking market poses a particularly daunting task – one that has a growing line of developers who are ready to take the challenge.