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The implementation of PSD2 poses far more than a regulatory compliance challenge for the incumbent players, writes Serena Smith, division executive of international payments at FIS.

IS EUROPE ON THE BRINK OF A REVOLUTION?

The European payments landscape is undergoing a seismic transformation, the largest upheaval since the introduction of electronic payments. By 2022 European payments will be almost unrecognisable. Perhaps the most universal change will be the decline of cash and cheques and the rise of alternative payments. Payment service providers will enjoy a larger potential revenue pool and with a forecast CAGR of 10.9%, electronic payments is certainly a growth industry.

However, the industry also faces many challenges. The combination of regulation, technology and rising customer expectations are driving change. We believe success in this new era requires fresh thinking and a holistic view of payments. While this may seem simple in theory, it may require a fundamental review of business models and support systems. Why?

The payments landscape is an accident of history. In the beginning there was cash, then cheques arrived, followed by electronic payments, cards, online, mobile and so on. Each new instrument has its own scheme, rules and support needs. New instruments are always an addition to the existing processing burden, resulting in a siloed environment that impairs business agility and carries a staggering total cost of ownership (TCO). But it’s worse than that – there are disruptive forces that comprise a perfect storm for banks wedded to traditional business models.

OPEN BANKING AND INSTANT PAYMENTS – LIKELY BEDFELLOWS

Thus far, the world has embraced the notion of “instant” with new real-time payment schemes, like the New Payments Platform (NPP) in Australia. Following the same notion, the revised Directive on Payment Services (PSD2) will herald in a new era of open banking aimed at making European banking more competitive and democratic.

Among many changes, banks will be required to provide access to account information and payment initiation to regulated third parties, but only if the customer consents. Although the regulation does not prescribe technology, there is universal agreement that the application programming interface (API) will be a major catalyst of open banking. This challenges the traditional bank/customer relationship by forcing banks to manage not only the end-to-end value chain, but also become manufacturers of products that regulated third parties will distribute. Managing this new three-way relationship with customers will be critical to a banks success in a PSD2 regulated environment.

INSTANT PAYMENTS RAISING EXPECTATIONS

Closely aligned to open banking is the arrival of instant payments, through SCT Inst. Real-time technology is transforming the way individuals and businesses interact with their bank.

In the UK, Faster Payments have become ubiquitous in P2P payments and business has embraced universal instant business payments. People love the immediacy, convenience and security of Faster Payments: volumes have increased, limits raised and new, exciting overlay services created.

But it isn’t all about speed – core money movement is becoming a commodity. So, a key factor driving the uptake of modern real-time rails is the ability to add value to the transaction. Real-time technology has also heightened customer expectations about what their banking service should provide.

NEW PLAYERS WELCOME

PSD2 encourages non-traditional players into the banking market, particularly fintechs. These organisations are lean, agile and unencumbered by traditional thinking and legacy technology. Their tech-first mindset means they are well positioned to pursue open-banking/API initiatives. There has been plenty of talk about the threat of fintechs, but in practice they are likely to be complement bank services.

The fascinating area to watch is the extent to which the GAFAs (Google, Apple, Facebook & Amazon) expand their interests in payments and financial services. Larger retailers and utility providers may also threaten existing bank revenue streams.

Although no one knows exactly how PSD2 will evolve, it is hard to overstate its potential impact. European banking has changed forever, traditional relationships are under threat and banks need to do things differently. So, what should they do?   

BANKS MUST BUILD ON TRUST

Banks must capitalise on customer loyalty and confidence. In practice, open banking and instant payments are highly complementary and provide opportunities for banks to offer new services that deepen customer relationships. How? People trust their banks much more than technology companies. Recent research commissioned by FIS, shows that 47 percent of people trust banks over technology providers (16 percent) to provide them with an app to manage company finances.

A bank can act as a ‘safe harbour’ for consumers and businesses to use third-party applications. It can promote itself as a ‘control centre’ for customers so they feel more in control of their data. Customers will feel more confident about choosing third-party apps that are promoted by their own bank. New apps will build customer loyalty and generate new revenue streams.

MANUFACTURERS, DISTRIBUTORS, PLATFORM PROVIDERS – OR ALL THREE?

PSD2 changes the way financial products are manufactured and distributed. Participants must choose what role/s they wish to play. Under PSD2 they can continue to manufacture and distribute their own products but may also distribute third-party financial products, creating an Amazon-style ‘marketplace’.

PSD2 promotes both competition and cooperation. The role of the aggregator will be the key to building continued trust and cooperation among customers, and competitiveness with third parties and other banks – the party that leads the future relationship will have major influence on the bank behaviour of customers. Although regulation is driving this change, if banks want to be aggregators of their customer relationships, they need to go beyond legislative requirements and take more prescriptive action.

Banks can solidify their position in the PSD2 era is by electing to become an account information service provider (AISP), which creates new opportunities for them. Some major banks already have open-banking applications that allow their customers to view all their accounts, including those held with other banks. Such initiatives position the bank firmly in the fintech landscape, deepen the customer relationship and facilitate targeted marketing.

PSD2 also provides for an organisation (including a bank) to become a payment initiation service provider (PISP). For example, if a large supermarket becomes a PISP, payment for goods may be made instantly from the retailer’s app, as an alternative to a debit or credit card. The retailer may incentivise participation through a loyalty programme and will simultaneously avoid credit card fees and generate cross-selling opportunities. This scenario could play out in many payment situations in both retail and online, reducing payment friction and increasing customer convenience. Further benefits will be available in B2B payments, which require more sophisticated liquidity management and treasury tools, and where greater automation could significantly reduce administration and cost.

These examples demonstrate payment convergence, which is already underway. Whilst the changes in card payments have not been so dramatic, growth remains robust through contactless pay and tokenisation developments. Banks must be able to support all payment types equally and cost-effectively. Achieving a holistic view of payments is an essential prerequisite to maximise the benefits of PSD2, but few banks can achieve this without help. 

BUILDING FOR SUCCESS A HOLISTIC PAYMENTS BLUEPRINT

Payment providers, whether new or established, need technology partners that can boost their business agility and responsiveness. They must be able to deploy solutions quickly and cost-effectively, while maintaining high availability, service quality and compliance. But with payment margins under pressure, the TCO of a payments infrastructure is uppermost in every CIO’s mind.

Against a backdrop of intense competition and compressed payment margins, payment providers need partners that can help them align their technology with the business plan. The move to open instant payment rails is an opportunity to review the blueprint for payments. In practice, this means technical partners must deliver much more than software products: they must offer market insight and a deep understanding of the dynamics and TCO of a payments business.

SEEKING SYNERGY

Although different types of card and non-card payments have individual specificities, in our experience, there are also strong potential synergies that may not be obvious. By adopting a holistic view of payments, payment providers can identify areas to streamline and consolidate in core processing systems, but also in peripheral systems, such as fraud detection and dispute management.

Many traditional payment providers that have grown up along product lines are unable to realise these benefits without the help of a partner. An able technology partner must offer an integrated blueprint solution, such as FIS PaymentsOne, which delivers a seamless platform. Once the overall payments blueprint is understood, the transition to greater integration of payments can be modular.

SOFTWARE OR SERVICE?

No discussion about payments challenges would be complete without a mention of cloud-based payments as a service (PaaS). We are receiving great interest in our managed service, which is designed to insulate payment service providers from change and remove many integration barriers.

However, all payment providers start out from different points and we believe that technology partners should not be prescriptive about deployment. PaaS may be the right solution to the immediate opportunities for SCT Inst and open APIs, but we firmly believe that clients should have the choice of world-class payments components as either licensed software, a managed service, fully outsourced, or as a hybrid solution. The key is to ensure smooth integration, regardless of hosting arrangements and to reduce unnecessary friction and costs. We know that banks and payments providers are managing in a whirlwind of change so what’s right for today, may need to adapt tomorrow.  

TIME TO ACT

Some banks have embraced the new open payments landscape and have a bold vision of their future position. Others have adopted a more cautious approach: they are prepared but will be driven by market demand. While a ‘wait and see’ attitude is understandable, doing nothing is not a viable option. In the not too distant future, a payment will be a payment will be a payment. Banks that address PSD2 as simply a matter of compliance run the risk of becoming bookshops in the Amazon age.

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