Waiting at the departure gate at Heathrow Terminal 2, dressed as an eskimo as I didn’t trust the weather reports for Hamburg! The question I started to explore: Is Payment Service Directive 2 (PSD2) and Open Banking friend or foe for banks? There are 2 key players influencing change, the European Banking Authority (EBA) who have issued PSD2 and for the UK in addition to PSD2 the Competitions Marketing Authority (CMA) who have issued the Open Banking Initiative. People refer to these two bodies interchangeably, however there are differences. EBA is one of the key stakeholder for the CMA thus the overlap.
PSD2 and Open banking in a nutshell.
Lots has been written about PSD2, a directive which is data and technology led, set to accelerate the digital disruption which is already changing the banking world. If implemented with the right mind set PSD2 will introduce competition and generate new interaction and business revenue models. Read more about PSD2 on the European Banking Association (EBA) site. Here are the salient points, there are essentially 3 things to note. Banks are required to provide access to accounts (A2A) about their customer’s account/ payment (with the customers permission of course) to regulated third party providers (TPPs). This can be in the form of account information (transactions, balances etc) and payment initiation. The TPPs can be segmented into 2 parts Account Information Service Providers (AISPs) and Payment Initiation Service Provers (PISPs).
Open Banking came out of a market investigation by the CMA into the supply of retail banking services to Personal Current Account (PCA) customers and to small and medium-sized enterprises (SMEs) in the United Kingdom. The report outlines the findings and remedies. There is a great overview document which sums up Open Banking. In summary the CMA requires banks to enable personal customers and small businesses to share their data securely with other banks and with third parties, enabling them to manage their accounts with multiple providers through a single portal (the overlap with PSD2). Banks must publish information on quality of service on their websites and in branches, so that customers can see how their own bank shapes up against the competition. Banks have to remind their customers to review whether they are getting the best value, banks must send out suitable prompts such as increase in charges so customers can make informed choices in switching banks. List of the main remedies can be found here.
How will banks respond?
Banks are at different stages of maturity in their thinking and how PSD2 will effect their business models and revenue streams and what opportunities or threats they present. Banking can be visualised as 3 layers.
1)Experience layer (icing)
2)The process layer (jam)
3)Backend technology layer (cake)
Banks will need to decide on their strategy on which layer they want to compete in. Banks may want all layers of the full cake: provide all services end to end for customers. A vertical slice of the cake providing specific services only end to end or a specific combination of layers of cake. Banks have 3 main options, the services, size and market share they provide will dictate their strategy.
1 ) Do the bare minimum:
This will be the choice of niche private banks that have a personal relationship with their customers, they may not see this as an immediate threat or opportunity, just a regulatory change. For now they are more likely to do bare minimal and provide strong customer authentication, provide account information, payment initiations and open APIs. The strength of this relationship is key to ensure these banks remain relevant in the short term. I would expect however these banks to start transforming their business and system architecture, using the work carried out for the EBA and CMA as the blueprint for an open API, micro service approach. For the big high street banks who chose to do bare minimal and not transform their business and system architecture they will start to lose their relationship with their customers. This may not happen immediately however as more and more services and innovative products come to the market and market place banking takes off there is a real danger they will become invisible or irrelevant over time.
2) Partner the capabilities to 3rd party provider market place banking:
Banking is an expensive business, the margin on profits are rapidly depleting and with the cost of regulation, banks may not have the investment to build out the capabilities in-house. In this case they may want to buy or partner with third party providers and fintech. In the market today there are a multitude of offerings, technology consultancies are very busy churning out PSD2 blueprints, off the shelf services and API technology stacks for banks to consume. Fintechs such as Token are providing authentication services for banks to connect to TPPs. Amazon Web Services (AWS) have partnered with Mulesoft to provide solutions that banks can lift drop and integrate into their business.
Choosing this option might sound like a silver bullet, it ensure that customers can take advantage of innovative new services that are emerging whilst the bank still maintains and builds their relationship with the customer. Banks will need to be clear on what services they outsource or partner with and be sure to check long term operating costs and licensing cost. Banks will need to ensure the way they integrate with the services is loosely coupled using open non proprietary technology to avoid lock in and ensure flexibility to change providers. In theory API micro service approach provides this flexibility.
3) Create capabilities in house:
Big banks with enough cash flow and technical skills will probably adopt this approach. They will re-architect their business and system architecture to create new products and services over and beyond the ones mandated by PSD2. Note: Banks will still make use of third party providers such as AWS etc to host their services. Banks will need to have a clear plans on transformation if they bite off more than they can chew then they will have too much work in progress (WIP). Too many moving parts will create inertia and no true value will be delivered. The common sense approach of defining key deliverables, defining minimal viable products (MVP), starting small and ensuring organisational WIP limits will go along way to prevent delivery inertia.
Friend or foe?
In the short term PSD2 and Opening banking may feel like a real threat to traditional banks, in the long term it is a golden opportunity for innovation. With the right mind set, it opens up a whole new world of opportunities for banks to embrace working with customers to delivery their needs now and in the future. The ecosystem will change substantially where customers expectations of experiences will become fluid, banks will need to be set up to react to these fluid expectations.
As long as the banks align their strategy and delivery to take advantage of the PSD2 and Open Banking this will be great opportunities for banks. Today, a product’s user interface is the main touchpoint, however, API interfaces will become the new norm. This shift will rapidly piece together components, via APIs, into a new product, or sub-product. For banks it provides opportunities for new business models and revenue streams and untapped customer markets.
From a business stand point banks will need to get clarity on which layer they want to compete in experience, process back office area or all areas. They will need to define their core competencies what they are good at and what services they can consume from other players. They will need to redefine their business models and value changes based on marketing place banking, a clear strategy will define how they respond to the change.
From a technology stand point, banks will need to liberate legacy systems using technologies such as micro services, APIs and gateway layer. Substantial resources and discipline to stick to the strategy will be required for this to be achieved. For some banks this is 5 year strategy if not more!
From an organisation stand point, banks will need a mindset shift from having armies of people to deliver products to small highly skilled empowered teams 10x team of developers, testers, product owners and management. Who can deliver value rapidly to the end customer as well as drive innovative solutions. This set up of highly skilled feature teams will only work if organisation silos are broken down where collaboration and failure/learning are welcomed.
The future is an integrated ecosystem that enables customers to use financial services without even thinking about them, services will be integrated into our daily lives. The PSD2 and Open Banking will rocket boasts this future. I am looking forward to the next few months and years to see how banks respond to this golden opportunity.
Thanks for reading!