The key question for banks with the new PSD2 directive is: How can added value be created by cleverly using an API Economy? Banks are currently exploring ways to leverage open APIs (Application Programming Interfaces) to expand and change their business model. This is further enhanced by the fact that banks are under increasing pressure – from their customers, but also from competitors and regulatory authorities. And this pressure is driving innovation within the financial sector.
An API Economy changes business strategies of banks
An API Economy places new demands on banks’ business strategies, their revenue streams and profitability. In the future, leading banks will have a clear focus on their customers and the market and will collaborate with other organizations to strengthen their market position – through increased use of digital technology platforms or tools that support their specific business strategy. Open Banking and an associated API Economy will enable new products and services through collaboration between different business units within the bank, with other banks across different industries, and between banks and other related business sectors, particularly companies active in the technology and data sectors.
PSD2 as a framework for an API Economy for banks
Banks that are either based in or operate from the European Union will develop their API Economy under the EU Payment Services Directive 2 (PSD2), which will come into force in the member states in January 2018. Basically, the directive requires banks to allow third party providers access to their customers’ online payment services and account information if customers so request – and to do so in a legally regulated and secure manner.
This does not mean, however, that banks outside the EU have remained passive when it comes to establishing an API Economy. In North America, for example, collaborations and partnerships are developing between players from different industries, FinTechs and other organizations to drive innovation in banking products and services. For example, Citi, Capital One and MasterCard have established exchanges with API developers to enable external developers to deliver new innovative products that benefit their customers. Other vendors such as Braintree and PayPal have developed APIs to simplify integration into e-commerce websites and to establish themselves in the marketplace.
Summarized in short form PSD2: PSD2 requires banks to give third parties access to customer accounts and data so that authorised organisations and FinTechs can more easily offer their services to private customers – be it construction financing or insurance. Such services are connected via technical interfaces (APIs).
For example, if you have two accounts at two different banks, you should be able to manage and analyse both accounts via a third-party provider: According to the new directive, FinTechs operating such platforms will be allowed to link both accounts, so that the customer does not have to log in via the website of the respective banks, but can use an app, for example. There will also be new providers in the online payment market.
But there are also very tangible aspects, concerning the simplest data that banks have already had to provide since last year: This includes the exact location of the individual branches, details and comparison possibilities of individual products, but also where there are branches with disabled access.
What is the concrete impact of the API Economy on the banking sector?
Banks serving either retail customers or small and medium-sized enterprises in Europe will be forced by the PSD2 to take one or both of the following steps.
1. customer data, which were previously only accessible to banks, will be made available to authorised third parties
PSD2 will force banks to provide certain information they have about their customers to third parties that are Account Information Service Providers (AISPs). These AISPs, once authorized, will be given access to customer data for commercial purposes. The idea is for AISPs to provide other banks and financial institutions with sufficient data to promote competition, increase product innovation and improve customer service. Banks can try to meet these challenges themselves or join forces with partners in trying to monetize customer data in new ways.
2. banks can develop new services for how customers' payment transactions are processed and charged
PSD2 allows so-called Payment Initiation Service Providers (PISPs) to provide customers with alternative payment mechanisms that are directly linked to the bank account. This can lead to the elimination of existing card payment networks and associated fees. This is good news for vendors, as it should reduce the cost of fees when customers choose a PISP-based payment instead of an EC or credit card payment. It also eliminates transaction risks and ensures that funds are released more quickly.
If this also applies to large providers such as Amazon, it could lead to the elimination of fees altogether in the future, which could have a significant effect on bank revenues. Banks serving small and medium sized businesses will also come under pressure to open up to API technology.
Many companies are already frustrated that corporate banks are so slow to harmonize their services so that they can seamlessly integrate into increasingly digital supply chains. There is also a lack of interface standards across different banks, making connectivity difficult. APIs not only provide a solution to these problems, but also allow banks to more easily accommodate and promote third-party services.
New players in an API economy
The rise and establishment of an API economy will bring a whole range of new players to the financial market. These will take very different forms, some of which are already beginning to establish themselves on the market:
1. new banks as challengers
New banks entering the market with a more customer-focused approach, linking customers with their own products and services as well as with those of other providers. Their banking platforms and business models are called “API first” and they operate more like FinTechs than traditional banks.
2. financial technology companies, in short FinTechs
They specialise in certain banking products, but have a model that is much more transparent and less costly for customers.
3. technology giants like Facebook, Apple, Google or Samsung
They are interested in gaining access to open APIs to enhance their own customer data, customize their marketing strategies, customize their products and services, and strengthen their brand presence. Three of these technology giants (Apple, Google and Samsung) have already entered the world of payment systems, for example by offering their customers appropriate credit cards.
4. service sector without direct link to financial services
Service companies, such as utilities, could expand their services and offer services usually reserved for banks in order to increase their revenues and better monetize existing customer data.
Aggregators will also use both PISP and the AISP aspects of the PSD2 policy to develop services such as Personal Financial Management (PFM) tools. Current aggregators on the market, already collect simple product information and offer corresponding simple budget planning software for retail customers.
6. payment service providers (PSPs) and card networks
They will both be affected positively and negatively by PSD2. The idea behind PSD2 is to increase competition and reduce transaction costs for both customers and businesses. Providers such as WorldPay and credit card networks such as Visa and MasterCard will experience a slump in sales because the cards are used less. They will therefore look for new models, such as PISP and AISP, and offer new payment methods and mechanisms. Some – like PayPal – already offer such services, allowing direct account-to-account payments.
Enterprise Resource Planning (ERP) provider
They can also take advantage of the PSD2 directive by strengthening the link with their clients and providing new products tailored to their clients and for example specific tax issues, cash management or forecasting activities.
Traditional banks could establish 100% digital subsidiaries that are independent of the parent company’s existing legacy IT infrastructure. This is already the case in France, for example.
What role remains for banks in an API economy?
Ultimately, banks have two strategic options: They could operate as service providers, providing products and services to other banks and third parties, or they could evolve and become a lifetime partner for customers. They could thus move into the epicenter of a new, customer-focused banking sector by opening up in a timely and proactive manner to an API Economy – away from the previous, closed and inflexible banking system. Opening up to third-party providers will allow banks to take on a whole new role, as platform solutions for financial products and services are expected to become the norm in the coming years.
What role PSD2 plays in the development of innovative technologies, specifically what PSD2 means for block chain technology, is the subject of the last article in this short series.