PSD2: The European Payments Revolution? Part 4a: Introduction To Open Banking
The Second Payment Services Directive (PSD2) dealt with the integration of payment services in Europe through the Open Banking mandate which required banks to provide customer bank account access to third parties. This, of course, opened lots of possibilities to provide more transparency to consumers and more competitive means of accepting payments to merchants.
This blog post, our sixth post as part of the PSD2 series, continues our review of PSD2 with a discussion of Open Banking.
Background to Open Banking
As mentioned in our first blog post, PSD2 mandated banks to provide Third Party Providers (TPPs) with access to customer account information. These TPPs would either be Account Information Service Providers (AISPs) or Payment Initiation Service Providers (PISPs) with both having access to consumer bank accounts. AISPs would utilise access to customer bank account information and provide value-add services to consumers such as aggregating account information from multiple banks into interactive dashboards. PISPs, on the other hand, would be able to initiate payment transactions directly from the customer’s bank with consent. The diagram below illustrates how these two entities allowed for a change to the way stakeholders interacted with one another.
Benefits of Open Banking
The main beneficiaries of AISP payments would ultimately be consumers with greater visibility and ease of access over their account information as well as a greater competitive incentive for incumbent banks to offer more innovative account information services.
On the other hand, the main beneficiaries of PISP payments would be merchants predominantly of payments acceptance as well as other potential benefits. The cost benefit merchants could stand to receive from leveraging Open Banking is best illustrated by the diagram below.
(a four-party card model like Visa or Mastercard) a merchant will send the consumer’s card information to their acquirer who will send this information on to the issuer through the relevant card scheme (e.g. Visa or Mastercard). Each of these parties will levy fees that eventually get passed on to the merchant for accepting the card transaction. The funds will then be settled in reverse order. In a PISP environment, the PISP captures the consumer’s details and requests approval to initiate a transaction on behalf of the consumer. The issuing bank prompts the consumer to confirm, after which the issuing bank sends funds directly to the merchant’s bank account via a bank transfer.
Clearly, this presents a potential cost benefit to merchants as it removes card schemes and acquirers from the transaction flow as well as any fees they would typically . Furthermore, given that PSD2 mandates banks to provide such access, these third parties would not need to pay banks for this and therefore merchants can also stand to benefit from the absence of interchange fees.
How is the Open Banking Initiative Progressing?
As far as the adoption of Open Banking is concerned, the picture in Europe is fragmented with the UK leading the way. This is partly because the UK’s Competition and Markets Authority mandated the nine largest banks (CMA9) to adopt common API standards and to open up APIs by 13th January 2018, 18 months prior to the PSD2 deadline.
What are APIs?
Application Programming Interfaces (or APIs) allow entities to share information with one another. A good metaphor for APIs would be a plug socket which third parties can plug into to access data.
Furthermore, the CMA9 were mandated to set up a centralised programme, the Open Banking Implementation Entity (OBIE), which would coordinate and oversee the implementation of Open Banking in the UK. The fact that there are more TPPs that can access customer account information further adds weight to the idea that the UK is further ahead when it comes to readiness as well as appetite from suppliers (Figure 1).
Figure 1: Number of Third-Party Providers in The UK and EEA Countries (March 2021)
Figure 1: Number of Third-Party Providers in The UK and EEA Countries (March 2021, Open Banking Europe)
One of the key reasons as to why adoption of Open Banking in the UK appears to surpass that of Europe is due to the mandate to adopt common API standards and to set up a centralised programme to oversee the adoption through the OBIE.
API standards makes it much easier for TPPs to integrate with multiple banks without having to invest in a lot of time and money for each separate integration (source). Furthermore, the central oversight allowed for a collaborative approach by participants. In Europe, however, there was no mandate for common API standards or for a centralised oversight body. As a result, TPPs faced significantly higher costs in integrating with the thousands of banks across Europe.
Although there have been various initiatives for common standards in certain countries, none of these have been mandated and these have not necessarily been harmonised across Europe. Furthermore, while data aggregators have emerged in trying to create simplified integrations that allow access to lots of banks across Europe, the varying API standards has meant aggregators have also struggled to get full coverage. Nevertheless, most aggregators can now provide substantial bank coverage through their APIs, but this will have no doubt slowed down the progress in Europe as compared to the UK (source). If we combine this with the head start the UK had with earlier deadlines, it’s not surprising to see that the UK is ahead of Europe.
In addition to this, it does appear as though Europe has, as a whole, taken the ‘wait and see’ approach where it has effectively waited to assess the approach taken by the UK and implement initiatives that have worked there. Indeed, the Euro Retail Payments Board (ERPB) is working on the Single Euro Payments Area (SEPA) API Access Scheme, which, although is not restricted to payments, should allow for common API standards across Europe, something which the CMA mandated the CMA9 to do from the outset. It is difficult to say how far behind Europe is as compared to the UK, industry participants generally seem to be of the opinion that Europe is about 12 months behind the UK (source).
The Open Banking element of the Second Payment Services Directive (PSD2) was one of the most exciting aspects of the regulation. It mandated more integration within financial systems and created new business models intended to offer more innovative and competitive solutions with benefits to both consumers and merchants. The Open Banking mandate, however, has been progressing at different speeds across Europe. The UK and the Nordics appear to be the furthest ahead with some retailers beginning to offer payment methods leveraging Open Banking at the checkout. Adoption across Europe is a lot more fragmented, although, it is reasonable to assume adoption in Europe is about 12 months away from where the UK currently is. Therefore, while the regulation could have done more to mandate common standards and collaboration from the start, Open Banking is still expected to deliver benefits to merchants.
Our next blog post will discuss the adoption of Open Banking from the consumer and merchant perspective.