The recent Competition and Markets Authority (CMA) report on the state of the UK banking market had a number of things to say about future direction, though perhaps the most important was the endorsement of open APIs and, in particular re-enforcing the commitment to Payments Services Directive 2, or PSD2, to use the common abbreviation.

But what is PSD2 and more importantly, what does it mean for banks, lenders and consumers?

What is PSD2?

PSD2 is an EU directive on payment services and despite the UK’s current stance on Brexit, the UK Government, though the CMA report remains committed to its introduction.

There are four main topics covered by the directive;

• Extension of scope beyond Europe and
• Third party bank account access to Account Information Service Providers and Payment Initiation Service Providers
• Standardisation of card surcharges
• Increasing security of online payments and account access

The effect of PSD2 will be wide ranging, although it is the requirement that banks open up their data and services to provide 3rd parties with access to them that is most interesting to us.  This will force banks to build, and make available, APIs in the expectation that this will invite more innovation in the payments space and increase competition for consumers.

What does it mean to Banks?

Banks have to make the interfaces available by the end of 2018 and in doing so, they face a dilemma. Either they use the regulations to create a whole new way of interacting with the customer or they fail to seize the moment and become further dis-intermediated from the customer and ultimately become the banking rails rather than an end-customer service provider.

In a number of ways we’ve been here before. The mainstream banking providers were so pre-occupied with capital adequacy (rightly so, some might say), regulatory issues and redress programmes for miss-selling that they failed to acknowledge and respond to the threats from the emerging Fintech providers. These innovators were able to provide differentiated, competitively priced, more customer friendly services in areas such as payment and money transfer (think TransferWise), lending (think Zopa, Funding Circle and other non marketplace lenders, such as 118118 Money, Oakbrook and Avant) and directly in their own back yard for consumer banking (Atom, Mondo, Starling, Tandem and others).

The risk that PSD2 presents to the Banks is whilst they hold the customer money and all the regulatory and adequacy risk this presents, the potential to lose the customer interface and brand loyalty is absolutely possible.

Interestingly, the provision of PSD2 allows third parties to build applications that sit over the bank account and present a new user interface to the customer, perhaps one that is lightweight and personalised to the particular customer’s requirements. Imagine that instead of logging into your Lloyds or Barclays accounts, you log into a new platform that dynamically pulls your balance and transaction data from the two banks and presents it in a single view, and you start to get a sense of the threat to the banks.

Who owns the relationship in this case?  Not the bank, they’re merely acting as the servicing infrastructure and whilst they may be able to charge account servicing fees explicitly or implicitly though overdraft charges etc, the loss of customer engagement inhibits their opportunity to cross sell.

First mover advantage will be fundamental for the banks. The one that launches the platform first, perhaps as a separate brand gets the opportunity to act as the aggregator and, ultimately gain both loyalty and a hugely detailed view of the customer’s financial position and consolidated balances.

Security is going to be a major concern to all of the parties involved with open interfaces, and it will take a brave consumer to allow open access to their bank account to a new start business that has little brand presence or loyalty.  That said, the obligations of PSD2 require the banks to increase security. However the mere fact that the APIs will exist will make the bank systems more susceptible to being targeted; potentially a reason why some banks may plan to slow pedal their implementations, waiting to see how others progress.

For the consumer?

Consumers already trust a number of third party service providers to manage elements of their financial lives, such as PayPal for money transfer and payments.  It won’t be long before PSD2 opens up a world of opportunity for the consumer.

Consider a few simple use cases. We’ve looked at simple account aggregation, but let’s take it a step further and add some personalised functionality. Using an If This Then That (IFTTT.com) approach, the new platform could be configured to automatically sweep excess balances at the beginning of the month to a higher interest account until such time as the balance drops beneath a (user defined ) threshold/level.  So far so good, we’re starting to see the some of the opportunity.

Let’s crank it up a few gears though, again, using IFTTT which can connect the customer to all manner of services and devices. How about a scenario where depending on the settings you have on your Hive or Nest central heating system, the platform automatically deducts more money from the consumer’s disposable income and drops it into a ‘bills’ savings account ready for when the increased bill comes in. Imagine that you turn the heating up tonight and automatically make allowance in your budget for the increased bill. The same applies for car travel, the further you drive, the greater the wear and tear and therefore the requirement for an increased maintenance allowance.

The opportunities really are endless. Link it to your Apple Watch or Fitbit and each time you hit your daily step goals a money treat appears. Connect to geo-location and when you pop into town, money is transferred from the savings account to the current account to avoid any embarrassing card declines then when you return home, the money goes back to the savings account – all automatically, without the customer doing anything and wholly based on their own rules.

Further disintermediation comes where the platform can be used to automatically move the customer from one bank to another, automating the current account switching process.

For the lender?

The opportunities presented to lenders are many and varied, though not without risk. For years lenders have had to rely on credit reference data to make lending decisions.  Essentially this is backward looking data, reflecting on how a customer has managed their outstanding loans over the years, though does not provide true insight into their financial affairs and assets. Banks which own the customer’s current account have had an unfair advantage; using their walled garden of data they can form a more rounded view of customer behavior and financial capability.

The obligation on lenders to take customer affordability into account when making a lending decision forms one of the key elements of the FCA’s guidance on responsibility. This has given rise to a series of new data sources from the CRA’s, emerging service providers and, in some cases, an increased data capture burden for the consumer. See our blog on alternative data sources here.

Even with these new sources, those customers with thin credit files (i.e. they have no, or little, loan performance data), find it difficult to get credit and are a long way from the financial inclusion that Government wants.

PSD2 changes all that and makes that data available anyone (subject to the customer providing permission). Apart from the objective aspects of confirming income, salary payment data and outgoings to form a more refined affordability score, the data also highlights where the customer is spending their money. For example if they have a large, increasing expenditure with gambling sites this may reflect negatively on their scoring, though conversely, someone who gives to charity may be marked up; not necessarily for financial reasons, but more because it contributes to a behavioral assessment.

An increasing number of lenders rescore their customers over the loan term, either for remarketing campaigns or for risk management (certainly this will become a greater requirement under IFRS9).  But imagine a scenario where the lender has ongoing access to read the customer’s bank account and see that, over time, their financial situation is worsening, then they have the opportunity (regulation permitting) to implement more tailored forbearance and TCF policies.

The converse is also true, coming back to our imaginary aggregation platform, how about a service which detects that the customer is likely to go overdrawn (they have the current balance and know the scheduled payments for the account over the remainder of the month and also have the historic payment data) and then offers either a payment holiday (interest bearing, naturally) or a cheaper line of credit product, protecting the customer from expensive unauthorised overdraft fees. This again, is exactly the type of service that customers will pay for and one which also reduces income for the banks. We may even find specialist lenders springing up offering bank-independent overdrafts as a standalone product.

But where there are benefits for lenders using the open data, there are also risks, not least in how the regulator perceives the data may be used. Potentially, they may take a position that whilst it’s all well and good for the lender to view the bank account data before they make a lending decision, shouldn’t the lenders also check account balances before they take a payment, particularly if it will adversely affect the customer’s ability to see themselves through to the end of the month?

Without a doubt, the winners from the introduction of PSD2, such an innocuous acronym, will be the consumer, with new service providers a close second, followed lenders and, depending on whether they grasp the nettle, the banks.