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Open Banking: Will PSD3 Regulations Change Everything?

PSD3 Regulation: What To Expect and When?

A recent survey by the Thales Group revealed that a staggering 38% of users are willing to switch to another provider offering better rates or services, highlighting the cut-throat competition within the banking and financial services industry. 

However, with regulations like the Second Payment Services Directive (PSD2), which aim to safeguard sensitive data from fraudsters, European banks face significant challenges to access customer data to offer popular services like digital wallets, short-term loans, and buy-now-pay-later options. 

Despite the challenges, PSD2 paved the way for an open payments ecosystem that encouraged collaboration between previously untapped banks and financial institutions, leading to the creation of new products and services. 

As the industry continues to evolve, the upcoming Third Payment Services Directive (PSD3) is expected to address several pressing issues and offer more support for institutions in the EU financial landscape.

Countries that use PSD2

Effects of PSD2

On the consumer side, PSD2 made payments easier by allowing users to give their consent to share information with third-party providers, which led to the emergence of third-party providers (TTPs) that ensure strong customer authentication and data security.

The EU Commission recently issued its feedback on PSD2 and announced the development of the Third Payments Service Directive (PSD3), an updated EU retail payments strategy. 

Although PSD2 has been a game changer since its implementation three years ago, there are still topics to be addressed before new regulations are decided upon. For instance, some banks are concerned that new standards will require them to build new APIs.

As we anticipate the changes PSD3 may bring to the financial services industry, it's important to consider its potential impact on services and to strategize accordingly. We aim to provide a fresh perspective on this topic to help stakeholders better prepare for the future.

What is PSD3?

PSD3 is the proposed continuation of the Payment Services Directive (PSD) framework that regulates electronic payments and the banking system in Europe and the EEA market area. 

While PSD2 has been governing digital payments and open banking in the European Economic Area since 2019/2020, PSD3 aims to regulate all electronic payments within the European Union and expand its influence. The framework is intended to be flexible and open to updates to keep up with evolving legislation and the payments market.

What is Payment Services Directive Consultation?

PSD3 is currently under consultation, as the European Commission seeks input from stakeholders to ensure that the standard takes into account all market developments.

The Commission organizes consultations before introducing new PSD standards to review their impact on consumers and businesses across the EU. The goal is to address systemic issues that have emerged in the Open Banking ecosystem as it continues to grow rapidly.

At a recent panel at Open Bank Expo Europe, participants discussed the slow adoption of PSD2 and the potential for PSD3 to provide a standardized approach. Many agreed that PSD2 was successful in some areas but failed to fully realize its potential.

What Will PSD3 Focus on?

It appears that PSD3 is going specifically to focus on open banking protocols, such as Know Your Customer (KYC) and Strong Customer Authentication (SCA). Additionally, it will likely focus on how the communication between banks, customers, and merchants will work. 

Certain areas will likely also be addressed:

  • Better protection against fraud

  • The promotion of innovative payment services

  • Improved rights for users

  • Less friction in online payments

  • Unregulated activities on the market (e.g. BNPL, cryptocurrencies, digital wallets)

  • Improve transparency for cross-border payments and fees

When Will Be PSD3 Implemented

While the exact deadline for the implementation of PSD3 has not been announced yet, it is anticipated that it will take up to 5 years based on the timeline it took for PSD2. After the new standard is approved, EU countries will have two years to incorporate it into their national legislation. Companies will have an additional two years to comply with the regulations.

Although it is possible that the process will be faster than the previous one, implementing the new standard and incorporating it into legislation is a complex task. Thus, it is estimated that it will take at least three years after the PSD3 becomes EU law before companies within the European Economic Area (EEA) must fully comply with it.

To stay ahead of the curve, banks, financial institutions, and payment processors are advised to begin exploring ways to adapt their systems as soon as the PSD3 goes through all the necessary legislative procedures within the member countries.

The European Commission will scrutinize the feedback from the consultation sessions and other research findings before drafting the PSD3, which is expected to happen in early to mid-2023.

Magdalena Stoklosa, the Head of European Banks and Diversified Financials Research, stated: “Open Banking has been less disruptive to banks than feared, so far - but the clock is ticking for banks, with new entrants able to provide banking services up to 50% cheaper, in part thanks to legacy-free IT.”

How Will PSD3 Influence the Payments Industry?

The finance industry has faced unforeseeable changes and challenges in recent years, including the COVID-19 pandemic, Brexit, and digitalization. PSD2 aided in digitization, but it needs to be revised due to gaps in legislation caused by new market players. It's unclear if PSD2 will be updated or rewritten as PSD3, but there is agreement that while it prevented fraud, it requires fine-tuning.

The framework we believe will be continued in a partial or complete rewrite would be:

  • Streamlining the provision of financial payments

  • Safeguarding operations and users from fraud

  • Making a safe environment for transactions

  • Keeping users safe with multi-factor authentication (MFA)

  • ISO 20022 was introduced to support the efforts of PSD2. It will simplify the processing language behind transactions and keep APIs more interoperable and standardized.

 We might witness possible regulations to currently unregulated or under-regulated activities such as:

  • Crypto payments

  • Buy-Now-Pay-Later (BNPL)

  • Operating payment systems or payment schemes

  • Digital wallet services (including mobile apps used for payments)

  • Triangular passporting

  • Feedback on digital payments

  • Perceived trust around the use of AISPs and PISPs

  • Increased transparency around cross-border payments and fees

Why is API Standardization So Important?

APIs are used in PSD2 to facilitate the sharing of payment account information between fintech companies and account servicing payment service providers (ASPSP). However, the lack of API standardization within PSD2 has intensified the fragmentation of the payments market in Europe. 

PSD3 is expected to address this issue by developing an API standardization system. Standardization will help the European Commission develop a centralized model that will unite banks and TPPs, but progress has been slower than anticipated. Despite the slow progress, financial institutions and fintechs should be setting up their APIs to offer better services and get ready for the upcoming changes.

Number of Open Banking TPPs in Europe

What Does The Future Hold?

Embracing innovation and working with reliable tech partners is crucial for banks to remain competitive in the ever-changing financial landscape. PSD3 is significant in fixing some of the issues and providing more support for institutions in the EU. While it will take time to see the actual changes, PSD3 offers a chance to create a more flexible system for the future. 

Turning a blind eye to the future is not an option for banks, and those who embrace innovation and work with progressive solutions will be better prepared for market changes and new directions.

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