2018 will be mentioned in Europe as the year of open banking. On January 13, 2018, after a two-year planning period, the European directive on digital payments, PSD2 (Payment Services Directive 2), was issued. This directive obliges European banks for the first time to open their APIs (Application Program Interfaces) to fintech companies (technology applied to finance) and other companies dealing with financial products and services. This change will allow third-party companies the access to payment data: basically there will be more competition for traditional banking domains. As a result, PSD2 is changing and will continue to change the relationship between consumers and financial institutions. The framework is not yet complete as some implementing rules and technical standards are not available, however, the work can be considered as ongoing. Let’s see in detail all the steps through which PSD2 has been obtained, what it is in substance, what are the advantages and risks, and how to get to open banking, that is to say what basically is a sharing of data among the different players of the banking ecosystem, of course authorized by customers.
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WHAT PSD2 IS AND WHY OPEN BANKING IS BORN
PSD2 immediately proved to be a trend capable of redesigning the European payments market first of all, but also of drawing a significant rupture with the past, encouraging the development of a new competitive framework featuring new rules allowing new players to take part. As the website pagamentidigitali.it explains, in the rupture/evolution fostered by PSD2 there are also the basis for that new way of doing banking, more open, more accessible, easier, both for customers and businesses, that has been branded as open banking. A way of “doing banking” that is probably already challenging the old and more traditional logics and scales. Basically, the new rules have been created to ensure better protection for online customers, to promote Internet innovation and mobile payments through online banking, and to improve cross-border payments within the EU.
SHORT HISTORY OF PSD2: HOW OPEN BANKING CAME ABOUT
The original directive, the PSD1, was enacted less than 11 years ago, in 2007, with the aim of increasing competition in the European payments market and strengthening consumers’ rights by applying the same set of rules that apply throughout the European Union. However, despite the issuing of this directive, the level of competitiveness is still low: in 2017 only 3% of European consumers bought banking products from another EU country. Moreover, due to the fast and steady technological changes, in 2015 the PSD framework no longer covered and regulated the new players entering the online payments market. Therefore, on November 25, 2015, the Council of the European Union approves the PSD2 directive, with the aim of enabling safer and more innovative payments. European Commissioner Jonathan Hill said: “This legislation is a step towards the digital single market: it will help consumers and businesses, and enable the economy to grow”.
On November 27, 2017, the European Commission adopted the regulation with the final version of the technical standards on customer authentication and safe communication with third party providers (TPPs) offering payment initiation and account information services. The text had to be voted on in Parliament and ratified by the Council within three months. The technical regulations shall apply after a transitional period of 18 months, i.e. (approx.) September 2019.
In Italy, on December 11, 2017, the Council of Ministers of the then Gentiloni government adopted the PSD2.
OPEN BANKING: WHAT THE OPENING OF THE APIs ENTAILS
While the new European Digital Payments Directive has increased the security of online payments, the key element of the Directive is the new mandate for banks to open up their APIs and customer data to third party companies, with the customer’s approval. These APIs can thus for the first time provide developers working on behalf of third parties with some channels to get to the bank’s customer data (except for spending habits and credit worthiness) and thus allow TPPs to tailor their products and services on the basis of such data.
WHAT APIs ARE AND HOW THEY WORK
API is the acronym for Application Programming Interface. An API is, in plain terms, a software intermediary that allows two applications to talk to each other. Shana Pearlman, Content Marketing Manager, brings an even more explanatory example: it’s like being in a restaurant, she says. The customer sitting at the table orders from the menu, but he needs an intermediary, in this case the waiter, to get the desired dish. The API is in this case the waiter.
A good API makes it easier to develop a program by providing what can be described as “building blocks”. When developers create code, Pearlman explains, usually do not start from scratch. The way in which APIs make often repetitive but complex processes with very little code highly reusable is fundamental to workflow productivity. Crucial to application development is the speed that APIs enable developers to deploy applications. Currently, developers are much more efficient than in the past, as forced to write a lot of code from scratch. APIs allow to focus on the single presentation of their apps while delegating everything else to the same APIs.
A handy example of how APIs are used is the booking of a flight. When the user looks for flights, a menu of options is presented. (S)he chooses the city and departure and return date, as well as the travel class and other variables related to meal, seating or specific luggage requirements. Reserving the flight requires interaction with the airline’s website to access the airline’s database and check if there are seats for that date, costs, flight times etc. It is essential for the user to get access to the information in the airline’s database, whether interacting with the website or using an online service to aggregate flight offers. This access requires the user’s application to interact with the airline’s API. As a sort of efficient “waiter” (see example above), the API delivers data from the application used by the user to the airline’s systems on the Internet. It also handles the company’s response to the request and delivery to the application used by the user. In addition, through each step of the process, it makes it easier to interact between the application and the airline’s systems, from seat selection to payment and booking.
OPEN BANKING AND PSD2: WHAT IT MEANS FOR BANKS AND CUSTOMERS
According to this article from Agenda Digitale, in 2017 the first 50 banking groups worldwide were more or less the same as 10 years earlier, net of acquisitions and mergers. The same cannot be said for several other sectors, starting with mobile communications, where 10 years ago the first global player was Nokia, today actually disappeared. Until recently, the banks did not trigger the revolution that disrupted other markets. Yet the need for disruption has been raised several times by the customers themselves: 37% of European consumers said to be willing to change banks if their own are no longer offering up-to-date technological services. Until now, several banks have wavered to adopt new technologies, but with the arrival of fintech and the approval of PSD2, will be required to change in order to survive.
Open banking is designed to transform traditional banks as the ability to directly serve customers and give them added value will no longer be their privilege, but rather will be shared with fintech companies and tech retailer companies, as well as telecommunications companies. Many players will gain a competitive advantage by being able to enter the market without the heavy compliance and infrastructure that banks are required to maintain. Will competition turn into an advantage or a disadvantage for traditional banking institutions? It will certainly be a disadvantage for those that persist in maintaining their status quo and refuse innovation. However, the others, those that have undertaken or are undertaking a path towards both research and open innovation, could gain new opportunities. As far as consumers are concerned, PSD2 will give them plenty of choice and simplify their activities.
TRADITIONAL BANKS: HOW TO USE OPEN BANKING TO THEIR OWN ADVANTAGE
According to several surveys, many of the major customers of banks are likely to leave them in favour of the so-called aggregators. That’s why traditional banks need to adapt to change as soon as possible in order to survive. In addition, if open banking is regarded by many as a challenge, it can actually be seen as a strategic opportunity. However, how can this be achieved?
By working with fintech providers, for instance, banks can become the ecosystem or the platform for aggregating financial services. This will keep them in a relevant position and continue to meet the demands of current and future customers. As a result, open banking’s partnership with the fintech sector become essential: it can bring interesting services to the market faster and more economically.
OPEN BANKING: CASE STUDIES IN ITALY
There are some interesting examples of open banking on an international level. In Italy, Banca Sella is a pioneer of open banking: indeed, it was the first credit institution to launch Fabrick, an open banking platform in our country. In June 2017 it announced the availability of its technological infrastructure to companies and start-ups, offering the possibility of using services and functions hitherto accessible only by the bank itself. The Banca Sella Group thus anticipated the European PSD2 directive.
At the end of July, the platform promoted by Sella Group launched a startup with FinLeap, a German company (Berlin, 2014) focused on the creation of fintech startups, Beesy, was created with a capital of 2.1 million euros and offers a digital solution for the financial management of micro-businesses and professionals.
Another Italian case is the recent entry of our country’s first bank, Intesa Sanpaolo, into the capital of a startup, Oval Money, founded by Italians in London: Claudio Bedino and Benedetta Arese Lucini, former country manager of Uber in Italy. Oval Money offers an application linked to bank account and credit card that aims to provide updates and statistics in real time on the spending habits of the user for saving purposes. The application creates a personal digital “piggy bank” where the “change” of each transaction are automatically saved. Users can then apply for small peer-to-peer loans from other Oval Money users for emergencies, donations, gifts or other needs and return the amount with daily micropayments. A new way of organizing personal savings.
In June, the credit institution led by Carlo Messina took over a non-communicated share of the company founded in 2016. Its services will be integrated into the offer of Banca 5, the local bank created to reach a new and above all young target.
“The synergy – said Intesa Sanpaolo – will lead both companies to a strategic integration in the offer of products and services, in the relationship with users and in the standards guaranteed”. Benedetta Arese Lucini, in this interview with EconomyUp, commented: “Some banks opt for in-house solutions, others prefer to work with startups, more flexible and able to bring the digital experience. The potential of partnerships must be understood in this perspective: joining together brings value to both”.
(originally published by EconomyUp)
