Written By: Steven Winter – Corporate Finance
A law adopted by the European Union (EU) expected to revamp European financial services takes effect in January 2018. The Payment Services Directive—dubbed PSD2 for its second edition—was initially adopted in 2015, and will now force European banks to provide open access to their customers’ data. Among those now gaining access to this data are fintech start-ups, financial competition and foreign banks—as long as they have expressed consent from their customers. In effect, it provides customers with monumentally greater control over their information and how they choose to bank in this new environment. With a historically de facto monopoly on this type of information, traditional banks may soon find themselves with less market share if they do not find a way to collaborate with the deluge of rivals now entering their market.
PSD2, in effect, forces banks to share their application programming interfaces (APIs) with their competition—a move about which they have been unenthused since the first proposal of the legislation. APIs create a connection between computing systems—using a common language—that allows for information to be transmitted and shared between a host of different clients. This is done through connection to the API by whichever client attempts to access it, and provides for a quicker transfer of information to the person of choosing. Rather than allow for traditional banks to keep this information under lock and key, the regulation forces them to provide this same information if and once customers have given their consent for the new client to access this API. Above all, the practice increases customer information’s accessibility and transparency—providing customers with greater control over this personal information, and improving market flexibility. The market expects that this will allow third-party stakeholders greater access and potential to establish themselves in a traditionally closed-off market. These stakeholders include fintech firms, software developers, challenger banks and payment platforms. The specificities of the practice can manifest in automated recommendations using digital platforms—recommending bank-account type, as well as how best to invest, save and spend money.
While shareholders, auditors and accountants would all now have access to reams of information previously squirreled away by traditional financial institutions, the real threat comes from fintechs and development companies. Fintech companies have considerably outpaced traditional banks in providing exceptional customer service, agile banking and payment solutions, and simple banking experiences. While fintechs have yet to reach a significant scale of ownership in financial markets, their growing influence is chipping away at the supremacy of traditional financial firms. Without the amendment to the PSD regulation, this was a problem for the future, as far as financial institutions were concerned. However, with the introduction of the new European regulation, this risk has now drastically reduced its period to completion.
The development in Europe will prove to be a good bellwether for how the future of this practice could affect financial markets at large. The disruptive nature of fintech industries has forced traditional banks to either improve their services or collaborate with these new entrants to combine increased service alongside robust infrastructure. Ultimately, Open Banking will allow for new revenue streams, improved customer service, and greater access and support to underserved markets. However, as we are currently seeing, it will constitute a drop in profits and market control while prioritizing survival and longevity. Much of the same was seen in the video-rental industry with the introduction of disruptive streaming technologies, such as Netflix. This cooperation will take a concerted effort from traditional institutions, which are not fully complying with the law as yet. Recently, officials raided a slew of banks under suspicions that they had obstructed fintech competitors from obtaining access to customer information. As banks fall into line, officials are hoping that the Open Banking regulation will allow for a cleaner banking industry with a level playing field.
The rise of Open Banking is yet another in a growing list of disruptive practices and technologies affecting global financial markets. Chief among these were the development of cryptocurrencies and the proliferation of alternative payment methods. Both were technological changes that altered the way customers used, saved, traded and invested their money. Cryptocurrencies, in particular, have seen great success in recent years as the number and types of cryptocurrencies available threatens the supremacy of physical currency. The first transaction conducted by a traditional lending institution in bitcoin took place recently between the United States and Australia. But traditional institutions have a long way to catch up to a technology powered by a revolutionary blockchain technology that provides a perfect and permanent ledger of transactions.
Alternative payment methods have less to do with the currency used than with the provision of more convenient payment options offered to customers. Online-payment methods, smartphone-payment applications and a collection of other methods all wrest control from banks on how customer money is saved and spent. With the advent of new artificial investment advisors and algorithms set to perform the same functions as their human counterparts, there is now an invisible stopwatch counting down to when the industry yields to technical change.
Interestingly, this could provide substantial benefits for Chinese markets. China recently announced that it would open its banking markets to the world. Lifting the ban on foreign ownership of financial firms and allowing overseas firms to own majority stakes in various financial services, the announcement cracks open a typically sheltered industry and allows global financial managers new opportunities. However, if Chinese markets’ opening also coincides with embracing Open Banking APIs, it could jettison China’s financial industry to the top of global financial markets. Chinese development has long benefitted through its “picking low-hanging fruit” policy.
These small changes tend to provide a windfall of growth and funding that is largely available to the rest of the developed world. However, a simultaneous adoption of both Open Banking markets and Open Banking APIs could see China become a trendsetter and revolutionary in global banking practices. While first-mover advantages are yet to be seen, there is no reason to believe that Chinese financial institutions would not benefit enormously from Open Banking APIs.
Ultimately, banks will need to collaborate with these challengers now taking the Open Banking route to entering financial markets. The provision for fintechs opens the possibility for larger big-data companies—Facebook, Amazon and Google, some speculate—to open their own fintech services and enter financial markets. This development would be unprecedented, but would be definitive of the disruption already wrought by companies such as those that provide non-traditional services with no set infrastructure. One advantage financial institutions have is that financial markets do possess a set infrastructure, and financial institutions still posses the bulk of market share. Rather than resist the change as many traditional industry bulwarks are wont to do, financial institutions will likely take the advantage by either buying or collaborating with these fintech competitors, carving out niches for themselves in the new financial environment.