Later this summer, in September, to be precise, the payments industry is celebrating the second anniversary of PSD2 being fully enforced in European markets. Most of the readers will be familiar with the history around Payment Services Directives 1 and 2, but it is worth highlighting that one of the main objectives of PSD2 was to ‘foster innovation and create a higher level of competition in the provision of financial services and payments in particular’.
This was to be facilitated across Europe through the entry of new players (registered and licensed) into the industry and the open exchange of data between different players via APIs. This is where the term Open Banking came in. It is a term that is not being used in Europe alone anymore; in fact, Open Banking develops at a considerable pace in many regions and markets from Mexico and Brazil to Nigeria or Bahrain. Such significant changes are obviously not happening overnight – and different markets develop at different speeds – but for all intents and purposes, Open Banking seems to mature a lot. The UK and the Nordics are, according to Mastercard’s latest report on Open Banking readiness, the most advanced Open Banking markets in Europe – the number of API calls (i.e. interaction or data exchange between two parties) skyrocketed from 70m in 2018 to more than 5bn in 2020. New companies are entering this space almost weekly, and those that can demonstrate real promise benefit from capital injections from both financial and strategic investors.
Already the Retail Payments Strategy by the European Commission is contemplating the next stages of evolution and is talking about Open Finance and even Open Data.
In fact, a lot of activity can already be seen in the Open Finance space. Wealth Management still seems to have a number of different challenges attached to it and seems to be lagging other segments within Financial Services with regard to the usage and application of digital technology. For example, the lack of an established liability framework appears to be more crucial in this segment where transaction amounts are higher than in a typical retail environment.
However, there are many interesting solutions in the hugely popular ESG space (Environmental, Social, Governance). By accessing data from other sources, trade finance solutions have appeared that analyse the flow of goods to measure the ESG impact on the supply chain, investment platforms that assess the environmental impact on portfolio companies or greenwash services that apply a ‘green rating’ to total investment portfolios. It is a quickly growing segment.
But before we concern ourselves about Open Finance, let’s have a deeper look at the apparent success of Open Banking. As stated earlier, Open Banking is meant to help start-ups (or the technology divisions of banks) create innovative new products by leveraging new technology. The most promising use cases for such new products were expected to be in the following three areas:
- Account Information Services / Personal Finance
- Lending (consumers as well as SMBs), and finally
So when looking at the success and roll-out of Open Banking-based solutions, it is well worth looking at these three segments separately.
Let’s start with Account Information Services. Account Aggregation in itself is not new, and the idea has been around for many years. However, standardised APIs and an Open Banking framework clearly provide the stimulus for a much faster roll-out of such services by banks as well as start-ups. Note that new players in this space will require to be registered and licensed as Account Information Service Provider (AISP), one of the newly created roles in the PSD2. Account aggregation is exactly what it says on the tin: compiling different bank accounts into one central place. Banks must share their customers’ data via a standardized API format with authorized third parties and with the bank’s customer’s consent. All account data of one individual ranging from current, savings, credit card to mortgage account is accessible in one place. That is meant to provide better opportunities for individuals to manage their finances. As the use case for such services is easy to understand, many players have entered this space, ranging from fintech banks such as Revolut, to fintech arms of retail banks (e.g. Yolt being part of ING Group) to new players such as Tink (which at the time of writing this article announced its acquisition by Visa).
The second use case concerns the provision of loans and the decision-making progress of lending in general. Credit reference or credit score providers have also existed for many years but especially on the consumer side, Open Banking has led to new approaches that aim to assess the credit risk of individuals. Whereas traditionally, a credit score might have been determined exclusively by comparing regular income with existing debt to serve, more recent propositions aim to take a much bigger set of variables into the equation. In simplistic terms, such an approach considers that if an individual can make regular payments e.g. for renting accommodation or even a Netflix subscription this thereby demonstrates responsible financial behaviour and such payments should feed into the credit decision-making progress. Having access to more external data sources aims to improve those decisions. In the context of SMBs, there is equally the issue of accessing loan facilities but on top of that, there is also the crucial issue of short-term cashflow support. According to UK government data, there are 6m SMEs in the UK (96% of which are micro-merchants with 1-10 FTEs) and £23bn in late payments is owed to those SMEs. 53% of UK SMEs are victims of late payments and micro-merchants in particular are at risk as they don’t have the infrastructure to serve and chase. Again, new companies have started building propositions around accessing multiple data sources for quicker lending decisions or even QR-based solutions that aim to enable immediate payment rather than delayed invoicing. So again, another use case where Open Banking has led to new or improved product solutions and propositions.
That leaves payments as the third major use case. As stated earlier, in the UK there were approx. 5bn API calls in 2020. There were also 3.5m Open Banking based payments processed with the expectation that this will be raised to 1m transactions per month by the end of 2021. In other words, payments make up less than 0.1% of all API calls, and this raises the question of whether Open Banking has indeed been successful but not in a payment’s context. In next month’s newsletter, we will be looking at Open Banking-based payments in more detail, looking at some of the successful implementations, and analysing why payments may have fallen behind and what is needed to change that.
The content of this article does not reflect the official opinion of Edgar, Dunn & Company. The information and views expressed in this publication belong solely to the author(s).