Banks should start preparing for Payment Services Directive 2

20 September 2016 Consultancy.uk

Less than 18 months to go before Payment Services Directive 2, one of the most disruptive regulations in the financial industry, kicks in. Stefan Dierckx, CEO of Projective, reflects on the regulation’s impact. 

Payment Services Directive 2 (PSD2) is a European regulation that forces banks to open up their account (so called Access to Accounts) and payment infrastructure to third party payment service provides (TPP’s). For banks, opening up their systems, granting access to competitor banks and other commercial players on the market, and potentially losing hard-earned touch points with their end clients is not an attractive scenario.

To my surprise, a large number of European banks seem to consider this new regulation as just another rule with which they need to comply. “We still have 18 months to go, the technical standards are not 100% complete yet, so what’s the rush?” is a common reaction on the forthcoming introduction of PSD2.

Banks that have spent some time working out the potential consequences and fully understand the impact of PSD2 on their banking model are actively working on their future offerings under the motto “Offense is the best defence”.

Payment Services Directive 2 in banking

This new dynamic that will begin to play out in January 2018 will not only create opportunities for disruptive FinTech players, but also for banks. Why wouldn’t banks be able to position themselves on the market with so called ‘consolidator services’ (accessing data from multiple competitor banks), optimising, and even extending, the use of their existing payments network? The fact is that banks can rely on a loyal customer base, large IT departments, and related budgets. This is a luxury that most FinTech startups don’t have. 

Banks with a clear digital strategy do not see PSD2 as the finish line – as they know the banking landscape will continue to change. They are preparing for an open API environment that is not limited to Access to Accounts and payment instruction processing. It’s only a matter of time before the banks are pushed into an Open Banking API model. 

However, banking services development over the past few decades has been focused on optimising transaction flows and digitising the back office paper-based administration. Front-end channels such as branch bank, home bank and banking apps have gradually been added to the architecture, creating even more complexity in the banking architecture. As such, implementing PSD2 services in this complex architecture is easier said than done. Solutions such as The Glue can help to reduce the complexity and prepare the bank for an Open Banking API model. But even with The Glue, the urgency remains. With less than 18 months to go, the clock is ticking.

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The business and operating models of digital-only banks

04 April 2019 Consultancy.uk

In recent years, several digital-only banks have successfully managed to nestle themselves in the banking landscape, with their popularity continuing to increase. Looking at it from the customer’s point-of-view, there is little difference between these FinTech unicorns; looking at the bigger picture, however, reveals significant variation in their business models. Matyas Fekete, a consultant at KAE, explores some of the main similarities and differences in digi-bank business and operating models. 

What about the profit?

Unlike in the UK, in most of continental Europe, bank accounts and corresponding banking services are historically paid-for services. The fact that digital banks offer most of their services free of charge has undoubtedly helped them build a large customer base. On the other hand, despite comparatively low set-up and minimised operational costs compared to that of traditional banks, and given the lack of revenue stemming from the typically no-fee model, profitability has proved difficult to achieve. Monzo, for instance, recorded a net loss of £30+ per customer in its most recent financial year. 

In the start-up world, it is customary to focus on expansion rather than profit – see the case of Uber, for instance. Still, while profitability might not be their number one priority in their early stages of development, it must be a long-term goal of any business. With their ever-growing customer base, digital banks are increasingly under pressure to turn their business from loss- to profit-making. 

Credit where credit is due

Digital banks pride themselves on their fair (often meaning “free”) proposition and have so far stayed clear of offering loans (including credit cards & overdrafts), traditionally amongst the most lucrative products for traditional providers. Though somewhat reluctantly, newcomers are also realising that offering lending products is one of the most straightforward ways to offset losses made on their free, often high-cost services (e.g. overseas ATM withdrawals). Monzo, N26 and Starling have recently started offering credit products to their customers, with their loan offering expected to be extended to a wide range of services, from mortgages to overdrafts. Correspondingly, creating a lending portfolio can also pave the way for launching an interest-paying savings offering – a proposition seen as a basic banking product that is yet to feature in most digital banks’ portfolios. 

The business and operating models of digital-only banks

The premium customer

While most digital banks offer most of their products for free, some have extended their offering by paid-for premium services in order to create a revenue stream. As these premium features – including different types of insurance, unlimited free transfers/withdrawals, faster payment settlement or concierge services – are often offered in a subscription format, customers are typically prompted to pay for the full package rather than just the desired service(s), providing a significant revenue stream for the bank. Revolut, for instance, was amongst the first digital banks in Europe to break even earlier this year, a feat largely due to revenue from its premium subscription.

SMEs like digital too

Traditional banks typically service small and medium sized businesses under their retail rather than corporate banking arm. Having their product offering tested with consumers, and consequently gaining a reasonable customer base, digital banks have also identified SMEs as an ideal segment to extend their target audience to. The five FinTechs profiled have already gone, or plan to go, down this path by following up their consumer solution with a business account. While both propositions are typically built on similar features, some providers charge businesses a monthly subscription (e.g. Revolut), while others apply additional fees to specific services (e.g. TransferWise), banking on the expectation that businesses are more likely to be willing to pay for banking – something they are already used to doing. 

The marketplace model

While most digital banks offer a wide range of banking services, some of these tend to come from partnering with third-party providers. For instance, Starling Bank’s only proprietary product is its current account, which serves as a basis for the provision of ancillary services, ranging from loans to insurance, to investment opportunities. Instead of developing these services in-house, Starling enables a select group of partnering financial service providers access to its platform in exchange for a fee. In effect, Starling is using its customer base to create a market for its partners, charging a commission for each acquired customer. 

In such cases of digital banks applying this marketplace model, the majority of their income often comes from partners rather than customers. Naturally, only banks with a large enough customer base can be successful in this set-up, underlining the current intensity of competition amongst digital banks.

Banking as a Service

While customer-centricity is heralded amongst the main USPs of digital banks, some are looking beyond offering consumer-facing services to diversify their revenue streams. Starling, which is among the few digital banks built on its own proprietary platform, has recently leapt into the Banking as a Service (BaaS) industry, making its technology available to other start-ups looking to launch a digital bank. Naturally, this raises the question whether the two offerings could threaten each other’s success. Generally, as long as such partners operate in different markets, the two business lines should be able to thrive alongside each other. Further along the line, however, such partners could easily end up expanding their banking solution into the same market(s) as they aim for global success, and by doing so, becoming direct competitors. 

Different approach, same result?

It is fair to say that consumers in Europe looking to bank with a digital-only provider would have a difficult time finding relative advantages/disadvantages amongst the leading players in the industry. Still, despite the limited surface-level variety, exploring the business models of leading digital banks reveals different approaches to the challenge of making money. Alongside the more straightforward method of offering paid-for premium features/subscriptions, some are banking on the value that access to their customer base offers to third-parties, while others outsource their technology to neobanks wanting to focus on the Fin rather than the Tech. With competition amongst digital banks heating up, it will be interesting to see which business model(s) prove to be the winning formula in the long term.