The evolution of regulation spurs innovation in the payments industry

Author: Luis Maldonado, Professor IE University and Senior Advisor at everis

Payment technologies have been transforming the way transactions take place for years. Recent international changes in countries’ regulatory frameworks have meant legacy banks are being pushed to integrate technology and innovate – a vital step if they want to compete with new incumbents and comply with regulation.

Now, the regulatory focus has shifted to bolstering best practices because of new trends in how we shop, buy and pay for services, alongside an increased importance placed on the customer experience. Open banking and the EU’s Payment Services Directive 2 (PSD2) allow new technologies to transform traditional banking systems, providing essential security benefits and opening up a more competitive, customer-focused market.

IE Law School and everis joint 2018 report “Technology in Banking” brings current regulatory changes and their effects on the traditional banking world into focus.

Regulations shaping the open era

Some of the regulations that have recently (or soon will) come into effect will reshape the way banks look and feel.

In the EU:

• PSD2 (passed in 2015; EU countries had until 2018 to comply): To expand the financial ecosystem, opening bank data to third parties, streamlining payment possibilities and reinforcing security measures.

In the UK:

• Open Banking (in effect since January 2018): To give customers a more holistic overview of their finances and to choose the products and services most beneficial to them. Customers are able to give third-party providers access to their transaction history and information, allowing them to offer new products and services.

In Latin America:

• In Mexico, Fintech Law (approved March 2018): To allow more innovative payment systems, including mobile wallets and prepay services.

In Asia:

• In Japan, Banking Act amendments (June 2017): To promote Open Banking, aiming for at least 80 banks with functioning open APIs by June 2020.

The biggest impact: PSD2 and Open Banking 

The European Union’s Payment Services Directive main objective is to foster innovation and competition in banking while improving security and consumer protection. Third party providers (TPPs) are invited into the system to streamline payments, harmonize and uncover any hidden costs, provide new services, and increase security. In order to accomplish the PSD2 goals, Regulatory Technical Standards (RTS) and Guidelines have been published, outlining specific security requirements for strong customer authentication, data fraud reporting and common and secure open standards of communication. This required banks to provide an interface for TPP to access information and allow streamlined communication.

The new players in the world of PSD2 include:

• Account Information Service Providers (AISPs): Compiling customers´ bank information in one place to offer integrated management options, consultation, price comparison, etc.
• Payments Initiation Service Providers (PISPs): Increasingly streamlined payment services to complete direct payments instead of credit or debit cards.

As PSD2 takes shape across Europe, Open Banking regulations in the United Kingdom have opened the market: New actors, predominantly fintech companies, have led to more innovative payment systems; and information-sharing to more effective customer-focused services.

New actors, predominantly fintech companies, have led to more innovative payment systems; and information-sharing to more effective customer-focused services.

Consequences for banks

According to “Technology in Banking”, we are in a pre-revolutionary era, moving into an open era. Although banks are now forced to comply with specific regulations, the system itself is in the early stages of an overhaul. The challenge for banks will be to reevaluate their business models and position on the value chain. They will need to assess who they interact within the new financial ecosystem and what their technology strategy will be.

Value: Banks will no longer have a monopoly on the creation and distribution of products. Fintech companies, developers and aggregate financial management providers will make up the ecosystem. Banks have to think about providing TPP services to their clients, improving the customer experience using shared data to create a consolidated platform. The challenge will be to stand out by analyzing and understanding their clients’ needs.

Ecosystem: Banks will need to decide who they want to do business with to maximize their new model. They will need to decide which client segments they will target, which products and services to keep or create, and whether to form agreements with other banks, fintech companies, or large IT players.

Technology: Banks will be required to create Application Programming Interfaces (APIs) in order to connect and share information with TPPs. Although there are no strict definitions in the RTS for what each bank’s API need to look like, they will need to comply with access control, monitoring and security requirements. These new tech requirements will mean banks will need to rethink their technological infrastructure in order to keep up with the regulations and new system advances. However, it is far from clear how the market will react to the possibility that banks will create their own APIs and hinder the role of TPP.

Traditional banks have been given a nudge in the right direction. Current regulation is forcing their hand, but in a friendly way. The need to comply with new regulations will mean banks will have to rethink their place through innovation and improve their business in order to stay in the game.

Since the 2008 financial crisis, global regulations and also new regulatory bodies were developed to ensure that a new crisis of such magnitude could never occur again.

Read the article in Spanish here

Luis Maldonado has developed his career finance, both in the public and private sector. He was advisor to the Minister of Economy in Spain, Director of Strategic Consulting at PwC and CSO for a retail bank. He has also worked for five years at the International Monetary Fund, where he held different positions, as advisor to the Managing Director and in the Monetary and Financial Markets Department. More recently, he was Managing Director of the PwC-IE Business School Financial Sector Center. Currently, he is professor at IE Business School, Senior Advisor at Everis and Senior Digital Financial Sector Specialist at the IFC (World Bank Group). Luis Maldonado holds a Ph.D. in Economics from Alcalá University, he is State Economist for the Government of Spain, and he holds Degrees in Law and in Business Administration from ICADE University.