Open Banking: How Third Parties Can Benefit of a new EU Financial Regulatory

Consumers only trust banks when it comes to banking, but not for other services like consultancy!” “Only banks can develop financial services for end consumers!” “Banking services tend to be boring, because that’s how consumers experience it!”

Sounds familiar? These were the regular claims I heard from industrial incumbents all over Europe a few years ago. The banking industry in Europe has followed these assumptions for the longest time because there were no modern examples opposing these claims.

However, the reason for not having any opposing examples was not the hypotheses were correct, but that outside factors were preventing them from being tested (and ultimately proven wrong). The European banking industry was living on untested hypotheses.

That they are now being tested comes through support from an expected source–the financial regulator. The new Payment Service Directive 2 (or in short PSD2) is changing the landscape of banking. The directory came into law in most European countries in January 2018, but its biggest impact will be felt in mid-2019. That is when banks will have to provide interfaces to allow third parties to access financial data and payment functionality from payment accounts.

How PSD2 offers a new level of competition on the frontend of digital banking products

PSD2 is part of the “Open Banking” movement that makes historically inaccessible data available to third parties. Many countries around the globe follow the European Union’s example for one simple reason: to increase competition in the financial services industry.

For too long, financial institutions have benefitted from barriers to entry and could consciously and unconsciously avoid innovation. The new regulation is enabling competition on an eye-to-eye level between incumbents (e.g.banks) and new players (e.g. FinTech startups or industry outsiders).

Due to the increase in competition, banks and FinTech startups have to create completely new products and approaches to existing problems. A new service has to be 100% digitally designed since the consumer will not simply accept products anymore that are just nice homepages based on manual and slow processes.

In the battle between agile attackers and big incumbents, the toughest fight will be around the question of who will own the front end in the future. The owner of the front end has the unique opportunity to communicate with their end consumer on a daily basis. This has historically not been exploited by banks, but it is one of the biggest strengths of technology companies.

Even though there are no short-term monetisation opportunities with “just providing the frontend,” the opportunities after significant user growth–more importantly, daily interactions–are massive. Banks will not and cannot lose this fight, as being the “stupid infrastructure player” will reduce their flexibility and chances of cross-selling. They also know very well that agile players can prototype and launch services much quicker and are thus are more likely to hit a home run.

PSD2 is the first step to allow new players in the banking industry to offer banking front ends and access data from banks and other data providers. But what is the right strategy to exploit this regulatory change? Just because access becomes available and entry barriers are being removed does not mean it will not be an easy win.

Regulations, high capital requirements and complex service provider structure are still tough to tackle for young startups. Nevertheless, 2018 might be the year when innovative companies benefit from the rigorous regulatory change in banking.

Three-Step Process for FinTech Beginners

Any company or startup considering entering the space of banking should include the following three steps in its ideation process.

a) Read and Understand the Regulation This might seem like a no-brainer, but you’d be surprised how much the level of knowledge about PSD2 differs among industry players. On the one hand, PSD2 is cracking silos and is providing third parties access to financial data, but it is important to understand which banking accounts and financial data will become available, and thus which ideas will really work.

On the other hand, PSD2 is often considered as an anti-bank and pro-startup regulation, but that is not the case. Startups or third-party providers have to be fully compliant with the law and in most cases that requires a PSD2 license (depending on the country and exact service offering). This is especially for new players and industry outsiders a new obstacle that is being implemented through PSD2.

b) Talk to Industry Insiders > Unfortunately, reading the regulatory and additional documents only provides half the picture. Therefore, direct contact to industry players is crucial if the company wants to sell a service to them. This is caused through many different factors, but most importantly that the industry incumbent can judge the impact of the new regulation much better.

More important than the regulation itself is often the implementation and acceptance by the industry. This step is especially crucial for teams and companies that do not have any experience in banking.

c) Connect to Other Industries After understanding the regulation itself and the perceptions of industry players, the last important step to connect development to trends from other industries. Banking in Europe has historically been siloed and the impact from other industries trends lags when it comes to banking. However, this is changing and whoever is starting a service in banking also has to take a look outside of banking. Topics like GDPR, Blockchain, and Voice are just the tip of the iceberg.

New regulation opens up tremendous opportunities and PSD2 might be the one with the broadest opportunities. Common ideation processes can be a big help to identify customer needs and develop new products. However, whenever the idea is close to a financial regulation, the team should pay special attention to the above mentioned steps.

Often it can be rather easy to be a first mover and having the regulator indirectly supporting your business is a powerful weapon. But opportunities will attract other players too and speed is often one of the deciding factors. These three steps can be very helpful to identify valuable ideas faster and execute from there.

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Lars Markull
Reading time: 5 min

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