PSD2 went live last year with much fanfare but little noticeable change. It is worth remembering the Silicon Valley adage “People overestimate the change over 2 years and underestimate the change over 10 years”. We at HBW believe Open Banking and PSD2 API’s will cause a seismic shift in the balance of power between retailers and Banks, to the retailer’s advantage! We see two broad areas of change for banks;
- Reduction in cards income.
- Changes in market share in consumer credit.
We explain these in a bit more detail in the next two sections and finish with a description of the HBW view on the opportunities for banks.
Reduction in Cards Income
The PSD2 and Open Banking Legislation/ rules mean that retailers have a golden opportunity to reduce their payment costs. Retailers pay somewhere between 0.5% and 1.5% of the transaction value when a customer uses a credit or debit card. They hate this! (The actual fee structure for a retailer is very complex with a mixture of value based charges, per transaction fixed charges and monthly/annual fixed charges hence these percentages are only a range). For a £50 transaction this would be between £0.75 and £0.25. What Open Banking and PSD2 offer is the possibility that a retailer could be paid by credit transfer. This has two huge advantages for the retailer;
- The bank cost to the retailer of a credit transfer is of the order of £0.00 to £0.10. This is a massive per transaction reduction, particularly as these costs are fixed irrespective of transaction size so a £500 purchase, typically costing the retailer £7.50 to £2.50 in card fees could only cost £0.02.
- In the UK (and later in Europe when SEPA-instant is available) the retailer gets the funds in real time; not, as currently with a card based payment, a day (or more) later.
In short, retailers have an opportunity to achieve cost savings of about 1% of turnover. In order for retailers to achieve this shift in payment behaviour, they will have to make it worth the consumer’s while. They should be able to do this through a combination of user experience, promotions, loyalty card points etc. The consequences for banks is that the card income lines will be hit; in particular
- Merchant acquiring income
- Credit Card issuing income.
Change in Share of Consumer Credit
Retailers have always been seen to provide finance, whether by Store Cards, Hire Purchase agreements or other means. One of the constraints on their ability to do so has been that the credit cards gave consumers a very convenient tight coupling of consumer credit and payment method. If the change to move away from payment by credit cards as described above happens, then the tight coupling to consumer credit is removed and retailers have an opportunity to offer the credit. It’s not completely straight forward for retailers as the bank current account (the basis of the current account) comes with its own form of convenient credit, the overdraft. The retailer also faces a conflict of interest between
- wanting to sell an article as quickly and simply as possible and
- wanting to clutter the sale process by selling credit (the consumer credit directive does not make it easy).
However, there are examples emerging across the web and mobile ecosystems where retailers and merchants are finding ways to offer credit quickly and simply. Furthermore, PSD2 and Open Banking offer an additional benefit to retailers wanting to provide credit. The API’s can be used by the retailer to obtain bank account information and so improve their credit assessment of the customer. We do not expect every retailer to have their own version of credit offerring but we expect them to work with the new market players / lending partners that are willing to split the credit income and who are compatible technologically. Think Alipay/Wepay in China or the way Lendingworks partners with Revolut. Banks could be those new partners as we discuss in the next section. The retailers have to do quite a bit of engineering of their checkout and payment processes as well as developing consumer confidence in the payment method, probably involving a new payment scheme(s) with associated logos/ awareness. This may not be that much of a marginal cost to the retailers as even to make the current credit/ debit card payments work, retailers have to carry out substantial changes to comply with the secure customer authentication (SCA) aspects of the PSD2. For example, it is easy to imagine Amazon coming up with an “Amazon Pay” service that other retailers could adopt to reduce the card fees; likewise Google Pay or even an “M&S pay”.
The good news for Banks is that the legislation has forced them up the API learning curve (see “What are APIs?” for an introduction to this technology). They have had to develop a range of technologies and competencies in API’s and they are ahead of the curve, certainly in comparison to most retailers but even versus most other classes of financial services provider (Insurance companies, life and pensions and many start-up banks). This means they have got the technical wherewithal to be able to use the API services of other banks. We see three broad areas of opportunity as a result of this technological capability. The first relates to the re-invigoration of the current account. If one accepts that the pressure and incentives from retailers on consumers to use the API based payments is coming, then the logical consequence is that payment volumes will be driven over the current account and away from credit card accounts. Consumers will still need access to credit so Banks will have the opportunity to provide it via an overdraft on the current account. Hence banks, whether legacy like First Direct or neo like Monzo, that have or can develop strong current account offerings are at an advantage. The second is that banks can be a partner with retailers to help them with the changes. If they have a Merchant Services Division, then that would be a natural route to develop an offering (although there would be some conflict with their cards processing business). If they don’t provide Merchant Services currently, this is a good opportunity to start a new product line consisting of a combination of lending capabilities and API based tech to help the retailers. (There will be winners and losers as not all banks will be able to generate scale and capability quickly enough). The last broad area of opportunity is to use the API’s of other banks themselves for their own branded products and services. Example use cases we at HBW can think of include:
- Use the API’s to obtain current account information to improve their credit assessments of “New to Bank” customers and leads. Something they already do when they “own” the current account.
- Use the API’s to obtain current account information to improve savings and investment advice on where to put money/ how long to tie it up. Something they already do manually in their branches and wealth management areas.
- Use the API’s to help manage cash flow across numerous accounts by sweeping and pooling a customer’s money across his various accounts (something they already do for large corporates).
The challenge for banks in all these three areas is to develop these API based capabilities before the Digital start-ups. If you would like to comment on this, discuss this further or find out about similar issues, contact us by clicking here.