By unlocking open finance ecosystems banks can change their business models and improve their growth prospects through advanced tech integrations
PSD2 gave online banking customers the ability to use their accounts to make payments or access several kinds of account through one platform, thanks to software applications provided by trusted third parties.
While PSD2 does not specify the technology banks should adopt for dialogue with third parties, it quickly became apparent that APIs are useful for that purpose. APIs may be defined as sets of subroutines, protocols and tools that enable methods of communication between various software components both for banks and for third parties.
While many different online service providers have been active in API adoption, creating value and dependence on their services, banking in particular has rarely progressed beyond those terms required to be compliant with PSD2.
However, the advent of Embedded Finance, which sees financial services offered via third party internet platforms or popular mobile applications, offers banks the promise of new revenue streams and enhanced customer engagement. What’s more, some banks increasingly consider financial services marketplaces such as the UK’s GoCompare or Mortgage Supermarket to be an attractive means of enhancing customer convenience, since such platforms allow customers to match their specific needs with the products on offer.
Both Embedded Finance and financial marketplaces are examples of how banks can change their business models and improve their growth prospects through advanced tech integrations. Meanwhile, Banking as a Service (BaaS) represents another opportunity for banks to grow. Under BaaS arrangements, other companies can access a traditional bank’s infrastructure and services to offer financial products and services to their customers.
BaaS gives these traditional banks an advantage over fintech challengers, since they can win new customers and drive more product sales through third parties in exchange for access to their resources in areas such as compliance and regulation and their advanced technical capabilities.
In November 2023, the European Council announced that it had reached a provisional agreement with the European Parliament on a proposed mandate for instant payments across the EU from the end of 2024. This is expected to improve the availability of instant payment options in euro to consumers and businesses in both EU and EEA countries.
Under the provisionally-agreed new rules, payment service providers (PSPs) such as banks, which provide standard credit transfers in euro, will also be required to offer the ability to send and receive instant payments in euro.
These provisions apart, legislators agreed to grant payment and e-money institutions (PIEMIs) access to SEPA instant payment systems via changes to the Settlement Finality Directive (SFD). As a result, these entities will also be obliged to offer the capacity to send and receive instant credit transfers after a transitional period.
The implication of these developments is that payment system operators face a significant new challenge to onboard and offer access to instant payments for many new system participants. Host-to-host connectivity and certificate management do not feel relevant in this new environment. Adopting an API-based approach is much more promising, but this requires fundamental changes to the connectivity and interaction between market participants, including central banks and other national infrastructures.
The European Payments Initiative (EPI) is perhaps one of the most promising new directions for the future. The EPI aims to become a new payments standard for European consumers and merchants across all types of retail transactions, including in-store, online and peer-to-peer environments.
Positioned as a central innovation platform for the European payment ecosystem, the EPI aims to deliver more value and greater efficiency to customers through direct and instant payments between retail and corporate accounts. The EPI’s vision is for a pan-European, cross-border instant payment network – an altogether more ambitious undertaking.
It's important to note that the EPI will not introduce an EPI card. At the core of EPI’s offering is Wero, a digital wallet solution that operates on instant payment rails, plus the use cases covered through the QR-code setup. However, the EPI promises to integrate all different kinds of card-based transactions at the point of sale. This flexibility allows for a comprehensive approach to conducting transactions. At the same time, it brings the challenge of setting up seamless and stable integrations through APIs – something which seems to go beyond the common approach favoured by PSD2.
When it comes to APIs, the market has reached a new phase of development. It is perfectly normal that the first solutions to market were not future-proof, and that they were focused on compliance at a time when pressure to utilize APIs came from the competition banks faced from FinTechs. That said, it now seems that the indirect effects of regulatory initiatives such as PSD2 and the new instant payments mandate will provide banks with further impetus to use APIs more extensively. Today’s solutions, especially those built on open-source tools, will face a long road in adapting to this new environment.
One of the biggest challenges is whether existing banking capabilities are able to address the evolving demands and conditions of the payments ecosystem. If that is the aim, then these systems will require much more advanced API setups than simple compliance with PSD2 or even PSD3.
As always, market advantage will be gained by those who are more open-minded and forward-looking. When it comes to API approaches, the market is already moving far beyond PSD2’s vision for Open Banking, and even the new draft regulatory requirements for PSD3. Developing a fully-centralized and comprehensive API strategy that enables banks to manage platforms through open APIs will be a huge enabler of an Open Finance future – as well as enabling banks to engage with FinTechs to the benefit of all involved.