PSD2 is pushing banks to reinvent themselves, but are they up to the task?

By Paul Bowen | 13 July 2017

“Banking is necessary, banks are not” Bill Gates famously said in 1994, speculating on the future power of technology. As the Second Payment Services Directive (PSD2) comes into effect at the beginning of 2018, what once seemed like a controversial statement is now gaining increasing significance.

Designed to boost competition in the industry, PSD2 mandates that banks open up their customers’ account information to third party providers, via Application Programming Interfaces (APIs). Critically, this means that banks will soon face the challenge of competing with a burgeoning economy of start-ups in the fintech space waiting in the wings to take advantage of the lucrative opportunity, as well as the threat of tech giants with strong customer brands, like Apple and Amazon.

The regulatory barriers that previously kept competitors at bay are fading and banks will be required to address a host of new challenges that will define their relevance to millions of customers. Should banks be concerned by what lies ahead? In a word, ‘yes’ and here’s why.

Until now, banks have largely been able to take customer loyalty as a given; switching banks has been relatively infrequent – in the UK only 3.5 million people switched banks from 2013 to early 2017 (just five per cent of the 70 million active current accounts). But as more agile tech organisations are setting high standards in terms of rapidly delivered innovation and customer experience, customer loyalty is no longer guaranteed.

As a result of this, consumers, especially Millennials, won’t shy away from using new platforms that are better tailored to their needs. Indeed, 73% of Millennials have said that they would be more excited about a new offering in financial services from Google, Amazon, Apple, Paypal or Square, than from their own traditional bank.

Fintech companies like PayPal and TransferWise have already proved themselves highly successful at breaking into the market. Competition is extending to social media providers too. Facebook recently secured an e-payments license from the Central Bank of Ireland, indicating that its users may soon be able to pay people through its Messenger app in Europe. As more competitors emerge, banks face the risk of being reduced to a bit player in the customer journey; estimates for the potential loss of market share to new payment initiation service providers are high as 33% for online debit card transactions by 2020.

So, in other words, PSD2 represents an existential threat to banks in their present form. By the same token however, it is not too late for banks to turn this regulation into an opportunity.

Fighting the competition

For banks to retain relevance in the advent of PSD2, they need technology that helps them interact with their customers in a more intuitive and seamless way. And they need it fast. Banks must adopt new processes, models and tools, including:

API creation

For banks to extend their operations as a digital platform, create new channels and find new customers in the new environment, a comprehensive API Management solution will be essential. The right solution will pave the way for engagement with both internal and external developers, business insights, analytics, security and protection.

Customer-centric apps

Banks need to position themselves as a one-stop shop for their customers. Getting to this point will mean offering a seamless digital experience and becoming the best-in-class at enabling customers to manage their money. Transforming traditional banking apps to offer services such as wealth advice, tax or mortgages will enrich the customer experience, increase brand value and diminish banks’ threat of displacement.

Cognitive services

To build more personalised apps, banks must tap into an ever-growing collection of powerful artificial intelligence algorithms that evaluate sentiment and topics, learn how to recognise what users want and moderate content automatically. One major Asian bank used cognitive services to improve its customer service by developing a cloud-based, cognitive robot software that understands speech, gestures and even customer expressions. The robot takes customer service to a new level by interpreting questions and learning preferences while scanning the bank’s information, to provide a personalised service that becomes richer and more targeted over time.

Data driven learning

Banks own an unparalleled wealth of deep insight into customer behaviour that can be drawn through analysing customer spending, financial health and financial products owned. But if they don’t act on their valuable data assets now, a third party is sure to, when PSD2 comes into play early next year. Banks must start using their data and fast to predict customer opportunities and risks, and will need fitting machine learning tools and cloud services to catalyse this process.

Encouragingly, some banks are creating different partnerships to accelerate innovation in these areas to overcome the challenges PSD2 will bring. RBS is encouraging API experimentation with third party developers via BankofAPIs.com and Barclays recently set up Rise, a London-based fintech hub, to collaborate with pioneers in the space.

Ultimately, banks have a limited window of time to recast themselves in the eyes of their customers and maintain their relevance, and must start rapidly experimenting with, adapting to and adopting these emerging technologies. Rather than merely complying with new industry regulations, if banks are able to focus their efforts on new revenue sources, business models and customer-centric innovation, they will be able to retain and even increase their market share as the era of open banking comes into play.