PSD2 – the slow burn on bank valuations

Not really discussed in all the coverage on fintech in Australia is the impact of the Revised Payment Service Directive (PSD2) in the UK and Europe, forcing banks there to open their platforms to non-bank service providers from next year.

PSD2 will break these banks’ monopoly on their users’ data. It will allow outside parties – merchants like Amazon, or payment technologies like ApplePay, to access the banks’ customer account details to make payments, chopping in to the revenue streams of existing credit card companies and bank-to-bank payments.

It will not require customers to change banks. But neither will the new players need to be banks. It is most likely that the prospective payment providers will be names unfamiliar in banking, but well known outside it – certainly Google and Facebook, and a group of others besides, that will jump at the chance to provide payment services using the banks’ existing payment “rails”.

The maintenance of the safety of the existing bank account structure along with the lower fees on transactions associated with new entrants will be what is attractive to customers. 

Regulators in Europe, the UK and even here have long objected to the way in which the big four banks manipulate the payments system to maximise their revenue. It’s the reason that bank transfers take a day to be effected, or cheques take five days to clear, or on-line banking transfers can take a weekend. The proposition is absurd, given that the money can move the instant the electronic instruction is issued. Creating friction through payments delays is just a way to harvest return.

This will probably be the beginning of the fintech disruption which has been stalking the banks since the internet first became a force.

It is our view that the banks were facing upheaval as long as ten years ago, but these challenges were stopped in their tracks by the flight to safety following the GFC. The Australian banks astutely used the post GFC years to migrate customers to on-line banking, taking significant costs out of their business in the process.

But that is history. Money is inherently digital, and so vulnerable to any player that can access on-line networks – just ask Paypal, ApplePay or Visa.

It is also our view that this is not an immediate issue for Australian banks – the PSD2 directive applies to European banks, and maybe those in Britain. But it is a medium term problem for Commbank, Westpac, ANZ and NAB, and one that is being watched very carefully, as evidenced by the chatter of various big four executives in social media and elsewhere.

And the front end of the push in Australia can be seen in the Parliamentary paper Review of the Four Major Banks, from which sprang the grilling of bank chiefs including CBA’s Ian Narev (he defended Comminsure) and Westpac’s chief Brian Hartzer (he backed down on support for the six monthly name and shame sessions.)

The relevant section of that paper is entitled “Make it Easier for New Banking Entrants” which states that by the end of 2017 the Council of Financial Regulators review the licensing requirements “to determine whether they present an undue barrier to entry and whether the adoption of a formal ‘two-phase’ licensing process for prospective applicants would improve competition.”

For now, the discussion is around making it easier for financial institutions to have their customer’s details forcibly shared with other financial institutions (where the customer opts in). In doing so, it is thought, competitors will pitch for a slice of the payments business which are currently the exclusive domain of the customer’s existing bank. Think of it as a kind of number portability for banks.

But this looks like the thin end of the wedge. First, its just banks going after other banks’ business, but if the experience is favourable in Europe, there will be a push to bring it into being here.

Over time it could be viewed in the same way as the disruption which has hit Telstra or the electricity companies.

Telstra once owned the telephone network, but over time was forced to allow other operators the right to provide services on its infrastructure as long as a fair wholesale ‘interconnect’ price was paid. It’s the reason that we have iinet, Optus and TPG in communications, or AGL now selling electric power.

Of course, it had some unforeseen negative consequences, such as the wait times in call centres when something goes wrong. But this is viewed as a fair price to pay since it provides new companies with better cost structures and the opportunity to ‘re-sell’ the incumbent’s services, forcing the incumbent to examine its own cost structure to remain competitive.

But it also breaks down the incumbent’s (read banks’) ability to harvest return as a monopoly or oligopoly provider of services.