Europe can’t do open banking without the banks

The EU has made no secret that it wants a European payment solution as an alternative to the US-based VISA and Mastercard. Open banking can be that digitally-native alternative, the foundation for real-time cross-border payments in Europe.

But, to truly compete with cards, open banking needs banks to recognise it as a key driver of revenue, innovation and customer satisfaction. 

Five years ago this month, the EU created a framework for open banking. Through the Revised Payment Services Directive (or PSD2), newly regulated fintechs were encouraged to inject innovation and competition into banking and payments. 

Today, there are around 500 regulated open banking providers and millions of Europeans that have used their services. This growth is significant, but uneven.

People in Italy, for example, still have vastly different options and experiences using open banking compared to people in Sweden. One reason could be the lack of investment in the API infrastructure that open banking needs. Another reason could be the underlying payment infrastructure available in those countries. 

After five years of PSD2, we can look back to understand what worked, what didn’t work, and how to move forward.

What's holding open banking back?

An open banking payment can be broken down into two parts.

The first part is initiation. This is everything an open banking provider does to integrate a bank transfer payment option into a merchant’s checkout so that it appears as an option for the user when they press “pay”. This ranges from connecting to hundreds of banks via application programming interface (APIs), submitting payment instructions and managing the start of the consumer payment journey. 

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Banks should recognise that APIs are a new channel for providing services to their customers, and treat them as a product – just as they treat their online banking app.  

This is the part where fintechs have a lot of control, and where a great deal of innovation has happened.

But this part is also dependent on the performance of banks' APIs and frictionless user journeys enabled by the bank. Where these aren’t available, open banking can't flourish.

Banks should recognise that APIs are a new channel for providing services to their customers, and treat them as a product – just as they treat their online banking app.

The second part is settlement – the actual moving of money between accounts. After a payment is initiated through an open banking provider, the settlement is done by the bank. And that is where Europe is lagging behind by not having instant payments as the default payments infrastructure.

When combined with real-time settlement, open banking allows merchants to get their funds instantly. This gives them the certainty they can ship goods and it helps with their cash flow. A bank's relationships with merchants and SMEs can be improved through enabling these new, more efficient open banking payments.

SEPA Instant, the EU’s voluntary scheme for euro transfers, is available to a little more than half of Europeans today – although this varies between countries. Only about 10% of all transfers are made via SEPA Instant, with most account-to-account payments taking between two and three days to arrive.

Many banks also continue to charge users for instant payments rather than the merchants (as is the case with cards), which discourages use. In some countries, like Ireland, instant payments are almost non-existent. 

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The bank revenue opportunities from premium open banking services could also be considerable and... should convince even the more sceptical banks that open banking is a commercial opportunity. 

This is also an area where banks can make open banking a success. As the ones responsible for the settlement layer, they are uniquely placed to enable real-time payments across the EU.

Many banks have not yet seen the value of real-time payments for their own customers, which is partly why the EU is moving to make them mandatory through legislation. Open banking will unlock this value. 

The commercial opportunity for banks

Once the baseline of open banking and instant settlement is in place, banks will be able to build value-added services on top of it. Dynamic (or variable) recurring payments are an obvious example where cooperation between open banking providers and banks can create a trusted product that is in high demand among both consumers and merchants. 

The bank revenue opportunities from premium open banking services could also be considerable, and will become even clearer once the European Payments Council finalises its premium API scheme this year. It should convince even the more sceptical banks that open banking is a commercial opportunity. 

Overall, open banking is estimated to be worth over $110 billion by 2026, and banks are well placed to capture a good part of that.

This includes direct revenue coming from higher adoption by businesses, and thus higher payment volumes to business accounts, and from selling premium API services. It also includes savings coming from upgrading back-end infrastructure to support new open banking technology.

This modernisation will make banks more efficient and profitable as a whole, and in some cases allow them to better compete with  fintechs and challenger banks.

The benefits will go beyond open banking and will help banks boost customer satisfaction, make them more agile, and ultimately more successful in a digital economy.

Not to mention that the real threat to banks in the long run is Big Tech platforms, which are already growing their financial services offerings. Banks cannot overlook the opportunity to differentiate themselves and compete against them.

‘Pay by bank’ continues to grow quickly around the world, like in the US and South America. Europe can lead the way, and the upcoming changes to PSD2 need to focus on enabling a modern payment method. But regulation is just one aspect of it. Open banking is being held back. It is not a technology problem, it is a business decision.

The combination of open banking technology and real-time payments can challenge the card duopoly to create a truly European payment method. It can’t happen without the banks, and banks can’t afford to miss the opportunity.

Originally published by FTAdviser on Friday 13 January 2023.