Woman using a digital tablet for bank issues
#Digital

The rise of the non-bank

Global Trends
6 Mins.

The introduction of PSD2 has had a hugely powerful effect on the financial services industry, driving a wave of fintech startups and forcing banks to transform and innovate in ways they never had before

When the Payment Services Directive II (PSD2) came into force in 2018, it accelerated the generation of open banking. As a follow-up to the original PSD, which was designed to create a common European banking payments service, PSD2 introduced new customer rights around surcharges, currency conversion and complaints handling, along with extra authentication measures for payments.

While the full impact of PSD2 has not yet been realized, banks need to adapt and can still have competitive advantages by implementing biometrics as a solution for secure two-factor authentication.

A distinct advantage

Close up of a woman using a digital tablet for bank issues
The new players in the banking sector aim to make banking as easy as WhatsApp, as fun as Facebook and as sociable as Instagram

As electronic payments evolved, the EU felt the need to introduce a directive to stimulate competition in the payments space while regulating security requirements for its stakeholders. PSD2 was designed to unlock access to banking and break the stranglehold that large retail banks have on customers. 

PSD2 has subsequently opened the market. Previously, established banks could control their own customers: no one else had an opportunity to provide services to them. That has now changed – and the impact is being felt, fueling the rise of tech‐driven “non‐banks.”

According to recent research by Pepper, a mobile bank created by Israel’s Bank Leumi, two‐thirds of financial decision‐makers believe PSD2 has already given tech companies a distinct advantage over traditional banks.

“Most new players to the banking sector are tech companies first, built with a digital core, and solely focused on the customer,” says Michal Kissos Hertzog, CEO of Pepper. “They aim to make banking as easy as WhatsApp, as fun as Facebook, and as sociable as Instagram. With a digital core, they can respond quickly to market demands and changes. In turn, they win their loyalty, which is a big challenge facing the banking industry today.”

“Most new players to the banking sector are tech companies first, built with a digital core, and solely focused on the customer“
Michal Kissos Hertzog
CEO Pepper

Fintechs are opening up banking

Despite the clear threats, 56% of respondents to the survey said that open banking is also an opportunity for traditional banks to change and become more customer centric.

“Incumbents have recognized that they need to act to capitalize on the opportunity,” Kissos Hertzog adds. “To compete with new players, traditional banks are increasingly looking towards adopting a digital core in which they can effectively make use of the data they own for the benefit of their customers.

The major challenge that traditional banks face to innovating in the open banking age is the huge weight of legacy systems and processes they have to carry with them. Non‐banks have promoted more transparent and competitive pricing to disrupt several markets, including banking, foreign exchange and savings. Digital‐only platforms have also driven speed of adoption and the ability to expand into new geographical markets quickly.

By not having to worry about legacy infrastructure, non‐banks can be more efficient and proactive in their embrace of new technologies to gather customer and market insights. As a result, banks are increasingly looking to copy fintech formulas as adjacencies to their core business.

Security you can bank on

New security measures enforced in PSD2 have placed financial services firms under even greater strain. PSD2’s introduction of Strong Customer Authentication (SCA), which forces anyone processing electronic payments to require a minimum of two independent authentication elements when challenged by a card issuer, may have the right intentions, but the extra verification has also frustrated customers.

Non‐banks have an advantage in this area because they typically have a younger, more mobile‐first and tech‐savvy customer base, making it easier for them to deploy app‐based two-factor authentication. Traditional banks typically have an older, more diverse customer demographic, with different levels of digital literacy, making it more difficult for them to roll out and enact any change.

“Not only are digital‐native customers used to verifying their identity on their smartphones, but challenger banks can also use these devices as the second level of authentication,” says Daniel Cohen, director of fraud and risk intelligence at RSA Security.

As the number of digital payments and other financial services continues to rise, there is no doubt that PSD2 will lead to improved services and security for customers. The most successful banks will be those that embrace rather than fear open banking, becoming software powerhouses in their own right.

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