By Mike Wallberg, CFA
The following is the first of a series of articles exploring the “Payment Services Directive 2” legislation, which becomes law in EU countries in January 2018. The series will address the myriad ways that PSD2 is expected to impact the payments industry. These include expected changes to consumer and corporate behaviours; a new architecture for payment processing that will change how banks, fintechs, digital banks, merchants, and payment processors interact; and the race to establish dominance among the data aggregating Account Information Service Providers – a new role that will have significant informational advantages when developing products and offering advice. To be pragmatic, we start with the basics: how banks will need to adapt their reporting systems to comply with PSD2’s new rules.
In January 2016, the European Parliament reset the goals and countdown clock on payments in the European retail banking sector: Payment Services Directive 2 becomes law in January 2018. Well beyond the narrow vertical of payments, Gartner, Capco and others are calling it a fundamental, transformational change to a new “digital ecosystem.” So developing a “smart” strategy means investing to clear the short-term regulatory hurdles while keeping a trained eye on the (r)evolution underway.
The Relationship Banker will take you through the action, starting this month with a non-technical overview of some of the key reporting transparency components of PSD2 and the initial steps banks should be taking to hit the compliance deadline. The tidal wave of acronyms (with translations) will hit later.
What is in PSD2 and how afraid should you be?
The goals of the directive are ambitious and include:
- To make payments safer, more secure, and less expensive;
- To create a more integrated and efficient European payments market; and
- To level the playing field for payment service providers (PSPs).
To get there, there will be a significant revamp in the architecture of how payments are processed, including the introduction of a central clearing house for payment information. Many pundits consider it a platform for completely changing the way banks interact with fintechs and their clients – beyond retail banking and beyond Europe.
But let’s focus on the immediate problem: what are the new, enhanced functionalities in respect of reporting compliance banks have to deliver in 18 short months? And how can they best develop these capabilities?
Increased transparency and granularity of charges for payments
There are many questions PSD2 will force banks to ask of their current systems that will inspire the 01010 equivalent of the blank stare. The following key compliance and reporting requirements (hewn from the mammoth document here) may breathe life to your nightmares, but worry not: solutions do exist for addressing them (covered next). Note I use “bank” here but these technically apply to any PSP:
|Payment Service Providers Must:|
|1. Provide a summary and breakdown of all charges payable by the payment service user to the PSP, including interest and exchange rates, and the method of calculation along with the reference data to justify it.
|2. Proportionally reimburse pre-paid payment charges when a contract is terminated early.
Example: Bob pre-pays $100 for unlimited payments for the year. He cancels his contract after nine months. The Bank must refund $25.
|3. If the payer asks before agreeing to execute a specific transaction, the Bank has to tell them:
a. How long it will take to execute
b. Charges payable
c. A breakdown of the charges, where applicable
|4. The bank must provide a detailed breakdown by individual payment transaction to both the payer and the payee.|
|5. Payees have to tell payers – in advance – if they’re changing the standard pricing.
Example: The payee must tell the payee first, before offering a discount or charging a surcharge for a payment.
|6. With some exceptions, banks can’t pass along the cost of these higher reporting requirements onto their customers.
William Fry cites an EC estimate that “95 percent of card payments made in the EU will be protected from surcharges in future.”
|7. Banks can’t stop payees from levying charges on payers for specific payment instruments.
Though the charges can’t be more than the marginal cost borne by the payee to execute it.
How to tackle PSD2’s compliance reporting requirements?
A lot of what is described above can in fact flow naturally from a well-designed and executed pricing and billing system – a system that can be developed and deployed inside of a year without ripping out your core.
The engine would add an “innovation layer” between currently uncooperative systems – your core, your general ledger, transaction systems, CRM and so on – so you can extract your data to both report how payment fees are being generated and billed, and then better manage how you do so in the future. That can include revamping the way you strategically and tactically price and bill customers – by enabling rapid deployment of complex payment bundles, and managing conduct risk through systematic approvals systems.
And by taming and controlling the garble of data feeds now, banks may also more easily comply with future transparency regulations (PSD3, anyone?).
See Figure 1 for an example of using an innovation layer to transparently price and bill payments.
Figure 1: Using an innovation layer in practice
An example. Let’s walk through the first example: Provide a summary and breakdown of all charges payable by the payment service user to the PSP, including interest and exchange rates, and the method of calculation along with the reference data to justify it.
By adopting a transparent pricing and billing engine, banks can:
- Centrally house the reference rates for interest charges and FX in the innovation layer (i.e., LIBOR, noon buying rates).
- Establish rules-based protocols for who gets charged what premium over reference rates (i.e., a client with transactions over a certain threshold gets charged smaller premium) and control who has approval powers.
- Calculate charges within the innovation layer; and
- Export detailed and summary charges data to G/L, core, CRM and transaction systems.
Banks can then easily access, view and control the inputs to their pricing – satisfying regulators, improving internal price governance, and enabling total transparency to customers.
If the prognosticators are right, and flat-footed banks are fated to become commoditized capital providers of the future, developing the ability to compete with fintechs starts with addressing customers as individuals, and pricing them as such. By solving the PSD2 problem with a transparent pricing and billing solution, banks can stay out of the regulatory doghouse while preparing for the coming PSP revolution.
2018 is not that far away. It’s time to get to work.