COMMENTARY: Is Open Banking the Beginning of the End for Payment Networks?

By Rick Oglesby and Brad Margol

A 2015 European Parliament regulation, EU2015/751, caps the fees that a European cardholder’s bank may charge a merchant’s bank (interchange fees) at 0.2% for debit cards and 0.3% for credit cards. Also passed in 2015, and ramping up to full effect in January of 2018, is Europe’s revised Payment Service Directive (PSD2). Intending to increase consumer choice and empower new competition, the directive requires European banks to share consumer-banking information with financial-technology companies that provide payment services.

The combination of these two regulations dramatically decreases the value that payment networks provide to banks and merchants and raises the question, is this the beginning of the end for these networks?

PSD2 and open banking put the consumer in charge of his or her own banking information. If the consumer wishes to work with a startup payment provider, the consumer’s bank is no longer allowed to prevent the payment provider from accessing the consumer’s information and funds. Rather, the bank must, at the consumer’s request, provide open access. Banks can no longer monopolize payment services, even among its own banking customers!

The implications for banks are tremendous. First and foremost, the regulation greatly diminishes the banks’ competitive advantages in the provision of payment services. They will now need to compete head-to-head with nimble, digital fintech companies that differentiate through cutting-edge technologies. That’s not exactly a banking core competency. They will need to become tech companies if they are to compete directly, and, at the same time, they’ll need to securely serve up their data to their competitors in an easy-to-use format.

Furthermore, as fintech companies continue to disintermediate financial institutions’ customer bases, banks will need to compete within third-party software packages to sell banking services to their own customers. It may be a whole new world of banking, filled with value-added fintech companies that use banks as a back-end data utility while providing cutting-edge services to consumers who use banks for little more than funds storage.

But the implications for payment networks may be even more dire. The networks primarily provide their services to banks, which use the networks to accomplish two primary goals:

1. Monetize their transactions by riding the networks’ interchange system that enables all banks to charge the same price for their payment services without competitive pressures;

2. Gain universal acceptance for their payment instruments by riding the networks’ brand and connectivity between banks and merchants.

When interchange fees are capped at a low level, the value that a payment network provides to a bank is dramatically reduced, and the bank no longer has an incentive to force all payment volume to pass through the network.

What happens if, at the same time, banks offer direct access to their customers via an open application programming interface (API)? If consumers choose how payments will flow in and out of their own accounts, then network market share is no longer a function of bank decisions. Rather, it’s a function of consumer decisions.

We’ll have open-banking marketplaces where banks will need to compete every day for every customer, every loan, and every transaction, entirely in a digital format determined and controlled by third parties. There will be great incentive for merchants to connect to these marketplaces, where banks must compete outside of traditional, network-dominated ecosystems that limit competition.

It won’t take long for a few fintechs to code to all banking APIs within a market. Creating data aggregation and payment services that work across all banks, these firms will become more modern payment networks with access to more consumer data, without the need for bank opt-in. These new networks could slowly eat away at legacy network market share, one consumer and one transaction at a time. Regulators around the world, such as Sen. Richard Durbin, D-Ill., who seek to eliminate the interchange pricing model will have a blueprint for doing so. If successful, this could spread around the world.

Payment networks have long been nearly infallible. Their impossible-to-replicate merchant and bank coverage, coupled with their partnership model and distributed technology, creates a nearly impenetrable defense that has survived repeated competitive and regulatory challenges around the world. It’s nearly impossible to imagine new competitors displacing the leading networks without tremendous technology evolution and regulatory support.

However, the same partnership model and distributed technologies that make the networks so strong also limit the networks’ ability to adapt. The API may just be the technology evolution that is needed to alter the competitive landscape. New regulations that require that all banks share customer information are most certainly an accelerant. The combination of technology and regulation may finally be the formula that ends the networks’ reign of superiority over electronic payments.

If you’re in or invest in payments, Europe in 2018 is must-see TV. But if you think open banking will be isolated to Europe, think again. In the U.S., the Consumer Financial Protection Bureau has already been exploring options to force banks to share financial data in a manner similar to the requirements of PSD2. And, already, JPMorgan Chase is pursuing its own ways to interface directly with merchants. Both regulatory and market forces are already at work here in the U.S. It is unlikely that the Atlantic will be enough of a barrier to isolate these changes very long.

—Rick Oglesby and Brad Margol are principals at AZ Payments Group LLC, Mesa, Ariz.