New competition or new regulation: which is the bigger challenge for banks?

Anthony Duffy, Fujitsu: “I welcome new competition”

One of the most talked about issues in retail banking today is the emergence of the new entrant, or “challenger”, bank. “New” banks are being spun off from existing institutions and more than twenty organisations having applied for, or received, a banking licence over the past twelve months or so. Banking is becoming an ever more crowded field, as the regulatory authorities encourage new competition. Their goal is to weaken the grip that the incumbents are perceived to have, particularly in the current account and business banking markets.

But will new entrants really threaten the position of the largest and longest established banks? History suggest that the creation of a new raft of suppliers doesn’t always result in long-term change to a market. During the late 1990s, building societies such as Alliance & Leicester, Bradford & Bingley and Woolwich all converted into banks, each with high hopes of driving long-term change. And where are they now?

Furthermore, if the Payments Council’s Account Switching service is used as a barometer, it is debatable whether further choice is a priority for many bank customers. The Competition and Markets Authority has found that in Britain, there are more than 68 million active personal current accounts yet in 2015, the service was used to transfer just over one million accounts – perhaps suggesting that many customers are happy with their existing provider. Latest statistics suggest that the two banks that currently benefit most from the service, in terms of net accounts gained, are Santander and Halifax, neither of which could be described as the newest of “new entrants”.

I welcome new competition, not least because of their ability to drive innovation and change. I believe that most of the new entrants will be successful when measured against the goals that they will set for themselves. I particularly expect their existence to drive significant change within existing suppliers of banking services. But when I look forward five or ten years, I don’t see a fundamentally different market structure.

Where I do see significant market arising is as a result of continuing changes to regulation. In particular, the second Payment Services Directive (PSD2) has caught my eye. This initiative, which was adopted by the European Parliament in October 2015, casts a wide net. I expect two key elements to have significant market impact.

The first relates to the promotion of Application Programme Interfaces (APIs). At its simplest, this is code that allows two pieces of software to communicate with each other and it threatens to revolutionise key parts of the payments world.

Today, when shopping on the internet, the merchant (say, Amazon) will use an acquirer (such as World Pay) to contact the customer’s card scheme provider (for example Visa) to “pull” the payment from the customer’s bank account, details of which the customer provides via a debit or credit card. In the post-PSD2 world, the shopper using Amazon – rather than entering his/her debit or credit card details – will be asked if he/she wishes to give the retailer access to his/her bank account. If consent is given, the customer will be taken to his/her bank’s internet banking site, where permission for the transaction is granted and recorded, not just for this transaction but for every transaction until the authority is revoked.

So what is the significance of this? For the shopper, perhaps very little. After all, giving permission to a retailer to store card details is not very different to allowing the bank to do so. However, for the businesses involved in the transaction process – and banks in particular – I expect it to have a major impact. Acquirers and card schemes are likely to be disintermediated. Control of associated revenues might well change (although it is not yet clear how – customers could receive a share of the revenues that previously went to the disintermediated parties via lower prices, although merchants might also elect to keep these monies for themselves. And banks could charge merchants along similar lines to today’s interchange fee or use a different pricing structure). Furthermore, I expect that developing and deploying the IT required to support the changes will require considerable investment and effort.

If this wasn’t challenging enough for established players, the second, perhaps bigger, change lies in the creation of Account Information Service Providers (AISPs). I expect this to result in the creation of “consolidation services”, showing information drawn from a customer’s accounts held at different financial institutions. Such an offering becomes possible under PSD2 because it requires businesses that provide payment accounts to give approved third parties with access to their customer’s account information, providing the customer has consented to this.

So what does this mean in practice? I expect merchants to benefit from the Directive by being able to forge a deeper relationship with their customer and from lower costs compared to the interchange fees that they pay today. I expect customers to benefit by having the option to consolidate accounts in one place, making for easier financial management. But I also expect established banks to suffer from a weakening of their relationship with their customers; from lost revenues, as a result of changes to their payments business; and by incurring significant systems-related costs, none of which are likely to be compensated for by their new-found ability to position themselves as an AISP.

Quite simply, PSD2 opens another front in the ongoing financial services war. It mandates change, aimed at breaking the positions that established suppliers have long enjoyed. For incumbent banks, the challenge will not be easy to overcome. Lost revenues are always painful to bear, with lost market position perhaps being even harder to take.

But the large banks start with many advantages over the new competition. They already own the customer relationship, an asset which statistics suggest can be difficult for others to prise away. Investment budgets and resources, already stretched and now required to deliver more, are likely to be larger than those of the competition. And they are well placed to educate the customer as to the value that an AISP can offer.

So while new competition is not to be sneezed at, I believe that the opportunities and challenges created by changing regulation are a bigger threat to the market position of the established banks. I am confident that the banks will successfully rise to all of the challenges that PSD2 presents. And I think that this really would be something worth talking about.

By Anthony Duffy, director of retail banking at Fujitsu