PSD2 in Europe: Lessons for India’s Payments initiative

India’s payments landscape

The payments landscape in India has undergone a transformation in the last 5 years. From expanding National Financial Switch (NFS) that enabled ATM interoperability across banks to RuPay card network that helped increase card penetration to Unified Payment Interface (UPI) that has made 24×7 payments accessible through mobile, India now has a strong payments backbone, thanks to efforts of RBI and its progeny National Payments Corporation of India (NPCI).

The recent demonetisation, Payments Bank licenses and other government initiatives like issuance of RuPay cards to Kisan Credit Card and Jan Dhan Account holders, aggressive campaign on UPI, the launch of BHIM app and the upcoming biometric enabled Aadhar payment app have given the much-needed impetus to the digitalisation of payments.

This focus will help increase non-cash transactions in the hinterland, strengthen the financial inclusion initiative and more importantly ensure that India leap-frogs to mobile banking.

However, outside the government and RBI initiated actions, there has been very little private participation in building the payment infrastructure. Since these initiatives have been led by NPCI, it has inadvertently restricted innovation within its circle of influence, including a select coterie of legacy banks. Even the new gen fintechs in India have, at best, been incremental in their approach. It seems RBI is sticking to its old generation definitions and confusing financial intermediation, which requires expertise and trust building, with routine services like Payments, that require only a connecting platform.

While a few years back the physical distribution of the banks was the key to delivering payment services, with increased mobile penetration and availability of required technology, branches are no longer a the sole distribution channel. Payments as a service is fast becoming a back-end facilitator for buying goods and services and no longer need to be a front-end chore. There is no reason, therefore, that it should remain a prerogative of the banks. And it is in this context that India’s regulatory paradigm differs from likes of Payment Services Directives (PSD2) which the European Commission is now implementing. India can learn some great lessons from PSD2.

What is PSD2?

Payment Services Directives (PSD) are a set of guidelines first issued by the European Commission (EC) in 2005. It aimed to build and strengthen an integrated Single European Payments Area (SEPA) and reduce the entry barriers across Europe. It was adopted in 2007 and implemented across the European Union by 2009.

PSD provides a regulatory framework within which all Payment Service Providers (PSP), including non-bank players, are required to operate. These norms were reviewed and a second version titled PSD2 was published in December 2015, requiring the member countries to implement these by 13 January 2018.

The key objectives of PSD2 can be summarised as below

  1. Integrate payments across the European Union to build efficiency.
  2. Foster innovation by providing level playing field to non-banks with ‘Access to bank account’ (XS2A). By extension, this brings all the non-bank players (Third Party Payment service providers or TPP) under an updated and homogenous regulatory regime.
  3. Reduce the cost of transaction
  4. Improve safety and security norms for transactions

The directives segregates the payments market players in 3 broad categories

  1. Account Servicing Payment Service Providers (ASPSP) or the Banks where the customer account is maintained.
  2. Account Information Service Providers (AISPs) can be both bank or non-bank players who can now access information from multiple accounts held with ASPSP.
  3. Payment Initiation Service Providers (PISPs) can link to the customer accounts held with ASPSPs and offer payment services.

It envisages AISPs and PISPs to have access to customer account details, hitherto a monopoly of banks. While Banks can also act as ASPSP, AISP and PISP, the directives recognise and regulate other non-bank players who can play either of the roles in the payments value chain. It brings a more open payments culture, ultimately giving more choice to the customers.

Put simply, with PSD2 in place, customers can be bank-agnostic and still avail better services as:

  1. Service providers can now offer the customer a consolidated view of multiple accounts held by different banks;
  2. Payments are no longer dependent on bank payment gateways or card networks like Mastercard or Visa. Other players, including merchants like Amazon or Uber, can act as PISPs and directly send and receive payments from the banks. It also means Facebook, Twitter, Google, Linkedin or even smaller Fintechs may offer payment services embedded in their portals and facilitate transactions on the go!

This approach has lessons for India to learn (except for the confusing three and four letter acronyms!)

What can India learn?

  1. Leveling the field with Open APIs

To ensure access to account level information, PSD2 requires banks (or ASPSPs) to provide Open APIs (Application Programming Interface, which is a layer of software that connects a TPP to Bank’s systems) to AISPs and PISPs. Put simply, banks can no longer restrict the account level information to be shared with other PSPs, including new entrants and smaller fintechs, if the customer so desires.

Left to themselves, banks would consider the account level data both as a competitive advantage and a source that can be monetised for cross sell. Since neither the AISPs nor the PISPs take deposits, the Banks would continue to play a focal role as financial intermediaries, however, the front-end servicing no longer remains their exclusive fiefdom.

In India, such an approach can give a big boost to innovation and financial inclusion while simultaneously reduce dependence on the big banks. By mandating Open APIs, banks are forced to offer an interface to other players for not only accessing the account information but also gives them an opportunity to embed their banking services within the merchant applications.

  1. Making financial advisory accessible through AISP

Any data is dumb unless analysed. It is interesting that our savings or current account data is hardly of any use to us except for a specific purpose like taking a loan. The account statements lying in the core systems of the banks add no value to the customer on day to day basis. Now, imagine if this data can be smartly used to help the customer plan expenses by giving real-time inputs on whether he/she has the budget for that 4K TV or a foreign holiday?

If a customer has accounts with different banks, he/she needs to access multiple internet banking platforms or visit branches to even find out a consolidated balance. What if they can get a live feed of balances has and also get advisory that with the EMIs coming up for payment, next week’s balance would be much lesser and it’s better not to splurge! AISPs can now offer such services.

With access to all the customer accounts, AISPs can not only provide a consolidated balance statement and monitor expenses but also give better investment advisory with real-time inputs. The customers can see all their bank account details with a single login instead of multiple passwords of multiple banks.

Financial advisory is a powerful tool in building value for those recently included in the formal banking channel. In India, this has been relegated to cross-sell of Insurance and Mutual funds, with no analytics of usage patterns or financial goals of the customer.  A real-time access to the account information, expense analytics, simple reminders on payment due dates and a tool that can track the progress on your financial goals are just some of the use cases. Timely advisory can help everyone with better financial planning and discipline, more so for the most vulnerable sections of the society, who otherwise end up investing in some Ponzi schemes.

  1. Democratising payments through PISPs

PSD2 norms envisage multiple players to become payment service channels. The initial capital requirement to become a PISPs is €50,000 (₹35 Lakhs) plus an indemnity or guarantee to the regulator, who will then approve after required hygiene checks. It empowers many players, like retail chains and online merchants, to connect directly with banks instead of going through intermediaries like Worldpay.

In India, while RBI has experimented with the concept of Payments Banks, it is still a license based regime, with initial capital requirement of ₹100 crores and continues to encourage increased intermediation. What PSD2 does instead is to disintermediate and democratise the payments business.

With a more open structure like PISP, we can bring down costs significantly. Retailers like Big Bazaar or Infibeam or Amazon can connect to your bank account and avoid the merchant, interchange or gateway fees charged by banks or card networks like Visa or Mastercard. This can create a whole new payment infrastructure and reverse the trend to have any systemically large players in the market.

  1. Reduced cost of card transactions

PSD2 puts a cap on the interchange fees between the issuer (card issuing bank) and acquirer bank (POS machine provider or settlement bank) at 0.2% for Debit cards and 0.3% for Credit cards. These charges are normally advised by the Card network (Visa or Mastercard), ostensibly as an incentive for the banks to issue more cards. With PSD2, the excess profiteering from the interchange fees is restricted thereby encouraging merchants and customers to move from cash to card. EC provides the rationale for such a move

“These levels are based on an estimate of the fee at which a merchant would be indifferent between being paid by card or in cash….Consumers should benefit from the services of new innovative players. For instance, in the Netherlands, the cheap online payment solution (Ideal) was adopted widely by retailers largely because of the low interchange fees (below 0.2%). As a result, Dutch consumers do not have to pay credit card subscription fees in order to shop online.”

PSD2 norms go a step further. While the interchange is restricted, the overall cost to the customer may still be higher as merchants levy a Surcharge on card transactions on the pretext of recovering their transaction costs. PSD2 norms bar levy of surcharge too.

In India, the cheapest option available is RuPay card network with a recommended interchange fee of 0.45% -0.65% for debit card transactions. Additionally, RuPay charges 90 Paisa per transaction from the banks. Further, Merchant Discount Rate (MDR) (fees that the merchant pays to his bank for card transactions) are capped by RBI for debit cards, at a high rate of 0.75% for transactions up to ₹2000 and 1% for above ₹2000. While some of these are less than the other card networks like Mastercard and Visa, cumulatively these costs are still high enough to discourage small merchants to accept cards and if pushed, it is passed on to the customer as a 2% surcharge.

In the case of credit cards, it’s even worse with no guidance or cap from the regulator. The interchange fees are much higher and as a result, the MDR ranges from 1.5% to 2.5%. As you go down from the large retail chains or premium merchants to small retailers, this is entirely levied on the customer. The most blatant example is the 2.5% petrol surcharge paid by the customer at petrol pumps. The differentiation between debit and credit card is another flaw in the argument, often seen in regulatory reports.  Instead of being considered as an elite, retail lending convenience, Credit cards can be an effective tool for MFI-NBFCs to disburse small-ticket loans to the bottom of the pyramid and encourage cashless transactions.

Irrespective of whether the merchant pays or the customer, card transaction cost are prohibitively high in India. It’s a similar affair with online payments with Payment gateways where the costs are 2-3% of the transaction.

While RuPay is an attempt in the right direction, it is still driven by top-down approach of lowering the cost relative to Visa and Mastercard. The right approach should be bottom-up, where the pricing is decided on the basis of how much the constituents are ready to pay and make the difference between card and cash immaterial.

 

Conclusion

Needless to say, PSD2 stresses as much on security and safety of the transactions and customer protection. The European Banking Authority has been mandated to formulate Regulatory Technical Standards (RTS) and respective regulators would also decide on the materiality thresholds for risk grading of various transactions. The key lesson for us is that technology now enables both security and democratisation to go hand in hand. It just needs the regulator to look beyond regulations and licenses and move towards facilitation.

There is no denying that India is moving ahead to increase digitalisation and directionally not very different from what’s happening in other parts of the world. The learnings from PSD2 may just be another catalyst to speed up the process. Most importantly,  these ideas can help us foster an era of innovation, going beyond the government push and intervention.

By: Amit Balooni

Updated May 2017

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