Published 26th May 2020
The advent of open banking introduced significant changes to the well-established financial services industry, offering greater opportunities for fintech challengers as well as legacy banks and, importantly, the sought-after consumers now facing more choice than ever before.
For all the new developments, however, perhaps the most disruptive aspect of open banking is yet to be explored. While open banking legislation lets third parties access account data with the owner’s consent, the same PSD2 provisions also enable open payments, which allows any approved third party, with consent, to facilitate payments directly to and from bank accounts.
At first glance, open payments look like a minor change in the financial process that most people can safely take for granted. But closer inspection reveals that this change in who can access bank data can drive real change. Whether the power of open payments is fully flexed by established banks, fintech challengers or organisations outside the space, the key will be leveraging the latest technology and smart development to create solutions that benefit everyone involved.
Changing the everyday
Examining the likely impact of open payments on just one type of everyday transaction — grocery shopping — helps demonstrate its potential to fundamentally change how we purchase goods and services.
Originally, like every other transaction, a trip to the local supermarket ended with an immediate exchange of value between the shopper and retailer. Over time, card transactions became the norm, and events like the Covid-19 pandemic dramatically accelerated that change, with contactless payments suddenly not just more popular but also safer than physical cash.
When a shopper pays for their groceries by card, they set off a chain of background transactions:
Most consumers would be surprised to know exactly how many steps are involved in moving money from their account to their local supermarket’s — and would be inclined to ask why there is so much going on.
There is an obvious need for retailers to use secure payment processors with the accreditation and systems necessary to ensure prompt and safe payment. The banks’ involvement also seems reasonable, as they safeguard the customer’s money and provide access. It all appears fine and normal until we look at the fees incurred.
Nearly every step in the process involves someone charging a fee. There are flat fees, transaction fees, incidental fees and fees charged by the payment gateway, the payment processor or card network, the issuing bank and the acquiring bank. Those fees add up, and the one paying is the retailer and, by extension, the customer, who likely also pays annual fees for the card as well as any transaction fees charged by their bank.
The attractive alternative
In an open payments ecosystem, the same transaction looks dramatically different. A customer can give consent to a Payment Initiation Service Provider (PISP) to give the supermarket direct access to their bank account to take payment. Consent can be verified at the point of purchase through biometrics like Face ID or Touch ID.
Suddenly payment gateways, card processors and card providers aren’t needed, and the banks cannot apply fees. PISPs, as new players with low costs, can charge a fraction of the traditional fees.
Recent years have brought a host of predictions and attempts at payment disruption, including notable offerings like ApplePay. Yet, none have had the impact expected. It’s forgivable to think open payments would follow suit, but that would mean ignoring a few ingredients capable of driving real change.
Fees of 1.5% or 2% may not sound like a lot, but multiplied by the sheer volume of transactions processed by supermarkets, they add up quickly. Furthermore, the supermarket business is marginal. Average profit margins per item range between 1% and 3%, with some items, even acting as loss-leaders. In that context, cutting out both the transactional and fixed fees for gateways, card processors and banks could have a major impact for retailers.
The best changes tend to look obvious in hindsight. Open payments simplify a complicated process that now looks bloated. It delivers immediate value exchange between the two main parties while cutting out a host of unnecessary middlemen. It is easy to understand and is based on a relationship where trust has already been established.
One of the reasons Amazon have outperformed so many other businesses is their focus on the customer relationship. Regular Amazon shoppers take part in deals, Amazon Prime, wish lists and a number of other elements that help Amazon recommend their next purchase, fulfil it and deliver it to their door.
If that customer’s local supermarket is part of a chain like Tesco or Walmart, a move to direct payments can be a move towards a tighter relationship, based on trust. Customers may already be shopping regularly and participating in a loyalty program. Some supermarkets even provide insurance or mobile phone contracts. Setting up a direct payment relationship can take that experience to a new level. Imagine a Tesco app that allows you to pay for shopping without incurring bank transaction fees, with loyalty discounts applied as and when you want and deeper discounts offered because you pay direct.
The next step for payments
The potential of open banking APIs combined with increasingly innovative offerings from fintechs, non-financial challengers and even banks themselves is encouraging for both providers and customers.
PISPs are springing up all over Europe and in other regions and countries adopting similar open banking legislation. Many have already signed up thousands of banks complying with open banking rules. These new players have low costs, move quickly and can afford to charge a small fraction of the existing payment players. Their pitch is strong: go with us and reduce costs now.
For now, the banks, credit card companies and payment gateway providers control the process. They have trusted relationships and experience with complexities like fraud. However, the same was said of banks and consumer banking, and it hasn’t stopped the growth of new challenger banks like Revolut.
It may be that banks can seize the open payments opportunity and forge new, more direct relationships with retailers to deliver value for customers. To do so, they need to move soon and harness the strength of modern technology and dynamic solution development to shape the new reality of everyday payments.
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Ger O'Shaughnessy has over 25 years experience working with market leaders across all sectors delivering digital transformations. For your next software project, talk to our highly experienced team.