How regulations can increase competition and innovation in the banking sector: the EU example
By Bruno Gremez and Samir Kasmi, Co-founder of Fincluziv, Smart Fintex and CT&F Partners and ex-bankers (BNP Paribas, Société Générale, ABN AMRO).
The payment services industry in the European Union (EU) has experienced tremendous changes in the last 5 years thanks to the implementation of a new regulatory framework.
The first Payment Services Directive (PSD 1) was adopted by the EU in 2007 with the aim of creating a single payment services market across the EU in order to improve efficiency, competition and innovation in the European payment services industry.
PSD1 created a new type of regulated firms called Payment Institutions (PIs), which are able, amongst others, to open accounts, process payments and issue debit cards.
PSD1 also defined prudential requirements that PIs have to comply with and that are proportionate to the operational and financial risks that they take in their activities:
- Minimum capital: PIs engage in activities that are much more specialized and limited in scope than the ones of banks and credit institutions (for example they are not allowed to take deposits from clients), therefore generating less risks and making the monitoring and control of those risks much easier. Therefore the minimum capital requirement is much lower than for banks. The initial capital for a PI ranges from EUR 20,000 to EUR 125,000 depending on the nature of the payment services provided. A PI also has the obligation to maintain a level of ongoing capital, which depends on the nature of its activities and the volume of its business. The EU gives each member state’s regulators the possibility to choose the methodology; in the first methodology, the ongoing capital should be at least 10% of the fixed overheads of the previous year; in the second methodology the capital should be at least a certain percentage of the payment volume processed the previous year. For example, in the latter case, a PI processing a volume of EUR 5 billion per year would have to maintain an ongoing capital of between EUR 500,000 and EUR 1 million depending on the nature of its payment services. Such requirements are meant to ensure business continuity for a certain period of time in case any PI faces operational or financial issues. This capital requirement is limited thanks to safeguarding measures that are put in place to protect customers’ funds.
- Protection of customers’ funds: safeguarding measures should be implemented to protect customers’ funds. The main measure is the segregation of customers’ funds, which should not be commingled with any other funds and be kept separate from PIs’ own funds in an account with a credit institution or invested in secure, liquid, low-risk assets. Such funds should also be insulated as per each national law from potential claims of PIs’ other creditors, especially in case of insolvency. PIs can also, in the absence of funds segregation, use an insurance policy or guarantee provided by an insurance company or credit institution (that are not part of the same group as the PI) for the amount of funds that would have otherwise been segregated to offer protection in case the PI cannot meet its financial obligations.
- Compliance: PIs shall have the right governance, policies and procedures in place in order to comply with AML/CTF rules (anti money laundering / counter terrorism financing). These requirements are similar to the ones that banks must meet.
PSD1 was implemented by each member state’s regulators and has opened the European payment services market to non-banks such as FinTechs. These new players’ offer customers the possibility to open accounts very quickly (in some cases just a few minutes), effect payments and transfers in different currencies, and receive a debit card linked to their account. These services are offered at much lower costs than similar services from banks, and the customer’s experience is also improved thanks to the digitalization of services and the technological innovations involved.
The EU Payment Services Directive 2 (PSD 2) will come in effect in January 2018. PSD 2 will allow customers to use third parties for services such as bill payments, transfers, financial analysis of their revenues, spending habits, etc… while keeping their money with their existing banks. Therefore, PSD 2 will require banks to give third parties access to information on their customers’ accounts (with the consent of customers) through API (application programme interface). PSD 2 should increase competition and efficiency in the EU payment industry.
Although the population of the EU is relatively well banked compared to the rest of the world, the emergence of PIs has facilitated financial inclusion. For example, in France, one of the countries in Europe with the highest proportion of banked population, the French Central Bank still estimates that there are around 2.4 million underbanked people and 500,000 people without a bank account. Some new PIs, such as Compte-Nickel, have already facilitated access to basic banking services for this segment of the population.
Such type of new players could definitely improve financial inclusion in emerging markets where large parts of the population do not have bank accounts but have access to smartphones and internet. However, this requires regulations that favor innovation, competition and, at the same time, protect customers.