Will PSD2 and the Payment Accounts Directive help Overdrafts to disrupt the Credit Card?


In crude terms, the most valuable Enterprise customers for EU Credit Institutions have traditionally been internationally trading private enterprises with multiple Payment Accounts, term loans, deposits, M&A, trade finance, international payments and foreign exchange hedging.  The most valuable Consumer customers for Credit Institutions have tended to open a Payment Account as a youth and progress to a Debit Card and onto a Credit Card as their first source of unsecured credit. Over the customer lifecycle, this valuable Consumer ideally progresses to Secured Mortgages, Pensions and Investments with substantial Deposits as a Senior Citizen.    

However, Credit Institutions have customers with far simpler needs who may never borrow from a Credit Institution or who have yet to start borrowing.   In the Enterprise segment of a Credit Institution’s customer base, Public Administrations and Local Authorities are a prime example.   These customers may have deposits but their funding comes from Central Government or from fees for public services. In terms of making payments, these Public Administrations and Local Authorities have payroll payments for their employees and supplier payments to contractors.   In terms of collecting payments, these local authorities legally oblige citizens to pay dues such as local taxes, school fees and parking permits.  These Enterprise customers do not borrow nor do they use many of the more advanced business banking services used by internationally trading private enterprises.  They are not hugely attractive Enterprise customers for Credit Institutions seeking to cross-sell their full range of services. 

In the Consumer segment of a Credit Institution’s customer base, there are citizens with simpler financial requirements who need to make payments to Public Administrations and Local Authorities.  These can be citizens who may not have payment accounts with direct debit facilities or who do not use payment cards. These consumers can be reluctant borrowers from Credit Institutions or perhaps have yet to start borrowing.   They are not hugely attractive Consumer customers for Credit Institutions seeking to cross-sell their full range of services. However, notwithstanding the commercial appetites of Credit Institutions, Public Policy makers in the European Commission have been seeking to automate payment processes in this market segment for some years.

In 2006 and 2007, the Commission piloted the “EU-Pay” concept in a handful of Member States.   EU Pay was designed to “bring the benefits of quick and easy-to-use electronic payment mechanisms to all citizens, and not just the wealthy and computer literate.” The policy desire was a multichannel, Europe-wide, payment collection mechanism for Public Authorities, which integrated seamlessly with existing payment methods. Its usage would “make a significant contribution to improving Accessibility for All and reducing the Digital Divide”. EU Pay conceived of an environment where citizens who did not have credit cards, bank standing order mechanisms or access to or knowledge of the Internet would be able to use EU Pay to pay bills from public authorities (for example, shopping at the supermarket or when using a mobile phone).

Some private sector providers are now offering Payment Initiation solutions in this space.  Some Public Administrations in Italy and Luxembourg are using MyBank to build their e-government capacity.  MyBank is positioned as a citizen-friendly online payment method for tax collection, public school enrolment, parking and public transport, fines, etc.  MyBank is an e-authorisation solution that enables safe digital payments and identity authentication through a consumer’s own online banking portal or mobile application.  MyBank creates a direct link between a customer’s online bank account and the online business’s bank.  PSD2 will legally require all EU Credit Institutions that are Account Servicing PSPs to publish Open APIs to support Payment Initiation services of this type.

PSD2 is making Payment Initiation Services available but will the Citizens with simpler financial requirements be able to access these services through a Payment Account?

The EU Payment Accounts Directive intends to make sure that these citizens will have access to a Payment Account. The EU Payment Accounts Directive (PAD) was adopted in July 2014. Its main aim is to help the EU internal market for payment accounts work well. The provisions of the PAD come into force at Member State level on 18 September 2016.  The PAD seeks to improve:

  1. transparency and comparability of fee information about payment accounts to make consumers more aware of the fees and charges applied by account providers. It will also make it easier to compare Payment Account offerings, which may lead to more competition and better deals for consumers.
  2. switching of Payment Accounts by establishing minimum standards, to make switching more attractive to consumers and promote competition.
  3. access to basic Payment Accounts to ensure that all consumers legally resident in the EU have access to basic banking services, whatever their financial situation, to reduce financial and social exclusion.  This access must come in the form of a “Payment Account with basic features”

The PAD compels EU Credit Institutions to offer “Payment Accounts with basic features”. In order to ensure that “Payment Accounts with basic features” are available to the widest possible range of consumers, the PAD requires that they should be offered “free of charge or for a reasonable fee”. To encourage unbanked consumers to participate in the retail banking market, the PAD requires that Member States should be able to provide that “Payment Accounts with basic features” are to be offered to those consumers on particularly advantageous terms, such as free of charge.   With these Payment Accounts, which consumers must be able at least to:

  1. place funds in a payment account;
  2. withdraw cash from a payment account;
  3. execute and receive payment transactions, including credit transfers, to and from a third party.

Under PAD, EU Member States need to ensure that the number of Credit Institutions offering “Payment Accounts with basic features” is sufficient to ensure the reach of all EU citizens, to avoid any kind of discrimination against them and to prevent distortions of competition.   In principle, “Payment Accounts with basic features” should be offered by as many Credit Institutions as possible, with a view to guaranteeing that consumers can open such accounts at premises of a Credit Institution that is within close reach of their place of residence.  The Consumers that use these “Payment Accounts with basic features” must not be discriminated against when accessing such accounts. Credit Institutions can provide, at the request of a consumer, an Overdraft facility in relation to a “Payment Account with basic features”.  Credit Institutions must comply with the EU’s 2008 Directive on Credit Agreements if they do.

Payment Initiation Services using the “Payment Account with basic features” will be attractive to Public Administrations and Local Authorities.  Public Administrations and Local Authorities will have a strong incentive to promote the use of these Payment Accounts and they may even insist on the use of these Payment Accounts.  As the PAD ensures that these Payment Accounts will be available “free of charge or for a reasonable fee”, this will not be a particularly controversial public policy measure.

Public Administrations and Local Authorities will gain several benefits from the use of Payment Initiation Services with these Payment Accounts. They will be able to improve their processes with citizens who are reluctant to share their financial data on the internet.  As there is increasing labour migration within the EU, they can handle citizens from other EU Member States that might not be covered by local payment services and customs.  The Public Administration or Local Authority will not have to store and ensure the safeguarding of customers’ financial details. 

Public Administrations and Local Authorities also put little value on the “chargeback” process offered by traditional Credit Card schemes.  If the supplier will not refund money in a dispute and the consumer paid using a credit card, the card provider may agree to reverse the transaction. This is called a chargeback.  Sometimes a consumer using a Credit Card may want to dispute a card transaction if the supplier did not deliver the goods or services.  This can also arise when the goods were delivered but were faulty or not as described.  In broad terms, these are private sector problems and do not arise in the world of public sector parking permits, local taxes and school fees.

Following PAD and PSD2, we may see a divergence in routine digital processes between EU customers with simple needs and customers with complex needs.  Customers with simpler needs will use Payment Initiation Services on “Payment Accounts with basic features”.  They will infrequently access unsecured credit in the form of an Overdraft on “Payment Accounts with basic features”.  Customers with complex needs will use Credit Cards that are linked to Fully Featured Payment Accounts.  They will access unsecured credit through a Credit Card and they will access credit far more frequently than the customers with simpler financial requirements.

The active use of PSD2 Payment Initiation Services by Public Authorities on “Payment Accounts with basic features” in a relatively insignificant market segment for a Credit Institution will demonstrate a viable alternative to Card Schemes.  Demand for and usage of a “Payment Account with basic features” could spread well beyond the citizens with simpler financial needs.  A very sizeable share of the banking population could emerge that never use a Debit Card, causing a bottleneck on the traditional consumer journey to the Credit Card as the first source of unsecured credit.

Credit Cards brought unsecured credit to the mass market of consumers.  There are major industries devoted to issuing, acquiring, securing and servicing credit card transactions and credit card data.  Historically, the automation of the credit card value chain within the Financial Services industry has been significantly more mature than issuing and managing an Overdraft on a Payment Account. However, many now have automated the process of sanctioning an overdraft for consumers.  It can be put in place in a few hours.   The automation of Overdraft issuing and Overdraft management is steadily improving. 

PSD2 in Plain English (Payments Landscape
for Non-Specialists) (Volume 1)

The margins from issuing Credit Cards are falling for EU Credit Institutions.  They are now faced with Interchange Caps on Credit Cards.  They have to respond to margin-sharing demands from Apple Pay and other similar mobile payments overlay services.  The security of credit card data stored by Merchants is an increasing concern. 

After PAD and PSD2, a strategic question may arise for EU Credit Institutions – could an Overdraft on a Payment Account be a better option than a Credit Card for delivering unsecured credit to complex and very valuable customers?

Clayton Christensen theorised that sustaining technologies foster improved product performance.   Apple Pay can be viewed as a sustaining for unsecured consumer credit offered on Credit Cards, by incrementally improving the utility of the Credit Card as a payment product.   Consumers that regularly use a Credit Card for unsecured credit now have a wider and more modern range of options on how to use that Credit Card for payments.

Occasionally, however, disruptive technologies emerge: technologies that result in worse product performance, at least in the near-term. Disruptive technologies bring to a market a very different value proposition than had been available previously. Generally, disruptive technologies underperform established products in mainstream markets but they have other features that a few fringe (and generally new) customers value.  The use by Public Authorities of PSD2 Payment Initiation Services on “Payment Accounts with basic features” can be regarded as an early “fringe” usage.

The Local Authorities’ Payment Initiation Services that use the “Payment Accounts with basic features” will initially have a worse product performance for a Credit Institution than a Visa or Mastercard Credit Card.  The payments traffic will be initially confined to unglamorous parking permits and local taxes and will not be a mainstream payments flow.  PSD2’s Payment Initiation Services are confined to the European Economic Area and does not have global acceptance like a traditional Credit Card.   These payments customers will be slow to request unsecured credit and Credit Institutions may be slow to agree to give unsecured credit to these customers.

There are logical reasons why Credit Institutions might want to ensure that their Credit Cards might keep pace with digital developments in Smartphones and at Point of Sale.    They can find several reasons to adopt Apple Pay rather than consider how PSD2’s Payment Initiation Services could drive the growth and development of Overdrafts on Payment Accounts.   Firstly, the Payment Initiation Services and Overdrafts on Payment Accounts generally promise lower margins, not greater profits. Secondly, the Payment Initiation Services are likely to be first commercialised in emerging or insignificant markets (such as Local Authority payments from “Payment Accounts with basic features”).  Thirdly, banks’ most profitable customers with high Credit Card limits generally don’t want or need Payment Initiation Services (and you should always listen to your best customers).   However, these are exactly the decision making processes that Christensen describes as part of the “Failure Framework”, where incremental thinking trumps radical thinking and the likely rate of improvement in “inferior” solutions is not considered.

Over time, the merits of the new methods could become applicable in the mainstream.  The Merchant payee in a Payment Initiation Service has eliminated the need to collect and store personal data. Customer identity and confidential data are protected. Immediate authorisation of payments reduces the risk of fraud and charge-backs.  With the security and two-factor authentication processes in the PSD2 framework, Public Authorities may not only offer a safe method for citizens to pay taxes and services, but also begin to roll out online access to public services through secure digital identity authorisation.

In crude conclusion, the core value of a Credit Institution license is the ability to take deposits and give loans.  Short term and unsecured credit for a creditworthy consumer is often a stepping stone to long term and secured credit from the same Credit Institution.  There are many popular and wealthy brands seeking to join the Credit Card value chain and margins are being squeezed.  The automation maturity, risk management and user experience of Overdrafts on Payment Accounts as a means of unsecured consumer credit may still lag Credit Cards as a mass-market solution. However, local tax payments and parking permits may not be fashionable or high profile in the short term, but they could provide ingredients for the disruption of Credit Cards as the primary vehicle for unsecured credit in the longer term. 

[linkedinbadge URL=”https://www.linkedin.com/in/paulrohan” connections=”off” mode=”icon” liname=”Paul Rohan”] , the author of this post, is also author of “PSD2 in Plain English”.

PSD2 in Plain English (Payments Landscape
for Non-Specialists) (Volume 1)