The challenger in the red corner

From January 2018, you will be able choose who handles the payments from your account. It does not have to be your bank. A host of other firms can be used; they will not have to be a bank and you will not need an account with them. This innovation is the result of a revision to the European Commission’s Payment Services Directive (PSD 2), a set of rules designed to make payments within Europe cheaper, easy and better for customers.

“I think banks are struggling,” says Liz Oakes, director at KPMG. “They have data on customers, but they have never really used it in the way that consumers might find helpful to them. The wave of challengers [to banks] is a fantastic thing because the competitive pressure they are generating makes the legacy incumbent banks sit up and start to produce the kind of services and the innovation that we all like to see as consumers.”

PSD 2 will require banks to allow other firms to connect easily with their systems in order to facilitate payments. As a result customers can pick the best account for them – perhaps with a good interest rate – and also pick the best payment service for their needs.

It sets competition in banking at a new level. A whole new type of business will come into effect. Payment Initiation Services, which the Financial Conduct Authority says “initiate a payment transaction at the request of the user from an account held by the user at another payment service provider”, and Account Information Services, online services that provide a consolidated view of the user’s payment accounts from across payment service providers, will become regulated, viable businesses.

Introducing challengers to the status quo of banking is not new. The UK has seen startup banks giving the bigger firms a shove since the financial crisis first made them a bit wobbly, ranging from Ipagoo, six-year-old branch-focused Metro Bank, and soon-to-launch Atom Bank and Starling Bank, both technology-led startups. With the big banks currently focusing on streamlining their technology – the Prudential Regulatory Authority has referred to their IT as “antiquated” – new entrants see this as an opportunity.

Under PSD 2, incumbent banks will face yet another challenge as they risk becoming disintermediated from the payments business by an entirely new foe.

What they do care about is the here and now. Balancing cheque books is a lost art. Moving money from A to B without hassle is the expectation

“The new PSD 2 legislation really creates two different service propositions,” says Ms Oakes. “One is banking, with the three functions of lending, deposit taking and payments. The other is the new entrants who don’t necessarily want to offer lending or deposit taking. They just want to provide payment services. Consequently we will see different business models and different propositions.”

Banks are naturally risk averse and have been conservative in their use of customers’ personal data. It has been used to try and sell customers products at particular points in their lives. A new set of tools being offered by startup firms shows far more imagination, but they must really excite customers if they are to take hold.

“Consumer banking customers want a service to work every time and for the money to move to and from as ordered,” says Thomas Collins, director at KPMG. “Consumers are not concerned about the mechanism that gets it there.”

What they do care about is the here and now. Balancing cheque books is a lost art. Moving money from A to B without hassle is the expectation. Banks and service providers that can use data to offer financial management tools to help the digital customer effectively move their cash optimally are increasingly useful and viable.

For example, personal financial management tools that categorise spending, so the customer can evaluate the cost of latte consumption, really offer opportunities to save some money. When customers start to see patterns of spending it gives them the capacity to budget, potentially saving as a result. That support can only be welcomed in the current climate. The Chartered Institute for Securities and Investments suggests that 18 to 30 year olds should be saving £800 a month to get a pension of £30,000, yet the Office for National Statistics tells us this is 35 per cent of an average annual £27,200 salary.

“They will allow you to create a savings pot within your actual bank account, so that if you wanted to save up to buy a car, you could see that chunk separately from the rest of your current account,” says Ms Oakes. “There are fantastic concepts around contingent payments. As society moves to an era where more individuals are self-employed or working freelance, the date on which transactions leave your account is more critical. It makes managing cash quite challenging.”

Startups will likewise have to keep their own operational challenges under wraps while maintaining simplicity of use

Services such as direct debit that offer a fixed-date payment are looking increasingly inflexible in an environment where the mechanisms need to match customer circumstances. For example, contingent payments can be set up so that a bank or payments provider makes a payment on the day that money is due in, but not before those funds arrive.

These are great ideas, says Mr Collins, but the capacity for them to gain traction will rely on critical mass and that can be difficult to build up. “We have seen some people who have moved accounts since the process became easier, but the numbers are very low,” he says. “The only drivers that really catalyse people have been financial incentives, but as new services are offered, we may see a profound change in behaviour and the use of the current account switching services.”

A chicken-and-egg situation could develop in the near future as excellent service propositions are limited by customers who are conservative in their adoption and banks that are conservative in their offering. “Banks, in particular, are too nervous about crossing the threshold of providing advice,” says Mr Collins.

Many services that have been under the covers of the retail banking environment, such as dispute management services from credit card companies or bank account provision, will have been taken for granted by customers. Startups will likewise have to manage their own operational challenges while maintaining simplicity of use, warns Ms Oakes.

“The more third parties there are involved in a transaction, the more difficult it is to figure out where your money is as a customer and who you need to contact in the event of a problem,” she says. “For challengers to succeed, they will have to grasp how complicated this is for themselves and for customers.”