Payment competition and banking in a post-PSD2 world

I happened to be talking about access to payment infrastructure (something I blogged yesterday) at a client event yesterday, and got involved in a discussion about how the fintechs might begin to work with banks in the new world of PSD2 and mandatory APIs. This has been subject of great interest to me at the recent Money 2020 Europe (with top, top players like Shamir Karkal from BBVA and Alex Mifsud from Ixaris explaining why the move to APIs will mean a big shift in the delivery of banking services) and other recent events. Generally speaking, and this is a sweeping generalisation, I think there has been a shift in European bank thinking in recent times. They well understand that if they do nothing, then in the instant payments, API-centric, PSD2 world they stand to lose significant income. The outsourcing company Accenture, for example…

estimates that the new new breed of payment initiation service providers will erode 33% of online debit card transaction volumes and 10% of online credit card transaction volumes resulting in a total market share of 16% of online retail payment volume by 2020.

From Banks set to lose 43% of retail payments revenue under PSD2

So the Payment Initiation Service Providers (PISPs) stand to capitalise on the new arrangements (if the banks do nothing, of course). What kind of services might they provide? Well, an obvious example is integration with social media. If you look at the use of instant payment “overlay services” (as they call them down under) in the UK (PingIt and PayM) it is far less than the use of, for example, Venmo in the USA. And Venmo doesn’t deliver immediate settlement (it works through the debit card networks). In the last quarter of 2015, Venmo transferred $2.5 billion. In January 2016 alone it transferred $1 billion. So why is it so popular? It’s the integration with social media. Just over half the users are 18-24 and half the payments relate to food and drink sharing! On a US college campus, “I’ll Venmo you” has entered the lexicon. In the UK, “I’ll PingIt you” has not. Paym is growing steadily, but it is still only transferring about £12 million per month.

Venmo 1Q16

So now imagine, post-PSD2, a combination of the immediate availability of funds like PingIt and Paym with the social media integration of Venmo. It will be a wholly different payment experience. I’ll give you an obvious example. My wife and some of her friends are planning a weekend break in August. They do this through a Facebook chat group. But when it comes to settling up for hotels and air fares, everyone has to log out, e-mail everyone for their bank details and log in to home banking and set them up as payees, then make the payments. Then everyone else has to log in to their bank accounts to see if the money has arrived and that it is the right amount. In 2018, however, it will all be different. Facebook will be integrated with instant payments through APIs so that it can function as a PISP. When my wife gets a message to say that she owes her friend £100 for her air ticket, or £25 for her share of the dinner, or £10 for the tickets to a show, then she will put money into her return message just as she adds emoticons today. Under the hood, Facebook (which of course knows the bank account of the person you are sending a message to) will initiate an instant payment and within a second or so her friend will get a message to tell that the money has arrived. Remember, Facebook already do this is in the US through debit cards (like Venmo).

It’s not all about payments though. The other category of organisation with direct access to the bank account, the Account Initiation Service Providers (AISPs) also stand to benefit from bank inertia. The row about “screen scraping” in the US adumbrates similar pressure for bank strategies in Europe.

JP Morgan Chase CEO Jamie Dimon is incensed about fintech startups like Mint, Acorn and Bloom “scraping” his customers’ data

From Banking App Competition; Why OTT “Skinny Bundles” Fail | AdExchanger

I’m sure his experienced strategists will be quick to reassure him that third-party access to bank accounts (the data is the customers, not the banks, of course) ought to be seen to be an opportunity for JP Morgan Chase to develop some terrific new products and services. The reason why customers of JP Morgan Chase use Mint is because JP Morgan Chase do not provide a suitable, better product for them to use instead. Mr. Dimon, as a champion of free enterprise, would surely object to organisations building walled gardens and using regulatory barriers to defend them. If Facebook or Amazon provide a better financial services app for customers to manage their JP Morgan Chase accounts, then good for them.

In fact, it seems to me, that this is a very likely outcome of rational market evolution. I buy my electricity from whichever supplier offers the best deal for our household. When I change suppliers, I don’t need to change my TV. When I change banks, why should I change my digital wallet if I don’t want to? With a standard API, might personal finance management (PFM) app and my wallet app and my social networks will all access my bank account, whatever my bank. And if I change banks, whatever.

So… what makes sense for banks? Why bother making the wallet or PFM apps? Why not instead provide the best possible API to people who are better at making these apps. Why bother with PingIt and PayM? Why not instead provide the best possible API for PISPs to use. Why bother with fancy applications at all? Why not instead provide identification and authentication services (through APIs of course) that all of these other apps, APIs and services will depend on. After all, if I’m going to give Facebook access to my bank account then Facebook need to be pretty sure that it’s actually me and I need to be pretty sure that it’s actually Facebook. My bank is a rather obvious middleman here.

DCSI Schematic v2

All of which leads me to suspect, as I have mentioned before with tedious regularity, that the banks should focus on what the Euro Banking Association call the “non-mandatory, non-payment APIs”  (as shown above) as a basis for strategic advantage and get together to agree a digital identity infrastructure and a common set of digital identity APIs. Nothing to it, really…

You can’t rob a glass bank, even if you work for it

At the Imperial College (packed) discussion on “Distributed Ledgers – Future Research Challenges“, chaired by Professor Bernard Silverman FRS, the Home Office Chief Scientific Adviser (and a mathematician), a series of speakers (including yours truly) sparked a valuable and fascinating series of discussions around the topic and, in my case at least, left me feeling as if I’d actually learned something.

In the morning, Iain Stewart from Imperial College introduced us to his “Nonsense Watch”. It turned out that his nonsense watch only had two things on it:

  • We hate Bitcoin but we love the blockchain.
  • The blockchain is efficient.

In a memorable presentation, elaborating on these topics, he told the assembled group that the a good way to think about the blockchain is to compare it to somebody swallowing condoms full of heroin and carrying them through customs in your stomach. It’s a really inefficient way to transport heroin around but you have to do it because “powerful forces” (as Iain called them) are trying to stop you from doing it!

I will never forget that example! Anyway, just to explain the background. Consult Hyperion were asked to become part of a consortium bidding to examine the potential for Bitcoin, the blockchain and suchlike across a variety of sectors in response to the Treasury’s decision to allocate £10m in funding for the topic. In this context I (along with a couple of my colleagues) took part in discussion at Imperial that brought together academics, technologists, government and a number of different businesses (including banks), which is why we were listening to Iain.

I thought it would be helpful, with such a mixed group, to use a narrative that would help people to communicate effectively and share ideas. This is why I used the “glass bank” example that I’ve used before and built on the presentation that I gave to the Dutch National Bitcoin Congress in June. As it turned out, it worked very well on the day and after discussing it with a couple of other people I’ve decided to expand it as clients might find it a helpful way to think about the new technology (as they get a bit bogged down in Bitcoin and cryptography). I have to say that it worked largely because Richard Brown from IBM had set things up so nicely for me with his discussion about “Creation Myths and Shared Ledgers” that immediately preceded my talk.

The actual purpose of my talk, narrative aside, was to put forward three solid ideas for research threads that could form part of the project. I’ll blog about this, but I was looking for examples of areas for genuine research, areas where the answers aren’t known, that could complement shared ledger technology in some way to deliver something special or different groundbreaking.

In the end the three examples I settled on were:

Homomorphic encryption. Although I wouldn’t say I was absolutely up to speed on the state-of-the-art in this field I do understand the rudiments and it strikes me as an area where any small improvements could lead to pretty significant benefits. This is an area where pure mathematics is needed and I would’ve thought that most businesses and even technology companies just do not have that kind of research going on.

Publicly-private records. This builds on the idea of “translucent” databases to use homomorphic encryption encryption to put data on public blockchains that can be audited in necessary ways but remain private. I don’t think it’s enough just to store encrypted data on public blockchains. If we can agree on the use of the word translucent to mean data that can be audited while remaining encrypted, then I genuinely do feel that a new kind of financial services industry could be on the horizon.

Bottom-up identity. It occurs to me that if it was possible to use homomorphic encryption to store publicly private records about an individual then the cryptographic techniques that are currently used to demonstrate attributes without revealing them (e.g., interval proofs) might be transformed to help creates a shared infrastructure for identity built on very different foundations (e.g., testing that an age is >18 without decrypting the age).

As I say, these are areas for research. I don’t know what might be discovered in these fields any more than anyone else does, but I have a feeling that it might be both important and of immediate practical application. Now imagine that we bring those technologies together to create “glass institutions” in the financial services world. This would be utterly transformational, in a way that making payments cheaper and quicker (even if this were true) is simply not.

The idea of glass institutions may seem paradoxical but with the advances in technology and our evolving understanding of how replicated shared ledgers might transform a variety of different kinds of systems, I think we can begin to explore their impact. I rather like the language of translucent transactions and I think it works well with the glass bank narrative to open up sensible discussions at the business (and regulatory) level.

So where does this take us? Well, as Richard said in his talk, a replicated shared ledger in financial services is unlikely to be “permissionless” in the censorship-resistant sense that Iain was talking about at the start of the day. However, it is entirely possible and highly desirable to construct replicated shared ledgers that allow for permission and innovation in the use of the ledger even if the ability to create transactions on the ledger is permissioned. Of course, this is not to say that both permissioned and permissionless ledgers cannot co-exist. Michael Mainelli provides an excellent narrative for this perspective, talking about the “Temple of Financial Services” in comparison to the “Souk of Sharing Economies”.

While my heart is with the Souk of Sharing Economies, my head recognises that there may be room for both. A sensible union would be a few, competing, ‘blockchain-type’ services encircling the globe providing end-of-day validation and recording of transactions, while thousands of mutual distributed ledgers do the busy work of serving thousands of shared economies. In effect, the merchants of the Souk bring their ledgers up to the Temple to be validated and timestamped by whichever priests occupy the Temple of Financial Services. It may not be orthodoxy, but it’s not heresy either.

[From iGTB – Liquidity Management – The Temple & The Souk – The Future Of Mutual Distributed Ledgers]

The permission, distributed shared ledger of the Temple will mean disruptive change. I can show this by giving a couple of obvious examples: what if a company chose from a group of regulator-certified auditing applications instead of from a competing group of auditors? Auditing banks’ books would become a continual process and you might even have multiple different applications constantly auditing the same bank on behalf of regulators, shareholders, customers, pressure groups and even rival banks. Anti-money-laundering processes would shift from expensive and rather useless gatekeeping combined with floods of suspicious transaction monitoring to being a variety of different anti-money-laundering applications combing through the shared ledger entries to find transactions indicative of misbehaviour (at which point, law enforcement agencies could apply for warranted access to the unencrypted ledger entry or relevant meta data).

This is why I don’t think it is an exaggeration to say that the shift to shared ledger technologies might be one of the most important innovations of our image of our age, and I will close by making another historical analogy to support that point.

In Victorian Britain, the collapse of railway companies led to a colossal crash in 1866. It was caused (and here’s a surprise) by the banking sector, but in that case it was because they had been lending money to railways companies who couldn’t pay it back rather than American homeowners who couldn’t pay it back. The British government then, as in 2008, had to respond. It suspended the Bank Act of 1844 to allow banks to pay out in paper money rather than gold, which kept them going, but they were not too big to fail and the famous Overend & Gurney went down. When it suspended payments after a run on 10th May 1866 (as frequently noted, the last run on a British bank until the Northern Rock debacle), it not only ruined its own shareholders but caused the collapse of about 200 other companies (including other banks). The directors were, incidentally, charged with fraud but got off as the judge said that they were merely idiots, not criminals.

The reason I choose this example is that railway companies then held the same commanding position in the economy as banks do today, so the impact on UK plc was substantial. Bear in mind that the first railway service in the world started running between Liverpool and Manchester in 1830 and less than two decades later (by 1849), the London & North Western railway was already the biggest company in the world. When the Directors of these gigantic enterprises went to see the Prime Minister in 1867 to ask for the nationalisation of the railway companies to stop them from collapsing (with dread consequences for the whole of the British economy) because they couldn’t pay back their loans or attract new capital, they didn’t get the Gordon Brown, investment bank advisers, suspension of competition law and the tea and sympathy of 2008. Disreali sent them packing as he didn’t see why the public should bail out badly run businesses, no matter how big they might be.

Needless to say, the economy didn’t collapse. As you may have noticed, we still have trains and tracks. A new railway industry was born from the ruins, the services kept running and the economy kept growing. And there was another impact. Andrew Odlyzko’s paper The collapse of railway mania, the development of capital markets, and Robert Lucas Nash, a forgotten pioneer of financial analysis argues that the introduction of basic corporate accounting standards following the collapse of the railway companies was a significant benefit to Britain and aided the development of Victorian capitalism.

So, with the well-worn maxim about not letting a good crisis go to waste in mind, I would like to advance this hypothesis: the long-term impact of the financial crash of 2008 will be a shift to the replicated shared ledger as the central organising principal for financial services. An entirely new way, as Richard Brown notes, of building financial institutions based on common ledgers and APIs.

Francis Keally’s vision will be realised and to the great benefit of society as a whole. After all, you can’t rob a glass bank, even if you work for it.


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