Eight years on, the banking industry is still feeling the after-effects of the global financial crisis. Ben Poole examines two pieces of this year’s regulatory pie – PSD2 and Basel III
PSD2: What’s new?
Following the Payment Services Directive (PSD), PSD2 came into force in January 2016. EU member states have two years to implement its provisions. PSD2 contains notable additions, including changes to geographical scope and currency. It also addresses business requirements such as authentication of payments and the granting of access to customers’ bank accounts to third-party payment providers.
The change covers transparency of terms and conditions and information requirements that payment services providers (PSPs) will need to provide for their transactions. The original PSD demanded levels of transparency when both PSPs were in the EU.
Now, PSD2 demands the same level of transparency even when only one PSP is in the EU. This also applies to all currencies where those payments are being made as they arrive in the European Union.
“This is a significant move and, from a customer point of view, it is probably quite a good thing,” says Angus Fletcher, Head of Market Advocacy, Global Transaction Banking at Deutsche Bank. “They will get to see greater levels of transparency around the payments they make.”
PSD2 also calls for two-factor customer authentication. This requires banks to look at the payments that are being made, determine whether they are comfortable with those payments and confirm the payments aren’t fraudulent.
The key here is that a bank can combine different elements to form two factors that it uses to verify the identity of the payer. These factors could be knowledge, possession and inherence.
“Part of the authentication discussion, and a broader trend beyond Europe, is around the levels of protection of client data and the security levels that banks are required to implement as part of their systems,” says Fletcher.
“This will mean changes to risk processes and, potentially, to systems and exception-handling that PSPs are going to have to look at introducing.”
PSD2 allows payment initiation service providers and account information service providers access to customer bank accounts for different reasons. Some providers will be able to initiate payments, while others will be able to provide their customers a ‘virtual wallet’, allowing them to see a history of their payments.
“This is good for customers. They should get access to more innovative services,” says Fletcher. For banks, however, this creates concern about how they ensure that the third-party providers linking to accounts have the correct authorisation. If fraudulent transactions occur, then the bank is liable for refunding the customer.
“This shifts the liability somewhat,” says Fletcher. “It remains on the bank, but this opens the process up to a new set of parties that banks will have to manage.” This change in the rules should make new types of products and services available to the customer. For banks, however, an increased workload and new risks could potentially arise.
Basel III: Overcoming implementation issues
While PSD2 only came into force this year, the Basel III standards have been a talking point for much longer. As they are standards, they must be enshrined in national or jurisdictional law. This implementation process is undergoing phased rollout, which began in 2015 and is planned to run through to 2018.
“I think we will see adjustments and national interpretations go beyond 2018,” says Fletcher. “The phased-in process is all about tweaking and changing the different ratios to get the best fit. On the one hand, banks need to be as safe as they possibly can. On the other, it is important that these ratios are not introducing burdens on organisations that force them to stop doing certain business, or create unintended risks to banking services.”
Another concern for banks continues to be the treatment of deposits, especially non-operational (those deposits not attached to business/payment flows). These have a significant balance-sheet effect under Basel III, as they must be held at central banks. Many corporate and institutional customers, however, want to be able to hold large balances with banks and have the ability to take those out at any point.
“It’s important for banks and their clients to really understand each other’s models, and to try to come up with something that works for all,” says Fletcher. There are several ways of doing this, for example through offering certain balance sheet efficient deposit products, such as call and/or rolling time deposits. Offering off-balance sheet products is another option for banks – products such as money market funds, which allow cash to be stored in a relatively safe place for customers. Reverse repurchasing agreements (repos) are also a possibility. The client can usually make a return on the cash as well, despite negative interest rates. However, there is still a capital effect felt when using reverse repo products, which may negate any return.
Basel III also affects trade finance. Banks use a number of core trade finance products, such as guarantees and letters of credit. These are off-balance sheet items – so-called contingent liabilities. This means that they will only be called on in certain agreed circumstances.
“Under some of the Basel consultations being carried out this year, in particular those focused on the net stable funding ratio and the leverage ratio, these products are being effected,” says Fletcher. “The end rules could change these tools and therefore affect the ability of banks globally to support what we see as real-world economy activities.”
Of course, the ongoing implementation of Basel III presents an opportunity for banks and their clients to understand how their strategies affect each other.
When a corporate requires services such as deposits or a line of credit, knowing how and when this will affect a bank’s balance sheet is important, as it will highlight possible overpricing or availability challenges, for example. For multinational corporates, it presents an opportunity to examine ways of making internal processes, account structures and balance sheet moves more efficient and cost-effective.
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