Learning from the Failure of the EU Payment Services Directive (PSD2) When Imposed Innovation Does Not Change the Status Quo
Payment Services Directive (PSD2) regulations were introduced to stimulate growth and competitiveness in the EU financial sector by simplifying the sharing of the infrastructure and customer data between incumbent banks and other players, including new financial institutions and fintech startups. Alas, the new rules received a lukewarm or hostile response from the industry incumbents, who perceived them as additional costs and a possible threat to their competitive advantage. As such, PSD2 became an exemplar of the gaining attention in literature phenomenon of "imposed innovation," a change that does not make microeconomic sense to incumbent firms but is instead mandated by influential non market stakeholders. So far, most of the imposed innovations cases were studied in corporate social responsibility, environmental or safety domains, with limited understanding of this phenomenon in other areas. Based on a detailed case study of PSD2 implementation failure in the German banking industry, we demonstrate that without certain identifiable contextual factors, the societally important innovations within an established industry might not materialize. By studying the implication of PSD2 and its effect on the EU banking industry, for the first time, we provide practical suggestions for how to improve the effectiveness of imposed innovation, from the public policy and firm perspectives. When Imposed Innovation Does Not Change the Status Quo 80 Rutgers Business Review Spring 2021 Banking Industry vs. an Imposed Innovation Is it possible to stimulate societally important innovations within an established industry when most incumbents passively ignore or openly resist these changes? The recent studies on imposed innovations point out that it is not uncommon to see implemented innovation projects that do not make microeconomic sense to incumbent firms (in terms of improving profitability or stimulating growth in the observable future) but are instead mandated by influential non market stakeholders, such as regulators, NGOs, or pressure groups.1,2 Examples of such imposed innovations are numerous: e.g. CSR initiatives, safety standards, or recent COVID 19 triggered changes in business processes across all consumer focused industries. Of course, some of these changes are also instrumental in achieving corporate performance goals, but a major part of these initiatives become pure costs to the implementing firms, which must be paid to preserve the ability to operate. However, not all imposed innovations can stimulate changes in the industry that their developers hope for, as this study's case of the German banking industry demonstrates. The advancement of information technologies (IT) particularly the development of networking and cloud services, has been the source of innovation challenging the status quo in many industries. The conventional banking industry has found itself profoundly affected by these changes, threatened by the rise of numerous IT focused fintech startups. The newcomers challenge the traditional banking business model by introducing innovative ways to make banking more attractive, individualized, and customer friendly. However, fintech growth has been severely hindered in some parts of the world (like the Eurozone) by the difficulty accessing a broader range of customer data, which is predominantly held by the financial incumbents (i.e. traditional banks) To level the playing field and boost innovation in the European Union (EU) banking industry, EU policymakers introduced policies enabling and simplifying the sharing of the infrastructure and data between incumbents (banks) and other players (e.g. fintech startups) A crucial component of these policies hinges upon the release of Payment Services Directive 2 (PSD2) in October 2015, which enhanced the first directive, PSD1 (released in 2007) PSD2 creates the legal parameters to harmonize the payment landscape and thereby makes transactions easier, faster, and cheaper to execute. Technically speaking, according to PSD2 policy, financial incumbents active in the EU zone by September 2019 had to offer application programming interfaces (APIs) to third party providers (TPPs) like fintechs and other technology companies "BigTechs" other banks, and financial startups, to exchange data with the prior consent of the account holder. In addition, PSD2 intended When Imposed Innovation Does Not Change the Status Quo Rutgers Business Review Vol. 6, No. 1 81 to improve security standards in terms of online payments, which has been a major concern for e commerce. In other words, PSD2 had to remove the large bank's unfair advantage due to controlling the customer data while also making the transactions more secure. The EU policymakers believed imposing PSD2 would facilitate innovation within the industry. The main idea was that the framework would provide an immense opportunity for fintech startups to grow their user bases, as their customers could now set up new standing orders, retrieve account turnovers, and execute their transactions via their online platforms. However, the policy fanned the incumbents' fear of a possible total loss over their banking activities and loss of their function as primary financial service providers to their clients. Furthermore, it also takes in non industry related businesses to engage in new security standards, which is unknown territory for the incumbents.3 As we see here, the case of PSD2 is a vivid example of what is known as "imposed innovation," providing a unique opportunity to study this phenomenon in the context of the banking industry. Imposed innovations are innovative activities and projects initiated by for profit firms as a result of pressure (e.g. policies and regulations) from external and non market stakeholders, such as governments, NGOs, and activist groups. Imposed innovation has been mainly studied in the context of corporate social responsibility and environmental concerns. Therefore, there is limited understating of the consequences and effectiveness of the application of imposed innovations in other areas. By studying the implication of PSD2 and its effect on the EU banking industry, for the first time, we provide practical suggestions for how to improve the effectiveness of imposed innovation. In this study, we focus on the PSD2 implementation process in recent years while having a closer look at the implementation in the German banking sector. We have conducted 23 interviews with experts in this area in the German banking industry, banking consultants, and academics, within a timeframe of 20 months, from March 2019 to November 2020. The first part explains the basic parameters of PSD2. The latter parts chronologically guide the reader through the different phases before and during the implementation. Important points, like the passing of PSD2, the identification stage of banks, and the postponement of strong customer authorization (SCA) are touched upon, ending in August 2020, after the first wave of the COVID 19 pandemic. The discussion forms the end in which the different stages are reviewed and critically analyzed. When Imposed Innovation Does Not Change the Status Quo 82 Rutgers Business Review Spring 2021 PSD2 as a Game Changer Payment transactions constitute up to 25% of a European retail bank's revenue.4 In 2007, the EU decided to harmonize the payment landscape by introducing a payment service directive, also known as PSD1. The initial intention of the regulator was to implement new technical standards in the banking industry to allow the installment of the Single Euro Payment Area (SEPA) The ideas behind PSD1 were: Easier and safer cross border payments within the participating countries Lower access barriers for new payment providers to increase competition Higher transparency in terms of transaction fees and execution times Stronger customer protection.5 However, rapid digitalization and technological innovations such as mobile payments quickly made part of PSD1 obsolete and ineffective. Consequently, legal adjustments to the first directive needed to be done to serve the constantly changing digital environment optimally. Hence, the EU rewrote the first regulation to fit the new circumstances and introduced the second version, so called PSD2, in 2015 (with the compliance date of 2019) The goals of PSD2 are: Higher security standards Extension of reach Creation of a more efficient payment landscape Increased competition in the sector. To achieve these goals, incumbent financial institutions need to allow fintechs access to their customer data through APIs. As a result, the policymakers believed that the imposed collaboration between incumbents and fintech startups would result in higher innovation within the traditional banking industry and, ultimately, better services for customers. Although PSD2 was designed to facilitate innovation and create a better environment for customers, in the short term, PSD2 would create significant challenges for the incumbents, including (1) a significant cost of compliance with PSD2, (2) increased competition between incumbents and fintech who are going to provide similar services, (3) the loss of customer data without additional revenue for providing it, and (4) an overall withdrawal of the banks' monopoly status over their client base, which could potentially lead to a revenue loss.6 When Imposed Innovation Does Not Change the Status Quo Rutgers Business Review Vol. 6, No. 1 83 New Competitors with New Possibilities PSD2 allows new competitors, such as tech giants, to step into the banking industry by legally enabling TPPs to implement their services into the incumbents' data setup. Hence, simple banking tasks, like transferring money, monitoring spending habits, and initiating payments, could be accomplished by the payment service user (PSU) without interfering with the credit institution's banking app or website (see figure 1 and figure