The Bankers’ Plumber on PSD2: APIs and the Blockchain

PSD2. Not a new Sony game console, but a European directive aimed at setting standards requiring banks to open up their systems. Essentially this has things FinTech at its core. Regulation will do something for clients. The Blockchain could help do more.

About PSD2

One of the requirements is for banks to open up their platforms to third party providers. This is due to take effect Jan 2018. Euromoney has a useful summary: here. Osborne Clark have a useful timeline overview of this and other regulatory must do’s: here.

In simple terms, the banks have to provide a means for any business, Fintech or not, to access their platform to effect transactions. This is an advance on today’s technology, because today you the consumer have to go to your bank and push the money out. There are some exceptions; in the UK, I pay my Amex bill by logging in to Amex and pulling money out of my RBS bank account.

Making “Pulling” widely available requires an API aka application programme interface. That allows a service provider to send a standardised message to RBS to take money from my account. At the simplest, there are arguments here similar to those around Apple Pay; who has the client  interaction?

So what?

The mere existence of an API does not lead to instant movement of cash. If and only if the service provider has an account at every bank its clients use, then the result of using the API would be instant settlement via a book transfer. If the service provider also has an RBS account, then money moves instantly; my debit is the other party’s credit.

The API alone will not necessarily result in an immediate transfer if there is no book transfer. Broadly, in most payments processes, an API call to my account with Credit Suisse will initiate a chain reaction that is not necessarily instant: if my credit is good, the payment will be queued up inside CS before it is sent sent to the external payments system My account is already debited, but the credit will happen sometime during the value date.

Do we need faster?

So, APIs alone do not make for faster payments. They might. If they did, then we would have finality sooner. Finality is a good thing, which today is only assured in some currencies. Those who CLS Bank for FX settlement know how this work. Monies which move are final. In today’s world, when you use a debit or credit for payment, then settlement with the merchant is largely next day.

In retail payments, there may be only a few cases where instant payments would help. For example, during a house closing. For corporates, instant would be a useful step; it would reduce intraday credit needs with their banks. For Financial Institutions, there would be even greater benefit, because that would increase the speed at which money is moved and reduce intraday overdraft needs.

Do we need the Blockchain aka Distributed Ledger Technology (DLT) and Central Bank Digital Money (CBDM)?

In a word, yes. Let’s say Deutsche Bank wants to settle a USD / TRL trade with Akbank in Turkey. Today, that process has settlement risk attached to it. A DLT platform, which allowed both Deutsche Bank and Akbank to have accounts in any currency with CBDM would allow that trade to be settled without settlement risk.

That same technology would help me easily send money to my brother in the UK. Today, I can have an easy to use, but expensive process via my bank, Credit Suisse. I tell them to make a pound payment from my Swiss franc account. They happily do the FX and make a payment out in GBP. Of course with margins wide enough to parallel park a supertanker. Or I can use a service like TransferWise, but have to push the money to them. TransferWise would be really happy if there were CBDM on multi-currency DLT and they could have accounts on the DLT.

Lessons Learned: PSD2 will bring openness, with APIs the weapon of choice to prize open the banks electronic doors. That will drive us a few big strides forward.

DLT and with it CBDM would enable really large leaps forward. Yes we would needs some rules about who can use an account on the DLT platform. We would have to have answers to important questions like who could open an account: must they be a bank?

Regulators might set some limits on the size of balances individual system users could hold. For example, the Fintech startup I am involved with, SONECT, might not be allowed to keep more than say CHF 100k in balances. That is easier to police than might be obvious. Let’s say the Swiss regulator, FINMA, is responsible for supervising SONECT. The way in which DLT platforms are constructed would allow FINMA to easily see that information. That same rule and role based access would show all the central banks if say platform users supervised by the Turkish regulator are not sticking to the rules, at least in macro terms even if the member names are hidden. I would expect regulatory performance to be mean reverting.

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