EBA REPORT ON THE IMPACT OF FINTECH ON PAYMENT INSTITUTIONS AND E-MONEY INSTITUTIONS BUSINESS MODELS JULY 2019 IMPACT OF FINTECH ON PAYMENT INSTITUTIONS AND E-MONEY INSTITUTIONS BUSINESS MODELS 1 Contents Contents 1 Abbreviations 2 Executive summary 3 1. Background 5 1.1 General 5 1.2 Methodological approach 6 2. Current landscape 7 2.1 Key trends 7 2.2 Key drivers 10 3. Current approach to FinTech 14 3.1 Interaction with FinTech firms 14 3.2 Interaction with BigTech firms 16 3.3 Use of technology-based innovations 18 4. Impact on payment and e-money institutions 24 4.1 Overview 24 4.2 Specific observations on each payment service provider category 28 5. Key challenges 30 6. Conclusions 32 IMPACT OF FINTECH ON PAYMENT INSTITUTIONS AND E-MONEY INSTITUTIONS BUSINESS MODELS 2 Abbreviations AI artificial intelligence AIS account information services API application programming interface APSP account-servicing payment service provider B2B business-to-business B2P business-to-person DLT distributed ledger technology EBA European Banking Authority ECB European Central Bank EMI electronic money institution FinTech financial technology FSB Financial Stability Board GDPR General Data Protection Regulation ICT information and communication technology KYC know-your-customer NFC near-field communication P2P peer-to-peer PI payment institution PIS payment initiation services PSD2 Revised Payment Services Directive (Directive 2015/2366/EU) PSP payment service provider RegTech regulatory technology RTS regulatory technical standards SMEs small and medium-sized enterprises TPP third-party provider IMPACT OF FINTECH ON PAYMENT INSTITUTIONS AND E-MONEY INSTITUTIONS BUSINESS MODELS 3 Executive summary This report focuses on the current trends and drivers shaping the business models of payment institutions (PIs) and electronic-money institutions (EMIs), hereinafter referred to collectively and interchangeably as institutions; their different approaches to financial technology (FinTech), including their interaction with BigTech 1 firms; the level of implementation of innovative technologies; and observed changes to their strategies and business models. However, this report does not envisage or intend to model scenarios for potential future development. The report is based on information and data collected by the EBA through its engagement with the supervisory community and the industry, including the broader activities of the EBA FinTech Knowledge Hub. The payments sector is currently undergoing an important transformation with the introduction of the Revised Payment Services Directive (Directive 2015/2366/EU, PSD2), new entrants offering innovative products and services, and incumbents adapting and revamping their offerings while payment methods are reshaping and the growth of instant and mobile payment methods accelerates. A number of technology-based innovations are transforming payments, leveraging mobile devices and connectivity, with examples ranging from digital wallets to automated machine- to-machine payments. The majority of these innovations are modifying front-end processes to improve customer experience while leaving the underlying operating infrastructure unchanged. Similarly to the key drivers identified in the EBA thematic report2 on the impact of FinTech on incumbent credit institutions business models (July 2018), PIs and EMIs business models are shaped and adjusted as a result of four key drivers, namely (i) customer expectations/behaviour, (ii) competitive pressure, (iii) technological developments and (iv) regulatory changes (section 2.2). The pace of competitive pressure is forcing institutions to become more dynamic, adapt to changes and improve customer experience, by leveraging innovative technologies, while acknowledging that customer needs can materially influence the development of business models in the future. The analysis of the findings of these two reports may suggest a relationship between the growth of the payments industry and disintermediation in banking, taking into account that incumbent credit institutions reported a negative impact on their revenues from payments business lines. The current strategy of most institutions appears to be the expansion of their products and services and entrance to new markets by (i) leveraging cross-border services, (ii) requesting credit institution or third party provider licences and/or (iii) embracing the new services provided under PSD2. The continuous innovation due to the nature of the industry is a key strength of established institutions in addition to their existing customer base, their customers trust and their experience in developing and launching new innovative products and services. In general, PIs and EMIs are smaller (in terms of size and complexity) than credit institutions, so they are usually more agile and flexible to adapt to changes, which provides them with a competitive advantage in todays fast- paced business environment. To this end, these institutions were among the first to adapt and thus 1 BCBS Sound Practices Implications of fintech developments for banks and bank supervisors (February 2018), bis/bcbs/publ/d431.pdf 2 eba.europa.eu/-/eba-assesses-risks-and-opportunities-from-fintech-and-its-impact-on-incumbents-business- models IMPACT OF FINTECH ON PAYMENT INSTITUTIONS AND E-MONEY INSTITUTIONS BUSINESS MODELS 4 some of them can be considered regulated FinTech firms. Moreover, some institutions are more technology-driven and have in place sufficient skills and adequate resources to develop innovative products internally to meet customer demands. While there is a slight trend towards the internal development of products and services using FinTech, without necessarily involving external partners, a significant number of institutions partner with FinTech firms and technology providers for the development of innovative products (section 3.1). A number of BigTech firms have already obtained PI/EMI licences, and existing players expect them to participate more actively in the EU payments sector. Nevertheless, many institutions currently provide payment/e-money services to BigTech firms or acquire technology services and expertise from them for the development of innovative products. With BigTech firms posing a potential threat to the sustainability of PIs and EMIs business models, institutions are planning to focus on strengthening customer loyalty in case of increased participation of BigTech firms in the payments sector (section 3.2). In terms of the level of implementation of innovative technologies (section 3.3), many institutions appear to mostly leverage cloud services and the development of digital/mobile wallets, with an increasing interest in the use of artificial intelligence, big data analytics and biometrics. The rapid development of technology and use of data create new dynamics, such as the growing importance of a large customer base for network effects and big data analytics. Distributed ledger technology is still at an early stage of development, with the exception of crypto-assets applications, and appears to have potential applications in the area of money remittance and real-time payments (e.g. real-time clearing). Notably, some institutions have concluded that this technology may not necessarily fit their products and services. The outlook of the payments and e-money sectors is quite positive in terms of revenues and profitability (section 4), with an overall expectation of an increased customer base and the introduction of new/revamped products, accompanied by an increase in internal FinTech developments and information and communication technology (ICT) spending. This may be partly due to institutions investments in building defences to mitigate the increased security risks in an effort to minimise disruption to users, payment service providers and payment systems from the growing cyber-security and fraud challenges. Institutions face different threats and challenges depending on their business models. The potential impact of active participation of BigTech firms, the uncertain impact of Brexit and the key dependencies on banks and card processors (for some PIs and EMIs) are observed to be the key threats to the sustainability of institutions business models (section 5). In addition, a number of key challenges will need to be addressed relating to operation resilience and ICT security, operational capacity, regulatory changes, customer education, and acquisition and retention of skills and talent. In the context of its ongoing monitoring of financial innovation, the EBA will continue monitoring the impact of FinTech on institutions business models. IMPACT OF FINTECH ON PAYMENT INSTITUTIONS AND E-MONEY INSTITUTIONS BUSINESS MODELS 5 1. Background 1.1 General Article 1(5) of the Regulation establishing the EBA (Regulation (EU) No 1093/2010) requires the EBA to contribute to promoting a sound, effective and consistent level of regulation and supervision, ensuring the integrity, transparency, efficiency and orderly functioning of financial markets, preventing regulatory arbitrage and promoting equal competition. In addition, Article 9(2) requires the EBA to monitor new and existing financial activities. These mandates are key motivations underpinning the EBAs interest in financial innovation in general and more specifically financial technology (FinTech), which is defined by the Financial Stability Board (FSB)3 as technologically enabled financial innovation that could result in new business models, applications, processes or products with an associated material effect on financial markets and institutions and the provision of financial services. The EBA has decided to take forward work in relation to FinTech by initially publishing a discussion paper4 on its approach to FinTech. Following the public consultation on this discussion paper, the EBA published its FinTech Roadmap (March 2018) setting out its priorities for 2018/2019. One of the priorities set out in the EBA FinTech Roadmap is the analysis of the impact of FinTech on institutions business models in order to enhance knowledge sharing among regulators and supervisors. To this end, the EBA has published a thematic report5 on the impact of FinTech on incumbent credit institutions business models (July 2018), in line with the priorities set out in the EBA FinTech Roadmap6, and in a similar fashion the EBA has now conducted a thematic analysis on the impact of FinTech on payment institutions (PIs) and electronic money institutions (EMIs) business models. This report aims to better understand the ongoing changes in these sectors and enhance knowledge sharing among regulators, supervisors and the industry. This analysis is based on information and data collected by the EBA through its engagement with the supervisory community and the industry, including the broader activities of the EBA FinTech Knowledge Hub. This report provides an analysis of the changes observed in the payment institutions and e-money institutions, focusing on the following: current key trends and key drivers shaping institutions business models; interaction with FinTech firms and BigTech firms; level of implementation of innovative technologies; potential changes and outlook; key threats and challenges to business models sustainability. 3 fsb/wp-content/uploads/R270617.pdf 4 eba.europa.eu/documents/10180/1919160/EBA+Discussion+Paper+on+Fintech+%28EBA-DP-2017-02%29.pdf 5 eba.europa.eu/documents/10180/2270909/Report+on+the+impact+of+Fintech+on+incumbent+credit+instituti ons%27%20business+models.pdf 6 eba.europa.eu/documents/10180/1919160/EBA+FinTech+Roadmap.pdf IMPACT OF FINTECH ON PAYMENT INSTITUTIONS AND E-MONEY INSTITUTIONS BUSINESS MODELS 6 The aim of this report is twofold: to provide an overview of the current FinTech landscape and the observed changes in PIs and EMIs business models, as observed by the EBA in the context of its continuous monitoring of financial innovation; to raise awareness and share knowledge of the main trends affecting business models, and provide support to supervisors and other stakeholders to identify and understand the potential challenges to the sustainability of institutions business models. 1.2 Methodological approach A number of different sources of information were used in the preparation of this report, namely: Industry feedback on the EBAs Discussion Paper on FinTech: feedback was received from the public consultation on the EBAs Discussion Paper on FinTech (August 2017). Telephone interviews with a sample of payment institutions and e-money institutions: bilateral telephone interviews were conducted with 13 EU payment institutions and e- money institutions between November 2018 and January 2019, having a broad representation with respect to geography, business models and levels of FinTech activity. These were structured discussions/interviews covering all aspects of the analysis. EBA online survey: for the purposes of this report, the EBA conducted an online survey among EU payment institutions and e-money institutions in March 2019. Overall, 65 institutions submitted their answers and the summary of the responses are presented in this report. The results are presented in an aggregated form and most figures are rounded. Any potential difference between the sum of shown responses and 100% is due to respondents answering N/A (not applicable) or giving no response at all. It is noted that the survey did not cover UK institutions. Discussions with competent authorities: round-table discussions with competent authorities focused on supervisory knowledge of emerging technologies/products affecting institutions and their business models. Desk research: background research was carried out into the overall FinTech developments and activities. For the purpose of this report, institutions refers to PIs and EMIs, unless otherwise stated. IMPACT OF FINTECH ON PAYMENT INSTITUTIONS AND E-MONEY INSTITUTIONS BUSINESS MODELS 7 2. Current landscape 2.1 Key trends The global payments business has been significantly growing in the last few years, with 11% increased global payments revenues from 2016 to 20177, partially stimulated by the accelerating transition from cash to electronic and mobile payments. The use of cash as a percentage of total transactions has continued to fall (ECB Economic Bulletin8 Issue 6/2018), with a few EU jurisdictions already striving towards a cashless society. Digital networks and devices continue to transform the way consumers communicate, work and transact. According to the Digital Economy and Society Index Report 20189, EU citizens engage in a range of online activities. It notes a growth in the use of online services and an upward trend in e- commerce, with about 68% of EU internet users shopping online in 2017. Nevertheless, e- commerce intensity varies greatly across EU Member States. Priva