Saturday, May 20, 2017

European Banking Sector: Effective implementation of PDS2, MiFid II holds the key

The European banking sector has been under stress over the past few years owing to various factors such as low interest rates, massive fines and feeble earnings results. Further, high levels of bad loans continued to be a drag on the European banking system. According to top audit firm KPMG, the European banking sector has around €1.1trillion (£0.94tn) in non-performing loans, almost three times as much compared to the US.

Besides high volume of bad loans, banks are grappling with weak balance sheet strength and inadequate loan loss provisions – all these factors have collectively crimped the performance of European banks. Top banks such as HSBC Holdings, Deutsche Bank and Barclays have all come up with disappointing earnings results. This is in stark contrast to big-ticket U.S. banks such as J.P Morgan, Citi and Goldman Sachs that posted stronger-than-expected profits in 2016, supported by the contractionary monetary policy in the US.

The banking sector clearly has a tough road ahead, but structurally, it is poised for a massive overhaul with the European Commission moving toward implementing the revised Payment Services Directive (PSD2) by January 13, 2018. What is the PSD2 all about and why it has generated so much buzz in the European banking sector? Well, PSD2 is widely seen as a ‘game-changing’ directive that is poised to bring an end to banks’ control over their customers’ account information and payment services and offer third party providers access to customers’ accounts through open application program interfaces (APIs).

This eyeball-grabbing directive is set to transform the payments landscape across the European Union. PSD2, once implemented, will pave the way for bank customers (both consumers and businesses) to use third-party providers to manage their finances. A likely scenario could be that of customers using Facebook or Google to pay their bills, making person-to-person payments (P2P) transfers with their money safely parked in their respective bank accounts.

PSD2 – administered by the European Commission – aims to ensure every EU bank is digitally optimized. In a nutshell, this directive will create cut-throat competition in the payment services market in Europe between banks and new payment service providers (PSPs) as well as drive innovation in the European Fintech industry. More importantly, it will eliminate hidden fees charged by banks. It is seen that banks find it convenient to add transaction fees but now with the market becoming more crowded, banks will have to put their ‘rethinking’ caps on. All these factors will go a long way in ensuring an improved customer experience. In fact, the perceived fierce competition in the banking sector is a big worry for most European banks. According to some estimates, 20-25% of banks could be at risk from the new competitors owing to PSD2.

The advent of PSD2 has triggered talk about whether PSD2 would mark the end of banks’ monopoly over customers’ accounts. Delving deep, it is reasonable to assume that banks are unlikely to lose their significance as far as catering to customer needs are concerned, while granting third party providers access to customers’ account information. The need of the hour for banks is to walk down the ‘reinvent’ path and come up with robust differentiators to stay competitive.

The host of regulatory approvals and licenses required to enter the banking space means that it is never an easy proposition for new entrants. But non-banking FinTech companies, by virtue of PSD2, could find it a lot easier to foray into the market and play a significant role in the future financial landscape.


The European banking sector is also bracing up for the second installment of the Markets in Financial Instruments Directive — better known as Mifid II – considered one of European Union’s most ambitious financial reforms. The challenges of complying with Mifid II – which will come into force in 2018 – lie in ‘how prepared’ asset managers are for so-called unbundling. Under Mifid II, asset managers are required to budget separately for broker research costs and trading costs – a significant departure from decades-old practice of asset managers bundling together trading and broker research costs into a single fee, often receiving research from an investment bank or broker in exchange for using them to carry out trades. Asset managers have two options – either they absorb their research costs or set up a research payment account.


A research conducted by Electronic Research Interchange (ERIC) revealed that 74% of asset managers foresee a reduction in investment bank research. MiFid II is expected to improve quality of research. For instance, if there are more than 400 reports generated for a particular stock, we can end up having a scenario of 50 reports or even less for that stock. This will further enhance requirements for in-depth bespoke research.


It is fair to assume that the effective implementation of PDS2 and MiFid II is of crucial interest to the European banking sector. Effective implementation of these directives will crank up competition in the banking sector, which in turn, will drive consolidation across the European Union and improve customer journey. For sure, PDS2 and MiFid II might pan out to be a short-term pain but would pay rich dividends in the long run.  
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