Excerpt
Table of Contents
1. Introduction
2. Neo banking and Regulation in Europe
3. Competition drives innovation
4. Neo banks – the new innovative players
5. The new innovative banks
6. Conclusion
7. Bibliography
1. Introduction
The number of FinTechs has been on the rise since. The European Fintech sector is the most valuable startup tech sector in Europe with an accumulated valuation of 123 billion € and it receives around 20% of all venture capital in Europe. The highest valuation of the FinTechs can be found among the neo banks. The largest European neo banks already have millions of customers and are now on entering the U.S. Market. (Roland Berger, 2016) (Fintech Capital; Dealroom, 2019) (Hashim & Field, 2020)
But what has happened since 2008 that enabled the quick development of new entrants into the European banking industry?
But what has happened since 2008 that enabled the quick development of new entrants into the European banking industry?
According to Davis, new regulations in the EU have created more competition by making it easier for new banks or payment institutions to obtain licences, enabling the customer to easily switch between providers and standardising systems and communication. In general, making it easier to get a product to the market (Hashim & Field, 2020).
2. Neo banking and Regulation in Europe
Europe is the largest market for neo banks with about 40% market share of the global neo bank market. This is due to the fact that regulation, unlike in the U.S. for example, makes it easy for banks to get licensed, launch quickly and for customers to seamlessly switch providers. Regulators were determined to create more competition which lead to the rise of more neo banks (PWC, 2020) (Hashim & Field, 2020).
The first enabling regulation, called PSD (Payment Services Directive), took place in November 2007 and was implemented by all member states before November 2007. By rewriting the regulations for payment service providers in the European Union, the legislators aimed to increase the competitiveness of the industry and to simultaneously improve the protection of the consumer. The results shape today’s banking in Europe. 36 European states (EU26 + 10 non-member states) have a unified European payment are, called SEPA (Single Euro Payment Area) that standardized and simplified international transactions (similar to SWIFT). All countries had to change the account-ids to the IBAN/BIC system and intra banking communication was standardized. The PSD also standardizes fees, maximum execution times for transaction and transparency requirements. Further, the regulation defined new categories, called “Payment Institution” and “E-Money Institution” that have a lower licencing barriers than banks and enables the licensee to handle e-money (European Union, 2007) (European Union, 2009).
The PSD was updated in 2015 with the PSD II directive, that needed to be implemented by January 2018. PSD II has an increased scope as it does not only target inner European payments but also includes payments that involve one European and one non-European party. The major updates of PSD II enabled customers to execute payments via PISPs (Payment Initiation Service Providers), meaning that banks had to open up their system and enable 3rd party applications access. Banks now also had to share account and customer information with third parties if the customer requires to, so called AISPs (Account Information Service Provider). PSD II also updated security measures for the customers by requiring a 2 factor authentication for individuals (European Union, 2015) (Deloitte, 2016) (Bundesbank, 2016).
The European Union also introduced MiFID II (Markets in Financial Instruments Directive) II that came to power in 2018. MiFID II does not affect the retail banks directly. It rather aims to protect the retail investor and enable more protection and transparency for trading. Therefore, it affects brokers and accordingly banks with a brokerage service. Brokers are required to transparently declare their cost structure and show the effect of the investor’s ROI under MiFID II. MiFID II also requires the broker to identify the customer’s suitability and ensure that he is aware of the potential risks he is going to encounter. In reality some of the steps taken to have turned out as a higher burden of paperwork, that does not necessarily improve customer protections (BaFin, 2017) (Konto.org, 2019).
Those regulations ensure a more competitive landscape in the European Banking Industry. A payment institution licence can already be obtained with a starting capital of 125 000 € and enables the holder to execute payment transactions from credit transfers to foreign exchange services. E-money institutions (EMI) can obtain a licence with a starting capital of 350 000€, they can enable the customer payments, as well as creating customer accounts with an IBAN, payment cards and e-wallets. Both, Payment Institutions and EMI licences enable new companies to enter the market, generate customers and offer new services without going through the difficult and capital intensive process of obtaining a banking licence (the– deposit credit institution) that requires a minimum of 5 Million € in addition to certain requirements about the management, board, governance and technological setup. Additionally, switching costs for the customer of banks decreased through unified regulations and the PISPs (Payment Initiation Service Provider – a PISP can initiate payments) and AISPs (Account information Service Provider – a AISP can access account information) accesses for customers that enabled on the one hand an account management independent of the banks interface and on the other hand the usage of 3rd party services independent of the own underlying bank account (European Central Bank, 2019) (Deloitte, 2019) (Walz, 2019).
3. Competition drives innovation
According to Aghion, an increase in competition leads to a significant increase in R&D investments and therefore an effort to innovate. To determine the effect of the regulation on the competitiveness of the banking industry we are going to look at the 5 Forces that govern competition in an industry, according to Porter (Aghion, Bechtold, Cassar, & Herz, 2014) (Porter, 1979).
Threat of new entrants. The process of obtaining a banking licence itself has not become easier through the regulations by the European Union though, some factors contribute towards diminishing the barrier. Capital requirements not for the banking licence itself but for some core services of the banking offer, such as the general account management have decreased from 5 Million € to 350 000€ for EMI and 125 000€ for PI Licences, as mentioned above. It enables new entrants to build up a customer base and proof their concept without having to go through the capital intensive process. Also, the possibility of running a direct bank without any branches and always in the customers pocket further results in lower entry costs (Deloitte, 2019) (Rachleff, 2019).
Bargaining power of suppliers. According to Siaw banks have been acting as suppliers previously but that changed due to the internet and the possibility of PISP and AISP standards. Banks have become a intermediaries that can enable the customer to access a wide range of financial products and services, proprietary and from third party providers. As now it becomes important to be the gateway for the customer instead of the gatekeeper, competition has increased for banks. It is not only a competition within the banking industry anymore (Siaw & Yu, 2004).
Bargaining power of buyers. The PSD standards have decreased switching cost and standardized upper limits for prices for banking services. Further learner cost structures enable new competitive pricing also for new entrants and the internet makes switching and creating new accounts easy and simple. Bargaining power for the buyer has therefore increased (Siaw & Yu, 2004).
Threat of substitutes. Through the new licences, substitutes for certain banking services like TransferWise (International money transfer) or Trade Republic (Zero-Fee Broker) could offer their services. As they can get the same access to the bank account data through AISP and PISP if the consumer unlocks it as the bank has, the customer can easily substitute single products of the bank with other providers. Generally those providers additionally have lower operation cost and therefore have competitive offers (Siaw & Yu, 2004).
Jockeying for position / Industry Rivalry. Neo banks have the chance to compete with large multinational banks as customer growth and acquisition is not constrained by physical branches anymore. Additionally the European banking industry experiences a consolidation of the banking industry, shrinking from 8 525 institutions in 2008 down to 6 250 in 2017. Return on Equity for banks varies on a yearly basis but it has been up to 5.6% again, which is highest since 2007 (there: 10.6%). The industry is therefore facing a more and more competitive environment, also aside from the PSD regulation (Siaw & Yu, 2004) (European Banking Federation, 2018) (Krecké, 2019).
The environment in the banking industry in Europe has become more competitive through the internet and the availability through smartphones but essentially through the regulations of the European Union. To compete in an environment with increased industry competition and threat of substitutes, the players are required to build new barriers and distinguish themselves by innovative offers.
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