The way we pay, and transfer money is changing fast, thanks to technology and the rise of digital era. Banking and payments are merging closer together, making it easier to shop and do business across borders.
But as digital payments grow, it’s clear that rules need to catch up to protect consumers, keep payments safe, and ensure fair competition among traditional banks and new FinTech players.
The Payment Services Directive (PSD) was the first step toward creating rules for the digital payments. But as mobile apps and online services evolved, it became clear that more was needed to keep fraud in check and ensure that everyone—whether a traditional bank or a new fintech company—played by the same rules. That’s how PSD2 was born.
What is PSD2?
PSD2 sets out rules that allow consumers to safely share access to their bank accounts with trusted third-party providers. These providers can then offer services like initiating payments directly from a customer’s bank account or giving a full overview of finances in one place.
Open Banking is one of the main outcomes of PSD2. With these, consumers can pay merchants directly from their bank account without needing a card. For businesses, this means cutting out unnecessary middlemen, saving on fees, and even avoid those nasty chargebacks.
But it’s not just about payments. PSD2 also enables tools, such as spending trackers, financial advice apps, subscription managers, automated payments, and integrated business solutions, all designed to simplify money management and improve financial decision-making for both consumers and businesses. These services make it easier for consumers to manage their money while creating opportunities for FinTech’s and banks to deliver better service to consumers.
Breaking Down the Jargon
PSD2 comes with its own set of technical terms, but they’re not as complicated as they sound. The main ones are:
· PIS (Payment Initiation Services): Allows consumers pay directly from their bank accounts, by choosing the "pay by bank" option at checkout.
· AIS (Account Information Services): Pulling together account balances and transaction data to help consumers get a better financial picture.
· TPP (Third-Party Provider): Any authorized company offering PIS or AIS services.
· SCA (Strong Customer Authentication): A security feature which requires two steps confirmation from the payer, like entering a PIN and using fingerprint recognition.
Pay by Bank or Open Banking
Pay by Bank or Open Banking was one of the cornerstone of PSD2, which has reshaped how merchants and businesses interact with consumers. It opened the way for third-party providers to access customers' financial data and offer a range of services. For example, a budgeting platform can connect to he client’s bank account, giving them a clear view of their spending and helping them to manage their finances better.
With Open Banking, businesses can now pull money directly from a customer’s account without the need for a card, simplifying payments and reducing costs. PSD2 has driven major fintech innovation across the EU and UK. Its success is now sparking interest in other regions, such as Asia, where Open Banking is beginning to make an impact.
Tackling Security Without Frustrating Customers
PSD2’s main benefit is the Strong Customer Authentication (SCA), which was designed to reduce fraud. SCA requires using at least two of three factors to verify a payment: something you know (like a password), something you have (like your phone or other device), or something you are (like your fingerprint or face).
While this is great for security, it can sometimes feel like a hassle for customers, especially if the process involves multiple steps. Early implementations of SCA made checkout slower and led to abandoned carts. But with better tools, such as biometric authentication and improved integrations between banks and service providers, the process is becoming much smoother. For example, using a fingerprint or face ID now makes authentication both secure and seamless.
In the USA, several providers and merchants still prefer to offer 2D solutions for a faster and more seamless checkout experience. However, this has also made the USA one of the regions with the highest chargeback rates.
PSD2's Strong Customer Authentication (SCA) is gradually being embraced by customers. With the introduction of biometric verification, the process has improved significantly, making it both secure and convenient.
Challenges Along the Way
As promising as PSD2 is, the road to success has not always been without hiccups. A few to mention:
· Lack of consistency in how banks implement the rules. Some banks set up easy-to-use systems, while others made things unnecessarily complicated, requiring customers to type in long account numbers or go through multiple steps to complete a payment.
· Limited support for biometric authentication. In the early stages many customers couldn’t use quick and secure methods like fingerprint or face recognition due to the limited support from the providers, leading to slower and more frustrating checkout experiences.
· Unpreparedness. Some banks were struggling to handle high transaction volumes, causing delays, errors, and disruptions that impacted both merchants and consumers.
· Disputes. Pay by Bank disputes are not as straightforward as chargebacks in card processing. While this reduces false chargeback claims and associated costs for merchants, it leaves consumers without an easy way to contest transactions if a product or service is faulty, creating an imbalance between convenience for businesses and protection for customers.
The Way Forward
Thankfully, these issues are being much better addressed today. Banks and financial institutions realised how to simplify the process, reducing unnecessary steps and ensuring that payments are smooth and secure. For example, customers no longer need to remember their 16-digit IBAN number, and more banks are supporting biometric authentication through their apps. These changes make paying directly from a bank account as simple as scanning your fingerprint or face.
For merchants, partnering with the right providers can make all the difference. Today, with the right payment and banking strategy, businesses can offer faster, easier payment options while keeping costs under control.
What’s Next for PSD2?
While PSD2 has been a big step forward, it’s clear there’s room for improvement. Some are already calling for PSD3 to address new challenges and opportunities in the fast-changing world of payments. However, real innovation often comes from the market itself.
Whether PSD3 will be sufficient or not is still a debate among many payment leaders.
Businesses who work with providers who go beyond the basics of PSD2 will be best placed to meet customer needs and stay competitive in the years ahead. Co authors: Viktoria Soltesz & Bhupesh Naranware