Do you remember when you first saw someone pay for coffee with a smartphone? Mobile wallets, which allowed this kind of payment, are just the most conspicuous example of the rapid innovation that’s been going on in the financial services industry in recent years.
From mobile apps to savings tools to blockchain, countless fin-tech businesses have emerged to facilitate new ways of managing money – and the market is expected to be worth $306 billion by 2023.
But why is all this innovation happening now? Improvements in technology are certainly a key ingredient, but just as (if not more) important are the regulatory frameworks which made the fin-tech revolution possible.
New rules introduced in the last decade or so have allowed a range of companies to begin offering financial services without having to become a fully-fledged bank. Instead, new categories were created, of which ‘Payment Institutions’ are probably the most common. What are these new categories, and what do they mean for you?
More competition and better services
Until relatively recently, the rules governing who could manage and process customers’ money were fairly restrictive. If a company wanted to do things like process payments, execute transactions or handle FX, the primary option was to become a bank. The trouble is, becoming a bank is a complex and expensive process. Banks need large amounts of start up capital and are heavily regulated.
However, this began to change in 2009 with the EU’s Payment Service Directive (PSD). The PSD, which was updated in 2015, aimed to improve competition and participation in the payment industry.
The PSD was a real trigger for innovation,and we’ve seen a big rise in the number of companies offering services which make payments cheaper, faster, more efficient and user friendly. These companies are working in a wide range of fields including:
- Money remittance
- Tools which make payment transactions safer or cheaper
- Card processing – including software and hardware to make it easier to pay
- Personal and business accounts that help with money management
There are now close to 450 Payment Institutions across Europe, as well as 340 Electronic Money Institutions(a similar category).
How are Payment Institutions different to banks?
Payment Institutions have a lot in common with traditional banks. You can still receive and send money, process FX, setup direct debits and much more. So, what’s the difference?
The way money is held
In a traditional bank, a customer deposits money into the bank’s funds. The bank then uses the all their customers’money to lend out and generate an income. That allows the bank to make a profit but is also a huge responsibility since, if there is a banking collapse,people’s money could be lost.
In a Payment Institution,each customer’s money is held in its own segregated account. The company running the Payment Institution is not allowed to use that money for the purposes of lending or investment – which means your money is protected in the case of a disaster.
Banks can make investments with their customers’ money and pay them interest on any returns. Since Payment Institutions don’t accept deposits in this way, they can’t make investments with your money.
Rights to issue credit
One of the most important purposes of banks is their ability to issue credit to customers – be that business loans, mortgages or other offerings. This is a highly regulated field and requires the bank to be backed up by large funds.
Payment Institutions are not in the business of issuing credit – the focus is all about making it easier to send, receive and manage money.
Why use a Payment Institution over a bank?
Payment Institutions can’t do everything that banks can – so why are so many people turning to them?
Much lower costs
Processing FX and sending money across borders is expensive with most traditional banks – it’s usually much lower if you use a Payment Institution
Tailored to your needs
Most banks are huge institutions providing services to millions of customers. Their products therefore may not meet your specific needs as well as a nimble Payment Institution that offers services for your particular industry.
At Xace, for instance, we offer services that target the financial needs of online casinos accounts, e-gaming companies and cryptocurrency accounts – who aren’t so well catered for by traditional banks.
Easier to use and faster
Traditional banks are often clunky when it comes to processing payments. This is largely because their back-end systems are built on old technology. Payment Institutions can offer much faster and easier to use services.
Payment Institutions are used by a huge range of individuals and businesses from all sorts of backgrounds – from private individuals to small businesses to larger companies. In many cases, customers are simply looking for a payment tool which closely matches their particular needs and makes it easier to manage money than a traditional bank.
Are Payment Institutions as safe as banks?
Customers are understandably cautious about handing over their money to newer payment industry players. We all know that banks are highly regulated and there are processes in place in case things go wrong.
The good news is that these concerns have largely been addressed in the EU’s Payment Service Directive. Rules are in place to govern business conduct, customer complaints, reporting and protecting money – which is not much different to what you’d expect from a traditional bank.
When applying to become a Payment Institution, the company needs to provide regulators with evidence that its payment system is secure, and show that it has insurance or other measure in place to protect customers’ money in case things go wrong (a list of FAQ’sis available on the European Commission’s website).
Driving the finance revolution
In the past decade, we’ve seen some truly innovative new financial services products emerging. By making it easier and cheaper to manage personal and business accounts, these companies are shaking up the industry and really boosting expectations about what customers can do with their money.
And all this innovation is, in large part,down to the creation of Payment Institutions and other categories like it.Without that trigger, the payment industry today would look very different indeed.
For an example of what a Payment Institution can do for your personal and business finances, learn how Xace works.