As an immediate result of the financial crisis, regulators are introducing stricter rules on liquidity and capital. However, the European payments landscape has been undergoing its own quiet regulatory revolution for some time now as SEPA aims to revamp the domestic Euro payment infrastructures.

Most recently, the industry has witnessed the introduction of the Payment Services Directive which enables the creation of a new category of Payment Service Provider - the Payment Institution. PIs are intended to embrace businesses that are not currently regulated as either Credit Institutions or e-Money Institutions such as pre-pay cards and certain mobile payment services amongst others.

The introduction of PIs on the market will encourage the growth of new, innovative payment services, but will also provide an alternative to the traditional payment services providers or banks. What do these new entrants mean for the market and how will the traditional players respond?

Payment Institutions explained

According to the European Union, there are currently just 71 registered PIs across Europe. With over 6,500 banks within the EU, PIs form just a small proportion of the market, due to the fact that a sluggish economic recovery across Europe has played a role in companies' reluctance to enter a new market and the  costs involved with applying for a banking license are not small. In addition, the PSD has yet to be fully implemented in all 31 EU countries. However, as Europe's economies continue to recover and the PSD is fully implemented across the European Union, the number of PIs is expected to grow.

PIs can offer payment services that were traditionally the preserve of traditional banks such as payment accounts and foreign exchange, or grant credit for up to one year, competing on an equal footing to banks in the payments arena. They also enjoy a much lighter regulatory regime than the traditional bank, benefiting from less capital requirements and no obligation for liquidity monitoring or stress testing. It is expected that PIs will have the ability to provide more innovative payments services and products, such as mobile, more quickly and cost-effectively to the consumer which could provide them with a competitive edge in the market.

Due to the financial crisis, the prospect of new PIs coming onto the market has not been top of the agenda for traditional banks as more pressing issues have taken centre stage. There has also been a certain complacency vis-à-vis the new entrants. In surveys conducted by the Financial Services Club and other industry bodies in 2009, banks stated that they were not overly concerned about PIs entering the market, affecting their traditional payments business. As a result they have tended to overlook them, or at least consider them as niche services.

As banks look beyond the economic crisis and plan for the upturn, they should consider the payments landscape with fresh eyes. As a result of the recent crisis, customer loyalty toward banks is at an all time low. A recent UK Deloitte study found that 51% of consumers surveyed are willing to move away from their current bank, to ‘new banks', such as Virgin Money or Tesco Finance or to a new provider, such as a PI.

What‘s more, banks' budgets are under more scrutiny than ever before. It is a widely accepted fact that when the crisis hit back in 2007, many banks had not completed their IT consolidation projects following a period of merger and acquisition activity. Banks' IT teams now find themselves with a generally outmoded and inflexible payments infrastructure and are in a position where they are competing for budget which does not generally stretch to payment innovations. The PIs, by contrast, are likely to be more innovative and less risk averse, not having the burden of the traditional bank infrastructures to cope with.

Three different payment models

As such, the appeal of PIs and new services for the consumer is clear and it is likely that the industry will undergo significant change in the coming years with three different payment models emerging depending on banks' long term strategy and focus on payments.

The first model will see PIs directly compete with banks by offering a range of payment services to consumers, including both issuing and acquiring. The emergence of such players is already evident with Tesco Bank, Virgin Money and Metro Bank set up, fiercely competing for market share. This avenue will see traditional banks having to re-focus and review their strategy for their payments business and could lead to fragmentation or potential consolidation in the market with clear winners and losers.

The second model will see banks and PIs co-existing and working alongside each other. This is a more laissez-faire approach where PIs and traditional banks will operate independently but offer more distinct and niche services that appeal to certain segments of the market. This model is particularly suited to those banks that do not see payments as a key part of their long term business strategy. It is likely to see the traditional banks continuing with their current payments offering, while allowing the new players to make headway in terms of innovative payment services in areas such as growing mobile and online.

The final and most widespread outcome might see banks and PIs forming partnerships and working together in order to maximise the benefits for each party. In this case, traditional banks are partnering with PIs to obtain access to new payment innovations that they may not have the time, resource or money to develop in-house. The banks opting for this route are likely to be the government funded banks and those constrained by siloed or legacy IT systems. In turn, PIs will obtain access to an existing customer base, allowing for an instant and relatively risk free revenue stream, while having an opportunity to share innovations on a global scale.

Although the path a particular bank may choose to take is not clear at this stage, both banks and PIs will form an integral part of the future payments landscape where neither one is redundant. The regulatory regime is currently in place means that PIs will always have to rely on traditional banks to get access to clearing and settlement systems, a rule that is outlined in the Settlement Finality Directive, and which is currently not open to PIs. However, it will be those banks that factor these new players into their future plans who stand to gain from the significant changes taking place in Europe's payments landscape. The coming years will see a shake-up of the European payments market - and hopefully further innovation and a healthy level of competition.

Fred Bar is managing director for euro services at VocaLink