Glossary
29 Jan 2025

What is Payments Service Directive 2 (PSD2)?

Subhasis Sahoo (Founding Member - Marketing)

Payments Service Directive 2 (PSD2) Definition :

The Payments Service Directive 2 (PSD2) is a key piece of legislation introduced by the European Union (EU) to regulate payment services and payment service providers (PSPs) within the EU and European Economic Area (EEA). This directive aims to create a more integrated and efficient payments market while enhancing security and consumer protection. It came into force in January 2018 as a successor to the original PSD1, which was implemented in 2007.

Table of Content :

  1. Payments Service Directive 2 (PSD2) Definition
  2. Objectives of PSD2:
  3. Key Regulations of PSD2
  4. How PSD2 Affects Businesses
  5. How PSD2 Affects Consumers ?
  6. The Future of Payments Post-PSD2
  7. Challenges of PSD2
  8. Conclusion

Objectives of PSD2:

  • Increase Payment Security: Implementing measures like Strong Customer Authentication (SCA) to reduce fraud.
  • Boost Competition: Encouraging new entrants into the payment services market, including fintech companies.
  • Enhance Consumer Protection: Providing consumers with more control over their financial data and transactions.

Key Regulations of PSD2

Stronger Customer Authentication (SCA):

PSD2 mandates that electronic payments be authenticated using at least two of the following: something the user knows (e.g., password), something the user possesses (e.g., smartphone), and something inherent to the user (e.g., fingerprint). This measure aims to significantly reduce fraud and enhance security.

Access to Payment Accounts (Open Banking):

PSD2 allows third-party providers (TPPs) to access payment accounts with the consumer’s consent. This facilitates the development of innovative financial services, such as account aggregation and payment initiation services.

Payment Service Providers (PSPs) and Their Role:

Under PSD2, PSPs are categorized into three types:

  • Account Information Service Providers (AISPs): Offer services that provide consolidated information on one or more payment accounts.
  • Payment Initiation Service Providers (PISPs): Initiate payments on behalf of the user.
  • Card-Based Payment Instrument Issuers (CBPIIs): Issue card-based payment instruments.

Each category has specific compliance requirements to ensure security and consumer protection.

How PSD2 Affects Businesses

Impacts on Banks:

Banks are required to open their payment services and information to licensed TPPs, fostering a more competitive environment. They must also implement SCA to enhance security.

Impacts on Fintech Companies:

Fintech companies can leverage PSD2 to offer innovative services, such as budgeting tools and alternative payment solutions, by accessing consumer account information with consent.

Impacts on Merchants and E-commerce:

Merchants must adapt to new security requirements, including SCA, to process payments. This may involve integrating new authentication methods into their payment systems.

How PSD2 Affects Consumers ?

Enhanced Security and Consumer Protection:

Consumers benefit from increased security measures, such as SCA, which protect against unauthorized transactions. They also have greater control over their financial data, as TPPs can access account information only with explicit consent.

Improved Payment Experience:

PSD2 enables faster and more convenient payment methods, including one-click payments and instant bank transfers, enhancing the overall consumer experience.

The Future of Payments Post-PSD2

The Rise of Digital Wallets and Cryptocurrencies:

PSD2’s emphasis on security and innovation paves the way for the adoption of digital wallets and cryptocurrencies, offering consumers more payment options.

Global Implications of PSD2:

While PSD2 is an EU directive, its impact is global. Other countries are observing its implementation, and similar regulations may emerge worldwide, influencing global payment ecosystems.

Challenges of PSD2

Implementation Challenges:

Businesses face challenges in implementing PSD2, including technical complexities and compliance costs. Ensuring that payment systems meet SCA requirements can be resource-intensive.

Consumer Adoption:

While PSD2 offers enhanced security, some consumers may find new authentication methods cumbersome. Educating consumers about the benefits and usage of these methods is crucial for widespread adoption.

Conclusion

PSD2 represents a significant shift in the European payments landscape, aiming to enhance security, foster innovation, and improve consumer protection. While it presents challenges, it also offers opportunities for businesses to innovate and for consumers to benefit from more secure and convenient payment options.