Financial services companies will have to prepare next year for the enactment of Payment Services Directive 3 (PSD3), a new set of rules governing the EU payment markets expected to come into force by the end of 2024. The general aim of PSD3 is to update and modernise the rules outlined in its predecessor, PSD2, and better unify rules across EU states. The result will be improved efficiency and security of electronic payments and financial services in general in Europe.

One expectation is that PSD3 will require payment service providers (PSPs) to adhere to enhanced fraud prevention measures. This could be done, for example, by enacting stricter rules on customer authentication and more extensive guidelines governing access to payment systems and account information.

To prepare for the changes PSD3 will bring, it will be necessary for fintech companies to thoroughly review and adjust their processes and compliance protocols. In the upcoming year, we will see enhanced efforts within the industry to adapt to the ever-evolving regulatory landscape, to better ensure the security of payment processes and customer data.

Heightened regulatory scrutiny

There is a reasonable expectation of heightened regulatory scrutiny in general in 2024. Events like the collapse of the Silicon Valley Bank and the Railsr incident shook the financial industry in 2023 by highlighting how even seemingly strong companies are susceptible to market forces beyond their control, like rising interest rates and falling investments. These incidents spurred some regulatory changes expected for the coming year, including heightened reporting requirements and closer supervision of risk management practices.

Fintech companies should expect to conduct thorough internal reviews to identify and address potential vulnerabilities and fortify their compliance measures. A key part of this process should be clear and open communication with regulatory bodies, stakeholders, and the public, to emphasise the steps taken to enhance security and compliance.

Such transparency will help foster a culture of compliance within the financial sector, which will be crucial to maintaining both a successful industry and consumer trust.

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Fintechs should also expect to navigate new regulations on the use of generative AI in financial processes to better protect consumer data and ensure the ethical use of this emerging technology. Fintech leaders are already calling for more regulation on AI itself, to help protect digital assets from increasingly sophisticated cyber threats.

Rethinking the BaaS model

Banking-as-a-Service (BaaS), or embedded finance, has continually expanded over the last several years, as businesses increasingly integrate financial services into their core offerings. While BaaS is a cornerstone of fintech, BaaS providers must maintain a level of flexibility, ready to adapt their service model to the financial industry’s shifting interests and, particularly, to its evolving regulatory environment.

One area where flexibility is crucial is in the matter of compliance. Because the BaaS provider holds the banking license that allows fintechs to offer financial services to their users, it is the BaaS provider who is ultimately responsible for the security of those users’ assets and information.

With regulations and risk management requirements becoming stricter, BaaS providers must be ever more prepared to ensure a high level of security and reliability. Where compliance has typically been handled by BaaS providers’ fintech partners, that responsibility is shifting more and more onto the shoulders of BaaS providers themselves.

One approach to dealing with this shift is for BaaS providers to embed compliance into their offerings. Alongside traditional services, like accounts, payments, and cards, BaaS providers could also handle onboarding, authentication, monitoring. By offering embedded compliance, or compliance-as-a-service, BaaS providers can reduce the complexity of maintaining compliance, thereby allowing fintechs to focus on their core business, which is one of the principles that gave rise to BaaS in the first place.

AI and its adaptability in the industry

As the transformative potential of generative AI has become clearer throughout 2023, fintech companies are looking to integrate AI more fully into the financial services sector in 2024. Beyond chatbots and virtual assistants, AI is being considered as a solution to more complex problems, like risk assessment, fraud detection, and customer authentication.

It is no surprise that fintechs are pursuing AI as a way to improve the speed and efficiency of their services. But doing so in a responsible and effective way will not be an easy task. It will be important to understand AI’s mechanisms, its biases, and its overall limitations before trusting it to solve some of the more difficult problems in the financial sector. As with any technology, fintechs will need to keep a close eye on AI as it finds its place and proper function in the industry.

A move toward sustainability

Environmental, Social, and Governance (ESG) considerations are expected to receive increased focus in 2024, as fintechs incorporate sustainability into their business strategies. ESG is a set of standards used to determine the sustainability of a business or investment. For fintechs, adhering to ESG standards can include making net-zero pledges, supporting efforts to combat climate change, and transitioning away from the use of energy-intensive technologies.

Such changes may be driven not just by regulatory changes, but also by increased commitment to social responsibility and increasing consumer demand for ethical and sustainable financial services.

In an increasingly eco-conscious industry, the integration of ESG considerations could lead to a competitive edge for fintechs, attracting environmentally conscious investors and fostering long-term resilience.

Marius Galdikas is CEO at ConnectPay