The Payment Services Directive 2, or PSD2, is a major European regulation that sets clear rules for how digital payments should work. Its goal is to make online transactions safer, give customers more control over their data, and encourage better and more innovative payment options.
Understanding PSD2 regulation is essential if you sell to customers in the European Economic Area (EEA), because PSD2 directly affects how your payments are verified and how customer information is shared during a transaction.
Key Takeaways
- PSD2 strengthens the security of online payments and sets clear rules for data sharing across the European Economic Area.
- Strong Customer Authentication (SCA) and open banking form the core of PSD2, reducing fraud and supporting new financial services.
- Marketplaces and businesses must follow updated compliance rules, including secure APIs, explicit customer consent, and clearer licensing requirements.
- As regulations move towards PSD3, businesses should prepare for stricter security standards and ongoing changes in the digital payments landscape.
Understanding PSD2: What It Means for Modern Payments
PSD2, or the Payment Services Directive 2, is a key regulation introduced by the European Union (EU) to modernise how digital payments work. It sets clear rules for how banks, payment gateways, and financial institutions must operate within the EU and the wider EEA.
The directive makes payments more secure and efficient by tightening authentication and improving transaction checks. It also supports innovation and helps the banking industry adapt to new technology through greater use of Application Programming Interfaces (APIs) and open banking frameworks.
Alongside these changes, PSD2 enhances consumer protection by improving transparency, defining rights more clearly, and strengthening dispute-resolution processes for electronic payments.
Key Pillars of PSD2 Regulation: SCA and Open Banking
PSD2’s framework rests on two main pillars: Strong Customer Authentication (SCA) and open banking.
SCA sets stricter security rules for approving electronic payments. Under this, a customer must confirm a transaction using at least two independent factors. These factors fall into three simple categories:
- Something the customer knows — like a PIN or password
- Something the customer has — like a phone or security token
- Something the customer is — like a fingerprint or face ID
This added layer of verification reduces the risk of unauthorised transactions and protects online buyers.
Open banking, on the other hand, requires banks to share customer account data securely with authorised TPPs, but only with the customer’s clear consent. This makes it possible for new apps and payment services to offer better tools—such as faster account-based payments or real-time financial insights.
Both pillars aim to reduce fraud and promote financial innovation across the European Economic Area. For any business operating under PSD2 rules, compliance with SCA and open banking is essential to process European payments smoothly and securely.
Strong Customer Authentication: Enhancing Payment Security
SCA is a key requirement under PSD2. It requires at least two independent elements for most online payments to ensure the payer is genuine. These elements fall into three categories:
- Something you know, like a password or PIN.
- Something you have, such as your phone or laptop.
- Something you are, including a fingerprint or facial recognition.
By combining two of these elements, SCA makes it much harder for anyone to misuse your payment details. Examples of SCA in action include entering a password, confirming with an OTP sent to your device, or completing biometric verification.
Not every payment needs full SCA. Low-value transactions and approved recurring payments may qualify for exemptions. Banks may also skip SCA when their checks show that the payment is safe and low risk.
For online card payments, 3D Secure 2.0 is the main method used to meet SCA requirements. It adds an extra layer of security while still keeping the checkout process smooth for genuine customers.
Related read :What is Strong Customer Authentication
PSD2 and Open Banking: Transforming Financial Services
Open banking is one of the most important shifts introduced under PSD2. It allows banks to securely share financial data with licensed TPPs, but only when a customer gives clear consent. This data sharing takes place through APIs. APIs act like secure digital bridges, allowing banks and trusted providers to exchange information safely and in real time.
Within open banking, two types of licensed providers play a key role:
- Payment Initiation Service Providers (PISPs): They can start a payment directly from a customer’s bank account. This gives businesses an alternative to card payments and often lowers transaction costs.
- Account Information Service Providers (AISPs): They collect a customer’s financial data from multiple bank accounts and present it in one place. This helps customers, freelancers, and businesses get a clearer overview of their finances.
Open banking encourages financial innovation by allowing businesses to build new payment solutions, budgeting apps, and financial tools using secure bank data. It also gives consumers more control, as they can decide who can access their information and how it is used.
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Benefits of PSD2 for Businesses and Consumers
One of the biggest benefits of PSD2 is stronger security. With tighter rules around authentication and data access, PSD2 helps reduce online payment fraud for both merchants and customers.
The regulation also supports fair competition by giving new payment service providers the chance to offer services that previously only banks could provide. Businesses can adopt new payment tools, streamline their checkout experience, and unlock fresh revenue opportunities.
Consumers can see the real fees and exchange rates before confirming a payment, which helps avoid hidden costs. PSD2 also improves customer protection by offering clearer refund rules and banning extra charges for paying with a card.
Overall, PSD2 helps create a more integrated and efficient payments market across Europe.
Navigating PSD2 Compliance Requirements for Businesses
- Apply Strong Customer Authentication: Businesses must use SCA for customer-initiated online payments. This means customers will confirm transactions using two independent verification steps, such as an OTP, a device prompt, or biometrics.
- Use Secure APIs for Open Banking: PSD2 requires businesses to use protected API connections when they interact with banks or authorised TPPs. This ensures that financial data is shared through secure, regulated channels.
- Obtain Explicit Customer Consent: Before accessing or processing financial data, businesses must clearly explain why the data is needed and get the customer’s permission.
- Follow Updated Rules for Marketplaces: PSD2 narrowed the commercial agent exemption, which means many marketplaces no longer qualify for it. As a result, they must follow stricter payment rules set under PSD2.
- Get a Licence or Work with a Licensed PSP: Because of the updated rules, many marketplaces now need a payment institution’s licence or must partner with a licensed payment service provider to handle customer funds legally.
- Maintain Strong Data Governance and Fraud Controls: Businesses must protect sensitive data, monitor for suspicious activity, and use tools that reduce the risk of fraud.
- Help Customers Understand New Authentication Steps: Customers may not be familiar with the extra verification steps required under PSD2, so businesses should explain the process clearly to avoid confusion and improve the payment experience.
PSD1 vs. PSD2: A Regulatory Evolution in Payments
The original PSD1 was introduced in 2007 to build a single EU payment market. It set the basic rules for consistent electronic payments and strengthened core consumer rights across the region. However, PSD2 was introduced in 2018, replacing PSD1 to keep up with new technology and changing payment habits.
One of the biggest upgrades in PSD2 is the introduction of SCA and formal open banking rules, both designed to improve security and allow safer data sharing. It also clarified unclear areas from PSD1, including rules for commercial agent exemption for online marketplaces.
Overall, PSD2 builds on PSD1 by making the payment system more secure, competitive, and supportive of innovation. It adapts the regulatory environment to the rise of fintech companies and modern payment service providers.
| Aspect | PSD1 (2007) | PSD2 (2018) |
| Primary Goal | Create a single EU payment market | Update rules to match new technologies and digital payment methods |
| Scope | Focused on conventional payment services | Expanded to include fintechs, marketplaces, and digital payment |
| Security Requirements | Basic security guidelines | Mandatory Strong Customer Authentication |
| Consumer Rights | Basic protections for electronic payments | Stronger refund rules and transparency requirements |
The Future of Payments: A Glimpse into PSD3
In 2023, the European Commission introduced plans for PSD3 and a new Payment Services Regulation (PSR). These updates aim to boost fraud prevention and improve how open banking functions. It will bring stricter SCA standards, which may include behavioural biometrics for more reliable verification.
The scope of PSD3 will expand to cover emerging areas such as instant payments, Buy Now Pay Later (BNPL) services, and certain cryptocurrency activities. This ensures the regulation keeps pace with new payment trends.
Overall, PSD3 seeks to strengthen customer data control and create more uniform rules across the region. Businesses can expect the new compliance rules to come into effect around 2027, so planning ahead will be important.
Ensuring Secure and Compliant Global Transactions with Razorpay
As European payment rules evolve, Indian businesses need reliable tools to accept international payments securely and stay compliant. Razorpay offers features that simplify cross-border transactions.
International Payment Gateway
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Support for Multiple Currencies and Payment Methods
Razorpay supports payments in over 135 currencies and provides access to global payment methods, including cards, local payment options, and international wallets. Allowing customers to pay in their own currency makes the checkout smoother and improves conversion rates for cross-border sales.
Unified Dashboard for Global Payments
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Conclusion
PSD2 has reshaped the European payments landscape by raising security standards and enabling safer digital transactions. It also opened the door to open banking, giving businesses access to new tools and services that improve payment experiences and support growth.
Staying compliant with PSD2 remains essential for secure and competitive operations, especially for businesses working with European customers. With PSD3 on the horizon, the shift towards stronger security, wider data access, and deeper financial integration will continue, shaping how payments evolve in the coming years.
FAQs
1. What is the full form of PSD2?
PSD2 stands for Payment Services Directive 2.
2. What are the main objectives of PSD2?
PSD2 aims to increase competition, improve consumer protection, and support innovation in the European payments industry.
3. What does Strong Customer Authentication (SCA) mean?
SCA is a key PSD2 requirement that uses at least two independent checks to confirm that the person making an online payment is genuine.
4. Is PSD2 mandatory for all businesses?
PSD2 compliance is mandatory for banks, payment service providers, and any business involved in processing payments within the EU or EEA.
5. How does PSD2 affect online marketplaces?
PSD2 tightens rules around the commercial agent exemption. Many marketplaces now need a payment institution’s licence or must partner with a licensed payment service provider.
6. What is the difference between PSD1 and PSD2?
PSD2 builds on PSD1, which adds stronger security checks, allows banks to share data safely through open banking, and gives clearer rules for new payment service providers.
7. What are the future developments after PSD2?
The European Commission has proposed PSD3 and a new PSR to further improve fraud prevention, standardise APIs, and strengthen open banking.
