PSD II, Adaptive Authentication, and Multi-Factor Authentication

The upcoming updated Payment Services Directive (PSD II) will, among other changes, request Multi-Factor Authentication (MFA) for all payments above 10€ which aren’t done electronically. This is only one major change PSD II brings (another major change are the mandatory open APIs), but one that is heavily discussed and criticized, e.g. by software vendors, by credit card companies such as VISA, and others.

It is interesting to look at the published material. The major point is that it only talks about MFA, without going into specifics. The regulators also point out clearly that an authentication based on one factor in combination with Risk-Based Authentication (RBA) is not sufficient. RBA analyzes the transactions, identifies risk based on, e.g., the amount, the geolocation of the IP address, and other factors, and requests a second means or factor if the risk rating is above a threshold.

That leads to several questions. One question is what level of MFA is required. Another is what this means for Adaptive Authentication (AA) and RBA in general. The third question is whether and how this will affect credit card payments or services such as PayPal, that commonly still rely on one factor for authentication.

First, let me clarify some terms. MFA stands for Multi Factor Authentication, i.e. all approaches involving more than one factor. The most common variant is Two Factor Authentication (2FA), i.e. the use of two factors. There are three factors: Knowledge, Possession, Biometrics – or “what you know”, “what you have”, “what you are”. For each factor, there might be various “means”, e.g. username and password for knowledge, a hard token or a phone for possession, fingerprint and iris for biometrics.

RBA defines authentication that, as described beforehand, analyzes the risk involved in authentication and subsequent interaction and transactions and might request additional authentication steps depending on the risk rating.

Adaptive Authentication, on the other hand, is a combination of what sometimes is called “versatile” authentication with RBA. It combines the ability to use various means (and factors) for authentication in a flexible way. In that sense, it is adaptive to the authenticator that someone has. The other aspect of adaptiveness is RBA, i.e. adapting the required level of authentication to the risk. AA can be MFA, but it also – with low risk – can be One Factor Authentication (1FA).

Based on these definitions, it becomes clear that the statement “PSD II does not allow AA” is wrong. It also is wrong that “PSD II permits RBA”. The point simply is: Using AA (i.e. flexible authenticators plus RBA) or RBA without versatility is only in compliance with the PSD II requirements if at least two factors for authentication (2FA) are used.

And to put it more clearly: AA, i.e. versatility plus RBA, absolutely makes sense in the context of PSD II – to fulfill the regulatory requirements of MFA in a way that adapts to the customer and to mitigate risks beyond the baseline MFA requirement of PSD II.

MFA by itself is not necessarily secure. You can use a four-digit PIN together with the device ID of a smartphone and end up with 2FA – there is knowledge (PIN) and possession (a device assigned to you). Obviously, this is not very secure, but it is MFA. Thus, there should be (and most likely will be) additional requirements that lead to a certain minimum level of MFA for PSD II.

For providers, following a consequent AA path makes sense. Flexible use of authenticators to support what customers prefer and already have helps increase convenience and reduce cost for deploying authenticators and subsequent logistics – and it will help in keeping retention rates high. RBA as part of AA also helps to further mitigate risks, beyond a 2FA, whatever the authentication might look like.

The art in the context of PSD II will be to balance customer convenience, authentication cost, and risk. There is a lot of room for doing so, particularly with the uptake in biometrics and standards such as the FIDO Alliance standards which will help payment providers in finding that balance. Anyway, payment providers must rethink their authentication strategies now, to meet the changing requirements imposed by PSD II.

While this might be simple and straightforward for some, others will struggle. Credit card companies are more challenged, particularly in countries such as Germany where the PIN of credit cards is rarely used. However, the combination of a PIN with a credit card works for payments – if the possession of the credit card is proven, e.g. at a POS (Point of Sale) terminal. For online transactions, things become more complicated due to the lack of proof of the credit card. Even common approaches such as entering the credit card number, the security number from the back of the card (CVV, Card Verification Number), and the PIN will not help, because all could be means of knowledge – I know my credit card number, my CVV, and my PIN, and even the bank account number that sometimes is used in RBA by credit card processors. Moving to MFA here is a challenge that isn’t easy to solve.

The time is fast approaching for all payment providers to define an authentication strategy that complies with the PSD II requirements of MFA, as fuzzy as these still are. Better definitions will help, but it is obvious that there will be changes. One element that is a must is moving towards Adaptive Authentication, to support various means and factors in a way that is secure, compliant, and convenient for the customer.

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