In this thought piece Nick Raper at Nuapay asks how can Open Banking make Direct Debits more secure?
As well told in a previous blog by Mike here, Direct Debits first emerged back in 1968, when a Unilever employee invented a solution to the problem of collecting variable payments from thousands of ice-cream sellers. The employee, Alastair Hanton, did this by obtaining authorisation to retrieve the money directly from the vendors’ bank accounts, as opposed to waiting for cheques to arrive or relying on standing orders.
Here in 2021, Direct Debit has long been established as a hassle free and frictionless way of making recurring payments for both merchants and consumers alike. In fact, throughout 2020, nine in ten UK customers used Direct Debits, with £1,178 billion being collected across 4.5 billion transactions.
Despite being an efficient way to collect regular payments, challenges remain. This is particularly the case with the first payment from a new payer, where it may take up to 2 weeks for a merchant to receive the funds from the initial payment. They see a significant number of failed first payments too, caused by a variety of factors.
First, due to the Bacs processing cycles, there is a significant delay between when a payer first signs a Direct Debit, and when the merchant actually receives the cleared funds from their payment service provider. This is due to the fact that the merchant must first submit the Direct Debit Instruction (DDI) to Bacs (which takes 2-3 days), before being able to process for payments (another 2-4 day cycle). First payments typically take at least 7 working days to clear in a merchant’s account – sometimes even longer, depending on the payment cycles.
Second, Direct Debits see a significant number of first transactions reversed, for a variety of reasons, including payers having insufficient funds or the account details being given by the payer being incorrect. These reversals then take additional time to filter back to the merchant. In the UK, Direct Debits clear the credit on the beneficiary account and debit on the sending account as separate processes. So, where the sending account rejects the debit, for example due to a lack of funds, the credit on the beneficiary account then has to be reversed. This creates a processing and reconciliation problem for the beneficiaries, and in some cases can pose a credit risk if they’ve already delivered part of the service or goods.
Thirdly, while only a very small portion of Bacs transactions end up triggering an indemnity claim (<0.5%), indemnity claims are typically higher on the first transaction. This is where payers using fraudulent details getting caught out, or those suffering “buyer’s regret” will stop the service, and most indemnity claims will come in within the first 1-2 months of a Direct Debit being established. Again, this is an inconvenience for merchants as it forces them to go and chase payment through another method.
From the perspective of the payers there are also some challenges. While there are strong and clear rules around merchant notifications, one issue is ensuring visibility of Direct Debits, as these can create issues if payers have insufficient funds in their bank accounts. Sometimes banks will send accounts into their overdraft to pay a Direct Debit, whilst on other occasions the transaction will not go through, resulting in a rejected merchant. Whilst banks are now doing more to help give consumers visibility of upcoming Direct Debits (you are more likely to now see ‘pending’ Direct Debit in your list of transactions), when payments they hadn’t fully budgeted for are processed, this normally results in a poor experience for the consumers.
When open banking first emerged in the payments space, some suggested that it was a potential threat to Direct Debits. To date, however, open banking has not yet delivered a workable variable recurring solution which could completely replace Direct Debits, and it will take a reasonable amount of time before this is a reality. In the interim, though, there is an opportunity for open banking to work alongside Direct Debits to create a more secure and efficient payment method for consumers and merchants alike.
One primary way open banking can add value is to use open banking payments to improve the Direct Debit sign-up process for payers. Nuapay, for example, has developed an online Direct Debit Instruction (DDI) service that allows payers to complete an open banking journey, authorise the transaction in their mobile banking app, and then pre-populate their account information into the DDI for future payments. The Direct Debit is then confirmed and future recurring payments are set up in compliance with the Direct Debit scheme.
Signing DDIs in this way has multiple benefits for payers and merchants alike. It makes it simpler for customers, due to them not needing to enter any account details. It also reduces the risk for the merchant. This is due to account details having been authenticated directly with the payer’s bank using Strong Customer Authentication (SCA), thereby eliminating the potential for fraud because the payer doesn’t own the bank account, or the bank details are incorrect. Payers are also less likely to make an indemnity claim down the track, as the merchant has stronger evidence of account ownership.
Additionally, some merchants, such as insurance companies, take on significant risk in waiting 7-10 days for the first payment. When the initial payment is made via an open banking bank transfer, it means the merchant receives the payment up front in real-time. This provides cash flow benefits (especially important in the current financial environment) as well as eliminating the risk of a reversal on the first payment, which may see the merchant having provided the service but unable to be paid for it.
Another way to improve the Direct Debit experience with open banking is on the payer side. Today, with open banking, customers can share their account data and information with collectors, who can then monitor customer account balances and optimise if (or when) they collect a Direct Debit payment. Using open banking, a merchant may see that a customer hasn’t yet been paid or has insufficient funds, and then ask the customer if they want to delay or reduce the payment – avoiding the risk of a reversal. While a consumer is unlikely to give access to their account to their local gym or mobile provider, they may be likely to in other sectors (such as credit or mobile wallet providers) where the customer may have other reasons for linking their accounts.
In summary, there is a strong case to be made for using open banking functionality to make Direct Debit transactions more secure. Payment fraud costs businesses and individuals in the UK £1.26 billion each year, therefore improving payment security for businesses is a prominent issue. There are also improvements currently in the pipeline for Direct Debits, including the New Payments Architecture, Request To Pay, and Confirmation of Payee (which will soon become available across more services). Open banking and Direct Debits’ combined functionality are proven to deliver huge benefits to customers and merchants alike, and are available here and now in the UK. Ultimately, Direct Debits can continue to benefit both merchants and consumers – while being bolstered by the security, as well as the speed and convenience that open banking provides.
This guest blog was written by Nick Raper who is a Director at Nuapay UK
As Director of Nuapay UK, Nick oversees the sales, marketing and product teams and is responsible for spearheading the company’s growth particularly within the Open Banking space. Prior to joining Nuapay, Nick was the Principal at A.T. Kearney’s London office. Working globally, he led projects predominantly across the financial services and energy sectors. This was following his tenure as Strategy Director for American Express’ international business.