The death of direct debit?

Is it time to get over our love of direct debit?

The payments landscape has undergone, and is still undergoing, seismic change. In 2018, we’ve seen the launch of the new Payments Services Directive (PSD2) and Open Banking, which promises a brighter future where customers can share data with approved third parties in order to help make payments and money management easier.

A much earlier innovation in the payment’s world came in the 1960s with the invention of direct debit. For several decades, direct debit has been the most popular method of collecting bank-to-bank transfers in the UK, and today, nine out of ten people in the UK with a bank account have at least one direct debit. To learn about the history and growth of direct debit, check out this insightful article, courtesy of GoCardless.

Flywire has seen direct debit prove to be a particularly popular payment method in the UK Higher Education market as it is a convenient means for students and their families who are paying their tuition and accommodation fees from a UK bank account.

Universities receiving payments via direct debit typically value the cost of receiving a payment, which is lower than recurring card payments, and the reduction in the staffing resources who manually chase when payments are due, by utilising a “set it and forget it” functionality.

However, some of the conveniences of direct debit pulling funds from a student’s account can lead to challenges for both the payer and the receiving education institution.

• Payments can take up to five days to clear under Bacs Payment Schemes Limited, making it unsuitable for immediate payments such as buying graduation tickets or course materials. It is also not suited to payments that have tight deadlines, such as the payment of a deposit that is required to secure a place at university.
• If a university wants to change the amount or date of the direct debit mandate, they typically need to notify the payer ten days in advance.
• Direct debit does not cope well with a scenario where a student has forgotten about the upcoming payment date and has insufficient funds in their account. This can lead to the payment failing or prove costly to the payer as their bank may charge hefty extra fees for going into their overdraft.
• Several universities have referenced that direct debit failure rates can be anywhere from 20–40% over recent years.
• The Direct Debit Guarantee means customers are entitled to refunds when payments are taken in error, or fraudulently. Fraudsters can take advantage of this by re-calling a payment six months after a study course has been completed.
• The payer is ultimately in control and can cancel the direct debit at any point. Universities would not have immediate visibility of a direct debit being cancelled.
• Direct debit schemes are globally fragmented (Bacs in UK, SEPA in the EUR region) and a university or any business wanting to provide a recurring bank-to-bank transfer for international students would have to forge a local banking relationship in each region.

Is Open Banking the answer?

Open banking may solve some of the issues universities and students encounter whilst also providing the benefits that come with direct debit. Until recently, banks have been the sole owners of financial data like account balance and payment history. Open Banking is designed to democratise the payments industry, with payment providers and other smaller organisations being able to apply to be Account Information Service Providers and Payment Initiation Service Providers. These approved organisations will be able to access financial data and set up account-to-account payment systems.

Benefits from Open Banking include:

• Immediate payments. PISPs trigger instant ‘push’ payments from a student bank account to a university when authorised.
• Reduced cost. Open Banking will carry much lower processing fees than credit and debit cards.
• Reduced failure rates. Push payments would only allow the credit on the university account if the debit is successful, thus reducing credit risk and ensuring there are sufficient funds in the student’s account. This would significantly decrease the failure rates experienced by direct debit.
• Greater security for payers. New mandates could be authenticated through payer’s online banking account, making fraudulent payments much harder to commit.

Direct debit and the “push” vs. “pull” models

While on the surface, it may look like direct debit is at risk due to the advances in Open Banking, there are important factors to consider—namely the “push” vs “pull” models.

The architecture created under Open Banking to support these changes flips the payment authorisation model used by direct debit, turning “pull” authorisation to “pushes” by consumers. At present, the initial push payments would require a customer to authorise the first payment, along with any future changes to the original amount, therefore negating some of the convenience of the “set it and forget it” direct debit.

The infrastructure now exists, in theory, for providers to use the Open Banking architecture that has been opened up by PSD2 in order to replace the direct debit process. Open Banking brings many benefits but could further reduce friction if there were some form of agreed mandate by the payer—such as a continuous payment authority used under recurring card payments. This is an exciting space to watch and whilst we don’t see the death of direct debit anytime soon, it will certainly lead to a change in behaviour for some payments. I cannot see Open Banking change how I pay my council tax, but I can see it altering the way organisations manage larger, less frequent payments over a set period of time such as collecting tuition fee and accommodation payments.