Open banking leads the way in reducing Bacs risk
By Liz Carroll, Senior Product Manager, Financial Marketplaces at Finastra
The Bacs scheme is experiencing ongoing growth. More than 1.7 billion Bacs payments were made during Q4 2023 with the corresponding value amounting to £1,418 billion. Direct Debits accounted for 71% of the volume and 26% of the value. Direct Debit gives payers a hands-off way to process their regular payments, while giving corporates an affordable and efficient way to control their collection cycle.
While the Direct Debit scheme manages an impressive volume of payments, there are some challenges. One of these being ensuring a successful first payment. A significant number of first payments fail, either because the Direct Debit Instruction is rejected, preventing the corporate from attempting to collect the payment, or because the first payment itself is rejected by the payer’s bank.
Additionally, there is a delay between signing up a new customer and the corporate collecting the first payment because of the Direct Debit notification rules and the length of the Bacs processing cycle. Corporates also have to contend with indemnity claims, which are more frequent with the first payment. But, thanks to open banking, there is a way to mitigate some of these risks.
What role does open banking play?
Open banking enables banks, third parties and technical providers to exchange data simply and securely. The functionality available includes downloading banking statement data to aid reconciliation, as well as facilitating both inbound and outbound payments. Although not a replacement for Direct Debits, open banking provides a route for corporates to make ad hoc payments as well as receive payments from their customers. Using these methods, open banking can be used to reduce Direct Debit risks by taking the first payment immediately, and in doing so checking the payer bank details have been correctly captured in real time. There’s also the option of performing a ‘penny test’ first for customers reluctant to make the first payment in this way.
Utilising open banking in the first payment
When a customer makes their first payment using open banking, they select their bank from a dropdown on the corporate website and are redirected to their bank where they follow their online banking login process. They choose the bank account for the payment, authorise the payment and are then returned to the corporate website. The bank sort code and account number from the open banking payment can then be used to pre-populate the Direct Debit mandate for the payer to submit, ensuring accurate details and successful lodging.
Open banking enables banks, third parties and technical providers to exchange data simply and securely.
The corporate benefits by receiving the first payment immediately without waiting for the Direct Debit process or incurring card processing fees. For customers, it’s easier as they don’t need to enter credit card or bank account details, using their usual online banking login instead. However, some customers may be hesitant to use open banking since it’s a newer method. Additionally, the payment isn’t protected by the Direct Debit guarantee or card payment protection, but this may be acceptable since it’s only part of the overall payment.
Performing a penny test
The penny test gives corporates another option to reduce their risk by checking the bank details a customer has entered. Once the customer completes the Direct Debit mandate and submits it, the corporate then uses open banking to automatically send a penny transaction with a unique reference to the bank account entered by the customer. The customer logs onto their online banking portal to view the transaction. They enter the reference number from the transaction into the field waiting on the corporate’s website or quote it to the call center handler; this confirms to the corporate that the bank details used were correct and they can lodge the Direct Debit mandate.
While this doesn’t reduce the time for the first collection to reach the corporate, it will reduce the number of rejected Direct Debit Instructions and failed first payments, as well as decreasing the likelihood of indemnity claims. The penny test can be used when making the first payment to a new beneficiary too, ensuring that the account the corporate is sending the payment to is correct before the bulk of the payment is made.
Reducing risk with open banking
Open banking adds an extra layer of functionality to traditional Direct Debit methods. This includes instant verification of account details, ensuring the account exists and is active. This allows corporates to reduce the risk of financial loss. It also helps save costs for the corporate as fewer failed payments means fewer customers to contact; this can be a time-consuming process and some customers may decide to cancel at this point. Collecting missed payments by card can also incur higher fees than collecting by Bacs.
While there are shortcomings with the Bacs Direct Debit scheme, open banking has significant potential to help mitigate risk in this space, enabling immediate confirmation of bank details, reducing fraud and enhancing the customer experience by making the sign-up process smoother and faster.