Most retailers accept card payments, but, while convenient for the consumer, it can be costly for the merchant. From interchange fees to the risk of chargebacks due to fraud, many merchants are having to shoulder the financial burden of offering card payments to their customers when Open Banking payments can be just as convenient as cards, and potentially far more cost effective.
When paying by card, and therefore using card scheme rails, there are three components of the cost that must be paid by the merchant:
- Interchange – to help cover the cost of the card issuer operating their business for their customers including their technology, lending money, defaults, and the operation of any rewards schemes.
- Scheme fees – to cover the cost of maintaining the scheme network infrastructure and the promotion of the card brands.
- Acquirer fees – to pay for the operation of the acquiring business and cover the financial risk of merchants going bust before they deliver goods to consumers.
The traditional card schemes have developed their technology and operations over the years, to the point where they now run very efficiently, very securely and offer a highly robust system that benefits both merchants and consumers. Most merchants will say that they are very happy with the way they work – they just think they are too expensive. The risk-sharing element of the schemes is also very well developed, and some of those fees do go to fund risk, which is inherent throughout the system due to the delays in collecting and settling funds, and delays to delivering goods after they are paid for.
Unlike traditional card payments, Open Banking doesn’t use card rails; when used on a mobile phone, the app on which the consumer is shopping gives them the option to “pay by bank” and automatically takes them to their banking app. The consumer then authenticates access to the banking app through the security method they’ve put in place, such as facial recognition, authorises the pre-populated transaction details, and then payment is complete. The money is taken out of the consumer’s bank account via Faster Payments, and received instantly by the merchant. When executed correctly, it is a completely seamless experience and one of the easiest payment methods via phone.
And because it doesn’t use the card rails, it doesn’t incur the same fees for the merchant. As it is authenticated directly between banks and consumers, the settlement and fraud risk is mitigated, giving merchants more confidence.
When paying by Open Banking, there are two key cost components for the merchant – fees to the Payment Initiation Service Provider (the Open Banking equivalent of the merchant acquirer) to cover the cost of initiating the transaction and switching it to Faster Payments, and whatever the merchant’s bank charges them to receive a faster payment.
Charging models for Open Banking payments are still being developed as the market matures, and the charges that a bank imposes for receiving a Faster Payment also vary – but let’s assume that each are 15p which seems like the current market average. This means that the total cost to a merchant would be 30p. The costs of accepting cards are a percentage of the value of the transaction, so clearly there will be a breakeven point when Open Banking payments become cheaper – at the moment this is around £67 for a debit card transaction and £30 for a credit card transaction. In other words, because accepting a debit card is already quite cheap, the transaction has to be above £67 for Open Banking to be cheaper. Credit cards are more expensive, so the breakeven point is lower.
But what if the bank’s charge to receive a Faster Payment was taken away? What if a payment provider offered to aggregate all those individual payments, and settle them all at once so that the merchant only paid this once instead of on every single payment? Then the costs are halved, and the breakeven point plummets to £29 for a debit card and £13 for a credit card. With the average card transaction in the UK sitting at £30, Open Banking payments make sense.
And this is where it gets really exciting because this was always the promise of Open Banking – that it would introduce new propositions, more competition, and more options for consumers and small businesses.
Of course, it’s not all a bed of roses. This solution puts settlement risk back into the system, and – as is often commented upon – there isn’t yet a well-proven refund path for consumers, so this payment is better for buying things for instant delivery. Although conversely, it also only really works online and not at point of sale yet.
But with a payment method that is demonstrably cheaper than cards, and works so well on a mobile phone, there has to be potential to develop this in a host of new and exciting ways.
The threat to progress is – as always – that there are winners and losers compared to the status quo. Making a retail payment through Open Banking changes the structural money flows associated with payments. It takes the fees away from banks issuing cards to consumers, eliminates scheme fees from the card schemes, but creates new potential income streams for the banks focused on business banking who receive the payments.
Given that Open Banking will reduce fees to the bank initiating transaction (usually a consumer bank), but still provide fees to the bank receiving the transaction via the payment receipt fee (usually a business bank). It’s likely that consumer banks may lose, but business banks will win from wide scale adoption of Open Banking payments.
The profit pool for merchant acquirers is broadly unaffected so we do expect to see those businesses creating new Open Banking payments propositions for their business customers. However, there is a threat to merchant acquirers (as well as the schemes) in that their very expensive infrastructure has been built to manage real-time authorisations and then apply complex pricing rules to card payments – both of which are redundant in a world of Open Banking payments.
The tide is turning, and it’s not a question as to whether banks and merchants should be considering offering Open Banking payment services to customers, but more a question of where and how they can operate in this ecosystem, and how the industry can offer solutions to drive adoption.