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Explainer: direct debit versus open banking payments

We take a look at the specifics of what a direct debit payment is, what an open banking payment is, and where they intersect.

Direct Debit versus open banking payments

Before diving into this discussion, it is important to remember that direct debits are primarily used for recurring payments such as subscriptions, whereas open banking payments have wider use cases spanning one-off as well as recurring payments. Therefore, while the points below are not always a direct 1-1 comparison, they should help you understand key differences, and think about what may be best for your specific situation.

About open banking payments

Open Banking is a secure way for consumers to enable merchants or service providers to authorise a payment directly from their bank account, usually via a third party such as Yolt. With open banking payments, your customers can instantly and securely transfer money between their accounts and make online purchases - all from within your app or website.

A key thing that distinguishes open banking payments from cards or wallets is that there are no intermediaries such as card schemes or wallet providers involved in the transaction – funds are directly from the payer's bank to a merchant or service provider's bank. And because customers need to authenticate payments within their banking app, it is as close as you can get to a fraud-free payment method.

You can read more about the advantages of open banking payments here: Eight advantages of open banking payments for any business

About direct debit

Direct debit is an automated way to collect recurring, variable payments, and - like open banking payments – is a type of account-to-account (A2A) payment that does not involve any other intermediaries. It is a ‘pull-based’ system, enabling a merchant to trigger and stay in control of recurring payment collection.

In the EU, SEPA Direct Debit is a Europe-wide Direct Debit system that allows merchants to collect Euro-denominated payments from accounts in the 36 SEPA countries and territories. In the UK, Bacs Payment Schemes Limited is the organisation with responsibility for the Direct Debit scheme.

Direct debit payments take a few days to clear (typically five days in the UK and three in the SEPA). As mentioned above, the key direct debit use case is for certain types of recurring payments such as subscriptions, since, once set up, payments are automatic, making life easy for the customer and revenue predictable for the merchant.

Similarities between direct debit and open banking payments

Since there are no intermediaries that need to take a fee from a transaction, both direct debit and open banking payments are considerably cheaper than comparable payment methods such as cards or wallets.

Likewise, both direct debit and open banking payments offer a seamless payment experience to customers. With open banking payments, the customer authenticates a payment in their trusted bank environment, quickly and securely, and recurring payments for utility bills and subscriptions can be initiated automatically. Subscriptions with direct debits are automatic – ensuring simplicity for the customer – although a mandate does need to be set up first.

Advantages of open banking payments

However, there are some areas where the two payment methods do differ.

1. Open banking settlement is faster

Since open banking payments leverage Faster Payments (part of Pay.uk, which is the company behind Bacs payments and cheques), and SEPA Credit Transfer, funds are often received instantly. As mentioned above, settlement for direct debit is a matter of days. For businesses that want faster cashflow, such as some types of ecommerce subscription businesses, this can be an important consideration.

2. Chargeback risk is lower

SEPA Core Direct Debit no-questions-asked refund policy makes chargebacks easy in the initial eight weeks following the payment. And in the UK, all banks and building societies who offer direct debits as an option must sign up for the Direct Debit guarantee. This means that banks, building societies and all other payment providers will refund any disputed payments immediately and with no questions. If chargebacks are an issue for your business, you may be interested in looking at open banking payments as an alternative to direct debit.

3. You can reduce time chasing debt by creating more convenient ways for customers to pay

For businesses such as utilities and lenders, open banking payments means you can improve conversion by offering automated recurring payments, or – if they miss a payment – following up with a QR code or text message that redirects your customer directly to their in-app bank environment.

The improved conversion reduces debt recovery costs. But there’s more. With Account Information Services, you can also offer them the right product based on their financial profile, identify which days of the month your customers are most likely to have their account balances topped up, and bill them in the 24-hour period after that. This should in turn further increase your payment conversion, reduce the costs of debt recovery, lower the cost of doing business, and so on. The pairing of account information with payments is something unique to open banking, that neither direct debit nor any other payment method can offer.

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