Unlocking Open Banking – is VRP the key to profitability?

Open Banking services are taking off world-wide. But questions remain about how some players – especially banks – can make money out of this new era. As Variable Recurring Payments (VRP) come on stream this year, we can expect Open Banking to accelerate.

Exclusive Payments Cards & Mobile research for a private client reveals that Open Banking implementations are soaring in some European countries.

From the UK to the Nordics and Baltics, we’re starting to see solutions in-market and consumer adoption rise. As we’ll see, though, this take-up is far from uniform across the continent.

On the other side of the world, China is perhaps the world’s leading Open Banking market, with government-backed digital ID enabling the secure and rapid development of everything from credit-scoring and micro-lending as Open Banking services.

Elsewhere, the United States has begun to see some regulatory movement, with the Consumer Financial Protection Bureau (CFPB) set to bring forward guidance on Open Banking later this year.

Show me the money

For all this promise, questions about how fast Open Banking is being implemented – and how to make money out of Open Banking – remain.

That’s especially the case for banks: after all, the first Open Banking mandate in Western Europe was created by the UK’s Competition and Markets Authority (CMA) to force banks to share their data and customer channels with other players.

In brief, what’s in Open Banking for banks themselves? And how can banks take advantage of Open Banking to enhance their profitability?

“Banks may have fended off new entrants with instant payments, but as yet they’ve not developed new revenue streams through Open Banking.”

The business case for fintechs providing innovative services is clear enough: ink a deal with an established retail bank to integrate your service to their retail banking app or portal, and as long as the service is good enough, you should see the revenues roll in.

For banks, the case is less clear.

Take Instant Payments – while banks in the UK, Nordics, Baltics and Netherlands all now offer instant payments, they’ve been able to do this thanks to system-wide initiatives or collaborations such as iDEAL in the Netherlands or Faster Payments in the UK.

Furthermore, systems like Vipps in Norway, Swish in Sweden and others have been effective in fending off competition from Non-Bank Financial Services players like Zimpler and Trustly that offer account-to-account payments.

If banks have so far protected their positions, then they have not – as yet – actually developed too many meaningful or ground-breaking propositions related to Open Banking.

Your speed may vary

All that might be about to change, however, with the introduction of Variable Recurring Payments (VRP) over the next eighteen months.

VRPs permit consumers to authorise third parties to initiate payments from their bank account on an ongoing basis.

Under the provisions of PSD2, Payment Initiation Service Providers (PISPs) can initiate payments from a customer’s bank account on their behalf.

This effectively opens up an entirely new payment distinct from traditional card schemes and acquirers, with money flowing from a customer’s account to a recipient in a process known as a Single Immediate Payment, or SIP.

The particular significance of SIPs – and all VRP payments – is that there’s no need to seek repeated consumer authentication or permission to enable the payment.

That’s also the case with other forms of VRP such as “sweeping” payments, in which (for instance) any money left in a current account at the end of a period could be “swept” automatically into a savings or investment product with a third-party provider.

VRPs also enable any organisation using subscription or repeat payments of any kind, from charities to sports clubs and more, to take payment directly from a consumer’s account.

By using a VRP, payees avoid interchange fees, benefit from vastly improved settlement times and faster flow of funds.

“Zion Market Research estimate that three-quarters of consumers are paying subscriptions that could become VRPs.”

Zion Market Research put this market at £6 billion in the UK alone this year, and estimate that three-quarters of consumers currently pay for subscription services that could become VRPs.

The UK blazes a VRP trail

As the first market in Western Europe to kick off Open Banking back in 2016, the UK has been one of its most enthusiastic adopters.

Despite this enthusiasm, just 15 percent of UK consumers had used an Open Banking service by the end of 2022, according to Forrester Research – and there were a mere 71 million Open Banking payments out of a total of 20 billion payments overall last year.

However, Forrester expect the number of consumers using Open Banking services to almost treble over the next five years – and see the volume of Open Banking payments as rising by 87 percent year-on-year to hit 1.6 billion payments or almost one in ten of all electronic payments by 2027.

“Use of Open Banking in the UK will treble by 2027 – powered by VRPs”

As things stand, consumers are using Open Banking payments to pay down debts (for instance, with Buy-Now-Pay-Later providers, credit cards and more), to initiate e-commerce payments, pay their tax bills or fund digital wallets.

These services have fostered growth to date in Open Banking. In mid-2022, however, the CMA mandated banks to enable the first form of VRPs – the “sweeping” payments described above which permit consumers to move money between their accounts with different providers instantaneously and without permissioning the transaction.

As a result, all major UK banks now offer APIs that allow third parties to integrate “sweeping” services for their customers.

Looking ahead, it’s likely that further commercial use cases will fuel growth in VRPs in the UK and elsewhere.

Specifically, consumers will be able to use VRPs to fulfil a range of cases which are currently dealt with by card payments – and they’ll be able to do so without using passwords, usernames and repeated permissions or authentications.

From the merchant’s point of view, the attractions are immediate settlement – and the ability to bypass acquirer fees and/or interchange.

Take e-commerce, for instance: rather than hold a card on file, consumers will be able to permit one-click payments to a marketplace or online retailer direct from their bank accounts.

Likewise, utility bills, charitable donations and mobile phone top-ups can all be executed with a single click directly from the consumer’s bank account.

What happens next

VRPs may be about to set UK Open Banking alight – but there are hurdles to overcome.

For instance, VRPs will enable the potential for much higher e-commerce payments direct from account compared to existing PSD2/SCA guidelines.

Keeping these payments safe means having better transaction risk indicators and warnings in place – as well as more consistent payment status and error messaging, so that any failed or at-risk payments are identified and managed quickly and effectively.

Finally, banks are going to have to work on their user experience to make sure consumers know how to set up a VRP – and what setting a variable amount to be paid monthly or quarterly means for their finances.

“APIs are going to have to handle richer transaction and account information, including digital ID.”

For banks and regulators in the UK and across Europe, one implication is that APIs are going to have to be able to provide richer transaction and account information, include digital ID information for all parties to a transaction, and be capable of managing a broader range of data sets for things like investment or life insurance as Open Banking transitions to Open Finance.

In essence, this means shifting Open APIs from something mandated by regulators to powerful, competitive instruments that enable the transfer of relevant information between organisations with limited or zero friction.

The introduction of VRPs in the UK also poses two wider challenges for the payments business.

The first challenge applies more to some of the UK’s peers in Europe than to Great Britain itself: namely, the fact that some laggard markets are beginning to fall further behind their more advanced peers, and must do more to modernise their banking systems.

The second challenge, more relevant to VRPs, is the question of why a bank would want to cannibalise its own revenue streams by offering VRPs – outside any regulatory compulsion to do so.

Charles Damen, Chief Product Officer at Open Banking payments platform Token, believes the answer to this question lies in an analogy with the music industry.

“If you look at the music business, 20 years ago it derived 100 percent of its revenue from physical performance and physical music formats”, he says. “Last year, 67 percent of its revenues come from digital streaming – and revenues across the music business are at record levels.”

In other words, change doesn’t have to mean threat – it can also mean opportunity.

The music industry has effectively transformed its revenue model to reflect changes in the way people enjoy music.

In the same way, banks must now look to shift their revenue model away from interchange and payment fees to a model – perhaps based on the commissions employed by the investment and insurance industries – that recognises the huge changes in consumer behaviour we’re going to see in the near future.

Open Banking across Europe

As this article makes clear, a divide is opening up in Europe between technologically sophisticated markets in the Nordics, Baltics, the Netherlands and the UK, and other markets on the continent which are lagging behind.

With some sources estimating Open Banking could add as much as three percent to a country’s GDP, some markets should be treating the provisions of PSD2 as an opportunity to be grasped, yet are not doing so.

Round-up of progress in selected European markets

In Germany, the Berlin Group – a consortium of more than 35 banks from across the continent – has agreed the implementation of an Open API standard, NextGenPSD2. The Berlin Group is now moving on to.

In Sweden, merchant payments platform Avarda has worked with Aiia, a Mastercard company, on the development of a payment solution that includes account-to-account payments for consumers plus a real-time balance indicator.

This means payments can be made without login to the user’s bank or passwords following successful login to their site. This solution has now been rolled out across the Nordics.

In Finland, Paytrail has been delivering Open Banking powered payments at e-commerce checkout since 2019. Powered by Aiia’s Open Banking platform, Paytrail enables e-commerce for more than 20,000 merchants and online shoppers, providing greater choice with new payment options and providing a more hassle-free online checkout experience.

Latvia’s Nordigen was acquiired by GoCardless in mid-2022. By incorporating Nordigen’s next-generation Open Banking connectivity, which covers more than 2,400 banks in 31 countries, GoCardless expects to significantly increase the speed of rollout for its open banking-powered offerings, including Variable Recurring Payments in the UK and PayTo in Australia.

“In Europe, sophisticated markets like the UK, Nordics, Baltics and Netherlands are pushing ahead, while others lag behind.”

Despite these successes, other markets such as Portugal and Italy have yet to agree national open API standards and, in the case of Portugal, currently have no domestic Open Banking services operational.

Looking at moves in the Nordics, Netherlands and UK towards Open Banking 2.0 and VRP services, such markets would be wise to get things moving quickly.

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