Due to the pressure of the cost of living, the demand for consumer credit is expected to increase across Europe. According to EY, loan rates should grow by 7.9% in 2022 and 5.5% in 2023 in the United Kingdom.
But there is a catch. Current methods of loan repayment, such as direct debits, have significant flaws.
“When you think about loan repayment, the current payment systems that businesses use are mostly unsuitable for business,” says Matt Parish, product manager at open banking provider TrueLayer. “Direct debits are used by many lenders but ultimately it’s a paper system that has just been modernized. New tech companies find it clumsy and slow.
Is there a solution? We asked the experts to explain the challenges we face in loan repayment, how new technologies can help, and what barriers we will need to overcome for adoption.
The problem of loan repayments
First, a little background. Borrowing is up in the UK due to difficult economic conditions, says Radhika Patel, product manager at TrueLayer. This increase is accompanied by an increase in the number of consumers missing refunds.
“Think about payment failures – it’s really problematic for understanding cash flow”
According to Patel, the reasons are many, ranging from simply forgetting to set up an automatic payment to having insufficient funds in an account. Overall, repayment issues usually boil down to one thing: a lack of flexibility.
Currently, the most common methods of reimbursement in the UK are direct debits and standing orders. According to UKFinance, direct debits are used by nine out of ten UK consumers to pay all or part of their bills. In 2020, 4.5 billion payments were made by direct debit, with an overall value of £1.178 billion.
But direct debits take three days to process, which can lead to issues for businesses over cash flow and chasing failed payments. Payment dates are also fixed, which creates problems for businesses that might have a slow time in the year, and direct debits can be expensive to process, especially for small businesses.
“Think about payment failures,” Parish says. “You’ll be notified of a successful direct debit payment, and then a few days later a vendor will turn around and say, well, that specific payment didn’t happen – that’s really problematic for understanding cash flow. ”
Enter Variable Recurring Payments (VRP)
For Parish and Patel, one solution is Variable Recurring Payments (VRP), an open banking technology. But what are they and why are they so important to businesses collecting payments online?
In July 2021, the UK Competition and Markets Authority (CMA) ordered the UK’s nine largest banks to implement variable recurring payment APIs that allow customers to automatically transfer (or swipe) money between their accounts. But another key concept of VRPs is that they can be used to repay loans with greater flexibility.
“Think of them as a kind of instant pick-up”
How it works? The short answer is, just like other open banking products. A customer informs their bank that they want to give a third-party provider access to their banking information – VRPs are basically a type of payment instruction – and that service provider can then help the customer make payments based on that. of its parameters.
“Think of them as a kind of instant direct debit,” says Parish.
Alan Ainsworth, director of policy and strategy at the Open Banking Implementation Entity (OBIE), which provided recommendations to the CMA for the implementation of VRPs, believes that the new method of loan payment will offer benefits to lenders, consumers and small businesses.
“VRPs automatically transfer excess money from a checking account to a credit card, overdraft or loan account,” he says. “They can also help customers pay off debt before incurring repayment fees, and keep their borrowing costs to a minimum by automatically transferring excess funds to help reduce their borrowing faster.
“For lenders, the benefits include reduced customer harm, the volume of bad debt on their books, and the administrative costs associated with collecting it.”
“A form of intelligent direct debit”
Like TrueLayer, the OBIE sees VRPs as “a form of smart direct debit” that allows customers to take control of their finances by offering more flexible and transparent means of payment.
Ainsworth says features like swiping to help users build a savings pot will help build financial resilience across the board. He also says that VRPs could help companies pay their taxes, for example by collecting corporation tax and VAT when paying an invoice.
TrueLayer launched its own VRP solution in April 2022. Benefits include real-time settlement, reduced transaction costs, no chargebacks for merchants (thanks to VRP customer protection), and easier payment for customers. VRP payments feature strong customer authentication (SCA), which may involve biometric data such as fingerprint and facial recognition scans. This greatly reduces the risk of fraud as it authenticates payments directly to the customer’s bank and eliminates the need to store sensitive data.
The path to VRP adoption
To date, the CMA has mandated VRPs for three major use cases: scanning to repay a loan in competition with an overdraft; swipe to a checking account or substitute checking account; and swipe to a savings account.
But VRPs can be used for a number of non-scanning use cases. These include paying for fixed subscriptions like a mobile phone bill, a variable subscription like gas and electricity, or even more bespoke use cases like ad-hoc one-click purchase scenarios.
“If you are a bank reading this you are probably already having conversations about the possibility of entering into a commercial VRP contract, my advice is to hurry and do it.
Parish says that while these three use cases cover most of the financial services industry – including all credit card repayments, nearly all loan repayments, all current accounts (like Monzo and Revolut, which are already studying technology) and most savings accounts – more can be done. He says the industry will need to go beyond the current parameters to achieve full coverage.
Parish expects VRPs to quickly prove their worth and it won’t take long for institutions to catch on.
“If you’re a bank reading this, you’re probably already having conversations about the possibility of entering into a commercial VRP contract,” he says. “My advice is to hurry up and do it. If you are a regulator, I would say, hurry up and force the banks to do this. We can build that and get it out.
TrueLayer, global open banking platform for payments and data