With new technology and instant bank payment rails, we could be looking at a future where, in the US, paying by bank is as common as paying by debit or credit card. This is already a reality across Europe and many other countries.
Merchants can significantly save on fees by getting their customers to switch from credit cards to pay by bank. For certain use cases, such as bill pay, people are already used to paying by bank but new technology is making the experience better. For use cases like e-commerce and retail shopping, pay by bank is much less common, but recent advances are reducing friction and making it more feasible.
What is pay by bank and how does it work?
Pay by bank refers to a direct payment from a consumer’s bank account to a business’s bank account, without the use of a credit or debit card. While these payments can be for any good or service, they're most often applied to bills, subscriptions, and loan repayments. They should not be confused with account-to-account (A2A) payments. The latter refers to payments to oneself to fund an account or peer-to-peer payments via apps like Venmo.
Pay-by-bank transactions require three steps. The first of these need only be completed once between a customer and a new merchant:
Step 1: Account verification
Also known as authentication, this step verifies the existence of the customer’s account and its ability to send funds. It can be carried out through instant verification APIs such as Plaid Auth, which verifies accounts in seconds. Alternatively, micro-deposits (the sending of small transactions, whose amount customers must then verify) can be used for accounts not connected to APIs or for users who choose not to use an instant method.
Step 2: Fraud and risk checks
Like any payment method, ‘pay by bank’ can be exploited by bad actors, even after the account’s verification has been completed. Companies offering the option should thus perform fraud and risk detection checks. Plaid Signal, for example, is a machine-learning fraud-detection tool that provides a fraud risk score based on over 60 attributes. Its use helps merchants better understand which payments they can trust and allows them to instantly enable bank payments for low-risk transactions.
Step 3: Money movement
The final step is the movement of money between the customer and merchant bank accounts. This is facilitated by a processor over one of three payment rails (more on this below). Organizations can use Plaid Transfer, which offers pay-by-bank functionality on all available rails. Or they can use a payment processing partner like Adyen, which has partnered with Plaid to bring bank payments to a wider public in North America.
As mentioned above, three payment rails exist in the United States to facilitate bank-to-bank payments. Any such transaction will be routed through one of them, depending on the use case.
ACH: The Automated Clearing House (ACH) offers universal coverage for bi-directional bank payments. Standard payments, however, can take hours to days to settle, depending on whether or not Same-Day ACH is used.
RTP: The Clearing House’s Real Time Payments network is an instant payment rail that’s accessible to the majority of banks in the US. It mostly facilitates the sending of payments, as its request-for-payment capabilities have yet to be widely adopted.
FedNow: The newest rail, FedNow, resembles RTP as an instant payment option. It currently only allows for the sending of payments, with request-for-payment functionality on the horizon.
The benefits of pay by bank vs. credit cards
Merchants whose customers use bank payments can enjoy several benefits, including:
Lower fees: Cost reduction is the main benefit of 'pay by bank'. In the US, merchants must pay around 3% in fees for every credit card transaction. When considered at scale, this number is massive. Some large enterprises pay billions of dollars in credit card fees per year.
More durable recurring payments: Unlike credit cards, bank accounts don’t expire. For bill payments and subscription services, this can reduce payment churn. But even ecommerce and retail apps can enjoy a more durable stored payment option.
More insights and flexibility: Credit cards handle all their payment services in-house. Bank payment rails like ACH leave greater room for optimization than card networks since merchants set up their own processes for authentication, authorization, and payment disputes. In addition, ACH return codes give merchants more insights into declined payments. At the same time, 'pay by bank' can act as a digital alternative to cash. This is ideal for use cases in which cards might be restrictive.
Are consumers ready to pay with their bank account?
Consumers are already used to making direct bank payments for certain use cases, like paying bills, funding new accounts, and purchasing high-value items. They aren’t as accustomed to doing so for one-time payments at lower price points.
That said, there's a high potential for pay by bank to impact everyday purchases and subscriptions. Internal research carried out by Plaid in late 2022 highlights why it's an attractive choice in certain scenarios:
Ease of use
Pay by bank can offer more convenience than many would imagine. It's often easier, for example, to log in to one's bank account than to enter one's credit card details. About 90% of respondents in Plaid’s research had their bank account credentials memorized or accessible via a stored password manager. For credit cards, that number was only around 30%.
Risk reduction
Pay by bank can mitigate several risks associated with credit card usage. For instance, customers don’t have to worry about missing payments due to an expired card or about acquiring excess debt. Moreover, direct bank payments reduce the chance of missed subscriptions or bills compared to cards.
Rewards and benefits
Reward points and cash-back incentives drive many consumers to use credit cards. This comes at an expense to merchants who, as mentioned above, pay around 3% in card transaction fees. These fees fund the incentive programs offered by card companies.
Merchants can do the same: By incentivizing customers to sign up for bank payments, they can achieve significant savings. In turn, they can give a portion of their savings back to pay-by-bank customers in the form of rewards points or discounts.
Gas stations have already caught on. In exchange for bank payments, apps like SmartPay Rewards offer 10 cents off per gallon, free coffee for every 80 gallons, and points toward convenience store items.
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The challenges of pay by bank
Pay-by-bank solutions present some unique challenges. Plaid works hard to address these to further the option’s development as a safe and secure alternative.
User experience
Historically, 'pay by bank' has been synonymous with a poor user experience (UX) requiring multiple steps. Customers had to enter their account and routing numbers—long number sequences that are often not readily at hand.
Instant authentication tools have greatly reduced the UX friction associated with linking bank accounts. Plaid further reduces friction by offering a simple and frictionless UX, particularly through our embedded search flow. This flow creates a more seamless transition to the account connectivity experience required for 'pay by bank'.
Plaid’s internal research revealed that an improved user interface design could lift pay-by-bank selection during a bill pay check-out flow from 39% to 72% (see below).
Fraud and risk factors
Most pay-by-bank transactions happen via the Automated Clearing House (ACH) and are revocable. This creates a potential ACH fraud risk, where fraudsters can make a purchase using information for an account owned by someone else; the owner of the account may then claim that the transaction was unauthorized. A customer-initiated return such as this can take up to 60 days to process. In the meantime, physical goods may have already been shipped and received. There is also the risk of bank-initiated returns, in which a financial institution cancels a transaction due to issues such as account closures or insufficient funds.
Plaid’s Signal product helps predict the likelihood of both these return types. It does so based on factors such as Plaid connection history, account usage, and past ACH events. When Signal deems a transaction to be low-risk, merchants can more confidently accept a bank payment.
Speed and settlement time
Most bank payments use ACH, which has a slower settlement time than credit cards. This can range from hours to days, depending on the form of ACH used (same day or next day) and the time of day submitted.
Other payment rails, including Real Time Payments (RTP) and FedNow, offer instant settlements but have limited coverage and capabilities for requesting payments. In their current forms, these payment rails work well for instant payouts (e.g. when a ride-sharing app instantly pays a driver) but still have a ways to go for requesting instant payments from customers in real time.
So long as that’s the case, merchants can use Plaid Signal to create synthetic instant ACH. In this method, Signal determines if a transaction is low risk. If it is, the merchant can proceed with the transaction as if it were a payment that settled immediately. If it's not, they can choose to re-verify the customer, wait to provide the goods or service to the consumer until the payment settles, or steer them to another payment option.
Incentives can encourage pay-by-bank adoption
To better understand how these types of merchant incentives influence a consumer’s willingness to make a bank payment, Plaid conducted a study of 800 participants representing US census demographics. The study centered on a hypothetical $1,000-value ecommerce transaction. Participants were offered discounts of $10, $20, $30, or $100 to pay by bank rather than credit or debit card—or no discount at all.
The results were clear: Not only do incentives work, they need not be high to get customers to switch. 67% of customers were willing to do so for only $10—a sharp jump from the 20% who were willing to do so without a discount. The percentage increase then tailed off for each increasing amount.
Likewise, the study showed that smaller incentives engender lower overall processing costs. The above incentive of $10 (1% of the total transaction value), for example, leads to the lowest total costs. For a company paying 0.5% for every ACH transaction and 3% for every card transaction, this translates into an average processing fee of 2%. A 2% incentive, meanwhile, raises that average to 2.6%—slightly more than offering ‘pay by bank’ with no incentive at all (2.5%).
The same is true for a company paying $0.05 in ACH fees and 2% in card fees. The 1% incentive leads to an average processing fee of 1.3%, while the 2% incentive brings about the same average as credit card fees alone. See the chart below.
Based on conversations with our pay-by-bank customers, these findings hold true in reality. The most common pay-by-bank discount incentives we’ve seen are between 1% and 2%.
Youth and convenience are drivers of pay-by-bank adoption
By understanding which groups prefer pay by bank (and why they prefer it), merchants can focus efforts on appealing to those groups.
According to an internal study by Plaid, youth is a main predictor of pay-by-bank adoption. Other factors, such as income, gender, and tech savviness, have no impact on pay-by-bank adoption when adjusted for age.
Another key driver of paying by bank is the expected convenience. Consumers prefer a seamless payment experience and may back out of purchases that require a complicated onboarding process. Offering a more convenient payment process using Plaid's payment solutions creates a UX-centered payment process that can drive the adoption of pay by bank.
The future of pay by bank
Use cases where we see pay by bank as a potential to be a good fit with low risk—given the tools available today—are:
Merchant digital wallet apps, such as the Starbucks app, where users fund a stored balance to their account. Many of these apps use credit and debit cards only, but Plaid’s solutions could help them transition to pay by bank, which would reduce payment fees without incurring greater risk.
High-value ecommerce or retail transactions where wire transfers are the main alternative. For transactions like purchasing a car, pay-by-bank flows powered by Plaid would be a more seamless user experience than a wire transfer.
For other use cases like low-value ecommerce and retail, pay by bank still appears poised to become a universally accepted payment option in the future. However, it will remain in a transitional phase until the request-for-payment functionalities of instant payment rails RTP and FedNow become fully operational—a requirement for widespread pay-by-bank adoption.
In the meantime, Plaid will continue to offer solutions that make ACH bank payments less risky for merchants, as well as work with industry leaders to facilitate a more seamless user experience. Expect to see pay by bank at an ecommerce or retail store sooner than you think.
Interesting in getting started with pay by bank? Learn more about Plaid’s payment solution or fill out the form below to speak with us.