Due to cost of living pressure, the demand for consumer credit is expected to rise across Europe. According to EY, lending rates are expected to climb 7.9% in 2022 and 5.5% in 2023 in the UK.
But there’s a hitch. The current methods for paying back loans — such as direct debits — have significant flaws.
“When you think about paying back loans, the current payment systems that businesses are using are mostly unfit for business,” says Matt Parish, product manager at open banking provider TrueLayer. “Direct debits are used by a lot of lenders but ultimately it’s a paper-based system that is only just being modernised. New tech businesses find it clunky and slow.”
Is there a solution? We asked the experts to explain the challenges we face in paying back loans, how new technologies can help and what barriers we’ll need to overcome for adoption.
The problem with loan repayments
Up first, a bit of context. Borrowing is on the rise in the UK due to challenging economic conditions, says Radhika Patel, product manager at TrueLayer. With that rise comes an increase in consumers missing repayments.
Think about payment failures — this is really problematic for understanding cash flow
According to Patel, the reasons are plentiful, ranging from simply forgetting to set up an automatic payment to having insufficient funds in an account. Overall, repayment issues generally boil down to one thing — a lack of flexibility.
Right now, the most common repayment methods in the UK are direct debits and standing orders. According to UKFinance, direct debits are used by nine in ten UK consumers to pay some or all of their bills. In 2020, there were 4.5bn payments made by direct debit, with an overall value of £1,178bn.
But direct debits take three days to process, which can lead to issues for businesses around cashflow and chasing failed payments. Payment dates are also fixed, creating problems for companies who might have a slow period in the year, plus direct debits can be expensive to process, particularly for small businesses.
“Think about payment failures,” Parish says. “You’ll be notified of a successful direct debit payment and then a couple of days later a provider will turn around and say, actually that specific payment didn’t arrive — this is really problematic for understanding cash flow.”
Enter Variable Recurring Payments (VRPs)
For Parish and Patel, one solution is Variable Recurring Payments (VRPs), an open banking-based technology. But what are they and why are they so important to businesses that collect online payments?
In July 2021, the UK Competition and Markets Authority (CMA) ordered the UK’s nine largest banks to implement variable recurring payment APIs that let customers automatically move (or sweep) 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 direct debit
How does it work? The short answer is, exactly like other open banking products. A customer notifies their bank that they want to give a third-party provider access to their banking information — VRPs are fundamentally a type of payment instruction — and that service provider can then help the customer make payments based on their 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 the new payment method for loans will deliver benefits to lenders, consumers and small businesses.
“VRPs allow surplus money to be automatically transferred from a current account to a credit card, overdraft or loan account,” he says. “They can also help customers repay a debt before incurring repayment fees, and keep their borrowing costs to a minimum by automatically moving surplus funds to help reduce their borrowing faster.
“For lenders, benefits include reducing customer detriment, the volume of bad debt on their books and the associated administration costs in collecting it.”
'A form of smart direct debit'
Like TrueLayer, the OBIE considers VRPs as “a form of smart direct debit” which allows customers to take control of their finances by offering more flexible and transparent ways to pay.
Ainsworth says features like sweeping to help users build a saving pot will help increase financial resilience across the board. He also says VRPs could help businesses pay taxes, for example, by collecting corporation tax and VAT at the point of settling an invoice.
TrueLayer launched its own VRP solution in April 2022. Benefits include real-time settlement, lower transaction costs, zero chargebacks for merchants (due to VRP customer protection) and easier customer checkout. VRP payments feature strong customer authentication (SCA), which can involve biometrics such as fingerprint and facial recognition scans. This significantly reduces the risk of fraud because it authenticates payments directly with the customer’s bank and eliminates the need to store sensitive data.
The road to VRP adoption
To date, the CMA has mandated VRPs for three sweeping use cases: sweeping to pay off a loan that competes with an overdraft; sweeping to a substitute current account or current account; and sweeping to a savings account.
But VRPs can be used for a number of non-sweeping use cases. These include paying for fixed subscriptions like a mobile telephone bill, a variable subscription like gas and electricity or even more bespoke use cases like ad-hoc, one-click purchase scenarios.
If you’re a bank reading this, you’re probably already having conversations about engaging in a commercial VRP contract, my advice is to hurry up and do it
Parish says that while these three use cases cover most of the financial services sector — including all credit card repayments, almost all loan repayments, all current accounts (like Monzo and Revolut, which are already looking at the technology) and most savings accounts — more can be done. He says the industry will need to move beyond the current parameters to achieve full coverage.
Parish expects that VRPs will quickly prove their worth and it won’t be long until institutions catch on.
“If you’re a bank reading this, you’re probably already having conversations about engaging in a commercial VRP contract,” he says. “My advice is to hurry up and do it. If you’re a regulator, I would say, hurry up and force the banks to do it. We can build this and get it out.”