Open banking: The next big thing for small businesses

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3,850,000 if you wrap it in quotation marks.

A lot is being said about open banking. And a lot of products powered by open banking are popping up on the market. In the UK, there are currently more than 100 regulated open banking apps.

But why is there such a push towards open banking, particularly for small businesses? To find out, we surveyed 1,000 small businesses across the UK and Australia, and the top five biggest benefits sought by small businesses were:

• Improving cash flow.

• Avoid wasting time chasing late payments.

• Having visibility over which customers have and haven’t paid.

• Improving the rate of successful payments.

• Reducing the amount of manual work required to reconcile payments.

The reason open banking is such an exciting technology for small businesses is because it can be used to deliver businesses exactly these benefits, where current payments technologies do not.

What is open banking?

Open banking describes the process of banks and other financial institutions opening up data for regulated providers to access, use, and share, in a safe and secure manner.

Banks are putting in place infrastructure for their customers’ data to be shared more easily with third parties, when the customer chooses to do so.

That last part is important. Open banking isn’t a ploy to allow banks to more easily sell their customers’ data. The intention is quite the opposite - open banking was conceived to improve financial services for customers. By banks opening up access to data they’ve historically kept in-house, new companies and new products can come to market, using this data in helpful, innovative ways.

Open banking can also be used to initiate Account-to-Account (A2A) payments. Here at GoCardless, we’ve leveraged that capability to start rolling out to our users a better way to collect one-off payments via a feature called Instant Bank Pay.

The size of open banking: Millions of users, billions of dollars

The origins of open banking in the UK lay with a 2013 proposal from the European Commission to revise an EU regulation called PSD2. In 2016, the Open Banking Implementation Entity (OBIE) formed - the organisation responsible for creating the software standards and industry guidelines that enable open banking. In 2018, they launched the Open Banking Standard itself, and in the years since then, open banking in the UK has exploded and shows no signs of slowing down.

Data from the OBIE illustrates the scope and pace of open banking in the UK:

• 300 fintechs and innovative providers have joined the ecosystem

• 6,000,000+ UK consumers and businesses now use open banking-enabled products to manage their finances, access credit, and make payments

• 100,000+ UK consumers and businesses become new active open banking users every month

And it’s not just scrappy startups leveraging open banking. Bigger players are also leveraging open banking technology in their products. Revolut is leveraging open banking to power verification and transfers into users’ Revolut wallets. And Plum is using it to allow users to integrate their challenger bank accounts, such as Monzo and Starling.

Even industry giants like Visa and Mastercard are spending big money to get into the space, demonstrating the power of the technology and the seriousness with which they take the threat. In the past two years, they’ve invested nearly $3 billion in major acquisitions of open banking providers.

In the US in the 1950s, card payments finally got their kickstart with BankAmericard. Today, card payments are ubiquitous. With hundreds of companies investing billions of pounds into developing open banking-powered technologies, we’re now seeing the next major evolution in how businesses and consumers around the world pay, with open banking.

How open banking payments work for businesses that invoice

The possibilities with open banking-powered products are vast. So it can be difficult to tangibly wrap your head around what these products are, how they work, and the benefit they provide over traditional solutions.

Let’s look at the payments space. For many small businesses, the default way of getting paid is to invoice a customer and receive payment via a manual bank transfer 30 days later. This brings with it the problem of late payment - and it’s not a small or isolated problem. According to a report from The Federation of Small Businesses (FSB), each year the late payment problem costs the UK economy £2.5 billion, and kills 50,000 small businesses.

Automating payment collection via Direct Debit addresses the root cause of late payments. But in some instances and for some customers, this might not be their preferred way to pay. What’s more, 85% of small businesses with recurring revenue need to collect one-off payments outside of their normal, ongoing invoicing cycle¹. When these payments require instant authorisation, Direct Debit isn’t suitable.

Payments products powered by open banking address these problems. While manual bank transfers are a clunky, admin-heavy experience for the customer, open banking payments provide a smooth flow. Simply tapping a link pushes the customer into their online or mobile banking app, with the transaction details pre-populated and awaiting a tap or click to approve.

This allows the merchant to initiate the payment process instead of relying on the customer to start a manual bank transfer. And the friction on the customer to complete the payment is lower. Meaning they’re less likely to put off prompt payment. We’ve seen this with our own open banking-powered payments feature, Instant Bank Pay - the customer is able to pay this in real-time and the merchant has a confirmation within seconds that the money has been processed. Comparably, manual bank transfers have a days sales outstanding (DSO) of 21.2 days, on average².

‍How open banking payments work for subscription and membership businesses

For small businesses offering a subscription service or membership, card payments tend to be the norm instead of bank transfers. But there are well-known issues for businesses accepting card payments, they tend to come with high fees, have slow payout cycles, with relatively high levels of chargeback and fraud.

Payment products powered by open banking facilitate the transfer of funds directly from one account to another, rather than through convoluted card networks. With fewer intermediaries comes lower fees.

Again we can look at Instant Bank Pay to see the difference in action. In April 2021 we modelled a £100 transaction through Instant Bank Pay, as well as seven card payment providers. The fees for the Instant Bank Pay transaction came out cheapest, at £1.20. The cheapest card transaction cost 36% more, at £1.63. The most expensive was £4.05 - a 238% increase in cost. These are costs that small businesses either need to absorb or pass on to their customers, risking their ability to remain competitive.

With the high volume of transactions that subscription and membership businesses process, the savings associated with using open banking-powered payments can make a significant difference to the bottom line over time. The sooner the switch, the bigger the benefit.

Open banking technology is great on its own, but even better with others

Small businesses can benefit from open banking-powered products on their own. But where they really shine, however, is in combination with other payment technologies. Take Instant Bank Pay again. It can be used by small businesses exactly as described above. However, it enables many more use cases for small businesses when used in combination with GoCardless’ Direct Debit functionality.

For businesses that invoice their customers on a regular, recurring basis - such as professional services firms - Direct Debit can be used to ensure those payments are automatically collected on time. Direct Debit also helps with customer payment preference and offers complete coverage in situations where some banks may not have a good Open Banking solution at this point. Instant Bank Pay can be used for one-off payments outside of the normal ongoing invoicing cycle - which is something that half of small businesses do 10+ times per month¹.

And for businesses that need upfront payment before offering their services - such as gyms and membership organisations - Instant Bank Pay can be used to instantly authorise the upfront payment, with a Direct Debit mandate being set up to collect all future payments. And both of these can be processed in the same quick and easy payment flow for the customer.

Open banking payments can benefit small businesses today

Although open banking is still trying to find its feet in many parts of the world, it’s alive and kicking in the UK. Already over 100 products are available to UK businesses and consumers, and already they’re providing tangible benefits over and above incumbent products in the same category.

By adopting open banking-powered payments over traditional methods like manual bank transfers and card payments, small businesses can get paid sooner, spend less time chasing up late payments, and save on costs.

¹ GoCardless market research, Feb 2021 ² A survey by Attest, commissioned by GoCardless, Dec 2020