What is pay by bank? | Stripe (2024)

Pay by bank is a payment method that allows customers to pay for goods or services directly from their bank accounts. It's becoming increasingly popular because of the level of security it offers, as well as lower transaction fees when compared with traditional card-based payments. Transactions are typically processed quickly, sometimes instantly, depending on the banking infrastructure, and authentication methods, such as bank login or multi-factor authentication (MFA), ensure secure transactions.

Below, we'll cover how pay by bank works, the associated benefits and challenges, and how this payment method is affecting the financial industry.

What's in this article?

• How does pay by bank work?
  
• Advantages of paying by bank over credit cards
  
• Pay by bank challenges
  
• The evolving landscape of pay by bank
  
• How pay by bank is changing banking and financial services
  

How does pay by bank work?

Pay by bank can be implemented through various technologies and platforms, including open banking, bank application programming interfaces (APIs) or dedicated payment gateways that support direct bank transfers. It's commonly used in e-commerce, bill payments and other online transactions. For a customer to use pay by bank, their bank typically needs to authenticate their identity and receive confirmation of the payment before sending the funds. Here's how it works:

• Payment initiation: The customer chooses "pay by bank" or "bank transfer" as the payment method when purchasing a product or service. This option is often available on e-commerce websites, bill payment portals or other platforms that accept online payments.

• Bank selection: The customer selects their bank from a list of supported banks. This is often presented in a drop-down menu or search function.

• Customer authentication: The customer is redirected to their bank's secure online portal or prompted to log in through a third-party interface. The customer might also have to provide additional authorisation for the transaction, such as a code sent to a mobile device, a security token or biometric authentication (e.g. fingerprint or facial recognition). This step verifies the customer's identity and authorises the transaction.

• Payment confirmation: The customer confirms the payment details, including the amount, recipient (business) and other relevant information.

• Funds transfer: After confirmation, the bank processes the payment by transferring funds from the customer's account to the business's account.

• Notification and completion: The customer and the business both receive a notification confirming that the payment was successful. This confirmation might be in the form of an email, SMS or on-screen message.

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• Settlement: The bank settles the transaction by updating the accounts involved.

Advantages of paying by bank over credit cards

Pay by bank offers certain advantages over paying by credit card. These are outlined below.

Lower transaction costs

• Lower fees: Bank transfers generally incur lower transaction fees compared with those of credit card payments. Payment processors charge businesses a percentage of the transaction value for credit card payments, which can be substantial. With direct bank payments, the fees are normally lower, benefiting both businesses and customers.

• Elimination of intermediaries: By transferring funds directly from the customer's bank account to the business's account, the need for third-party intermediaries is reduced, which leads to fewer payment processing fees and no interchange fees.

Better security

• Direct authentication: When paying by bank, customers authenticate directly with their bank, reducing the risk of phishing and unauthorised access. This process typically involves MFA.

• Fewer opportunities for fraud: Because bank transfers are often carried out in a bank's secure online portal or mobile app, there are fewer opportunities for fraudulent actors to steal customers' payment information.

Faster transactions

• Real-time payments: Some bank-based payment methods can perform instant transactions. Although credit card payments are authorised in real time, businesses don't usually receive the money instantaneously.

• Faster settlements: Direct bank transfers can settle faster compared with credit card settlements, which often take a few days because of batch processing and reconciliation.

Increased customer control

• Account-based payments: Customers can pay directly from their bank accounts without relying on credit limits or worrying about interest rates on outstanding balances.

• No need for credit checks: Bank-based payments don't require credit checks, making them accessible to those without credit or with a poor credit history.

Lower risk of chargebacks

• Reduced chargebacks: Credit card payments are prone to chargebacks because of disputes or fraudulent transactions. Direct bank payments typically have lower chargeback risks because of the secure authentication process and the reduced risk of unauthorised transactions.

• Simplified dispute resolution: Because the transaction is between the customer and their bank, resolving disputes can be more straightforward, reducing the administrative burden on businesses.

Accessibility

• Cross-border compatibility: Many bank-based payment systems are designed to work across borders, providing an easier international payment experience. Credit cards may have limitations in this respect because of varying acceptance rates and additional fees for international transactions.

• Inclusion for unbanked and underbanked groups of people: Some bank-based systems offer access to individuals who might not have credit cards but do have bank accounts, thus promoting financial inclusion.

Pay by bank challenges

As with any payment method, pay by bank can present challenges for businesses. Here are some of the potential challenges:

User experience

The process of logging in to a bank account, authenticating and completing a transaction can be more complex and time-consuming than card-based payments. This additional friction might deter customers from using pay by bank.

• Solution: Use technologies such as open banking and API integration to simplify the user interface and reduce the steps required to complete a transaction. Single sign-on (SSO) and consistent user flows across platforms can also improve the experience.
  

Transaction reversibility and chargebacks

Unlike credit card payments, bank transfers are typically irreversible, which can pose a problem for customers who need to reverse a transaction or address disputes.

• Solution: Implement clear dispute resolution processes and customer support mechanisms. Offer refunds or adjustments in the event of errors or customer dissatisfaction.
  

Security risks

Although bank-based payments are generally secure, they are not immune to security risks, such as phishing or identity theft. Customers could be tricked into providing their bank credentials to malicious actors.

• Solution: Educate users about security best practices and the risks of phishing. Use MFA, biometric verification and secure communication protocols to boost security. Audit payment platforms regularly to identify and address any vulnerabilities.
  

Cross-border compatibility

Bank-based payment methods can encounter compatibility issues when dealing with international transactions. Different banking systems and regulations in various countries can cause delays or additional fees.

• Solution: Collaborate with banks and financial institutions to standardise cross-border payment processes. Use international payment gateways which have experience in handling cross-border transactions.
  

Dependence on banking infrastructure

Pay by bank relies on the banking infrastructure, which might experience outages or downtime, thus leading to payment delays or failures.

• Solution: Implement redundancy and failover systems to ensure continuity during outages. Work with banks that have a reliable infrastructure and backup systems. Providing clear communication to customers during outages can also help with managing expectations.
  

Compliance and regulation

Bank-based payments must comply with various regulations, such as Anti-Money Laundering (AML) and Know Your Customer (KYC) rules. Compliance can add complexity and overheads to the payment process.

• Solution: Stay informed about regulatory requirements and ensure that all your processes comply with the relevant laws. Work with legal experts and compliance officers to maintain adherence to regulations.
  

The evolving landscape of pay by bank

The pay by bank landscape is adapting to technological advancements, changing consumer preferences and regulations, and emerging partnerships and use cases.

Technological advancements

• Open banking: Open banking initiatives, which allow third-party developers to build applications that connect to bank data through secure APIs, have increased pay by bank's accessibility and interoperability among financial institutions.

• Real-time payments: The development of real-time payment systems has enabled instantaneous bank transfers, transforming payment speeds and the customer experience.

• Artificial intelligence (AI) and machine learning (ML): AI and ML are being used to improve fraud detection, security and personalisation in bank-based payments.

Regulatory changes

• PSD2 and other regulations: In Europe, the Payment Services Directive 2 (PSD2) requires banks to open their data to third parties (with customer consent). This facilitates open banking and leads to increased competition and innovation in the payment industry.

• Compliance and security: Regulatory frameworks have adapted to focus more on data protection and security, with stricter rules for financial transactions.

Customer trends and expectations

• Convenience and speed: Customers are increasingly expecting quick and easy payment experiences.

• Security concerns: With increasing cyber threats, customers are prioritising secure payment methods.

• Mobile and digital payments: Consumer preference is shifting towards mobile and digital payments.

Industry partnerships and collaboration

• Fintech-bank collaboration: Fintech businesses and traditional banks are collaborating to create innovative pay by bank solutions.

• Integration with e-commerce platforms: E-commerce platforms are increasingly adopting pay by bank options.

• Interoperability and standardisation: Fintech businesses and banks are working towards standardising protocols and improving the interoperability of pay by bank among different banks and payment systems.

Emerging use cases

• Business-to-business (B2B) transactions: Pay by bank is gaining traction in B2B transactions because of its lower fees and direct bank transfers. This trend could lead to it being adopted more extensively for corporate payments.

• Subscription services: Subscription-based businesses are increasingly adopting pay by bank as a recurring payment option. This model reduces reliance on credit card processing and associated fees.

• Cross-border payments: Cross-border pay by bank solutions are growing in popularity, giving global businesses a lower-cost, faster option for transactions.

How pay by bank is changing banking and financial services

Pay by bank's features are changing banking and financial services by challenging customer expectations, industry standards and business processes.

• Customer-centric approach: Pay by bank has helped to shift the focus to customer-centric banking. Banks are incentivised to offer personalised services, allowing customers to choose how and where they share their data for greater transparency and customer control.

• Real-time payments: The rise of real-time payment systems for pay by bank processes allows for instantaneous bank transfers, transforming traditional banking timelines. This has implications for cash flow management and has led to the increased adoption of instant payments in various industries.

• Secure authentication: Pay by bank relies on secure authentication methods, such as MFA, reducing the risk of fraud and unauthorised access. This change has heightened security expectations across the financial sector.

• Fintech disruption: The adoption of pay by bank has enabled fintech businesses to disrupt traditional banking models and develop new services, such as budgeting apps, payment gateways and personal finance management tools. The competition faced by traditional banks from fintech businesses has driven innovation and forced banks to improve their services.

• Upgrading legacy systems: The adoption of pay by bank requires banks to upgrade their legacy systems to support modern APIs and real-time transactions. This transformation involves substantial investment in technology and infrastructure.

• System resilience: As pay by bank becomes increasingly prevalent, banks must develop resilient, reliable systems that can provide continuous service and minimise downtime. This focus on reliability can improve the overall banking infrastructure.

• Cross-border transactions: The rise of pay by bank has facilitated quicker cross-border transactions, letting customers make international payments more easily. This change is opening new markets for businesses and enabling more international financial services.

• Financial inclusion: Pay by bank is increasing financial inclusion by providing payment options to those who might not have access to traditional credit or debit cards. This expansion has the potential to reach underserved and unbanked populations.