U.S. merchants have long borne the expense of interchange fees for card-based transactions, often regarded as an inescapable cost of doing business in a country where the majority of shoppers reach for their credit cards automatically. More than 90 percent of U.S. consumers who had credit scores in Q3 2020 owned credit cards, for example.
Other countries with more developed open banking ecosystems and different consumer purchasing habits have explored alternatives to credit card payments that could light a path for the U.S. retail sector to follow. Mobile payment apps in India let consumers tap into the Unified Payment Interface (UPI) real-time payment system to fund retail purchases directly from shoppers’ bank accounts, for example, and services in the U.K. similarly enable rapid transfers of funds from consumers’ bank accounts into merchants’. Solutions such as the “request to pay” messaging service taking shape in the country are tapping open banking to ensure merchants can directly request payments rather than send out invoices, for example. Open banking underpins these and other initiatives, with apps relying on financial institutions (FIs) giving authorized FinTechs access to customer banking data to enable them to facilitate these account-to-account (A2A) payments.
The U.S. open banking scene differs, however, in that the decision to participate and provide secure third-party access to banking data has thus far been left to the discretion of FIs, with little federal policymaking encouraging or guiding adoption. Participation in open banking is mandatory in the U.K., by contrast, and the government in India has actively pushed policies and initiatives to entice participation.
Many U.S. consumers use mobile apps and wallets to make retail purchases, but these apps tend to rely on card networks rather than bank accounts to fund the transactions, with consumers typically loading payment cards into their wallets. The current state of U.S. retail payments does not have to be its future, however. This Deep Dive explores how the potential benefits of A2A retail payments for both merchants and consumers could help make open banking a reality in the U.S.
Tackling Merchant Fees
The interchange fees that merchants pay are a way for card companies to make profits as well as to offset the fraud they write off on their card portfolios, and the firms charge merchants more for transactions that are deemed riskier. U.S. merchants pay credit card interchange fees of up to 3.5 percent on average of each transaction’s value, and the exact costs can vary based on the card brand, type of card, merchant’s business category and whether cards are physically present during transactions or being used remotely. Merchants pay higher interchange rates when accepting card-not-present (CNP) transactions because fraud risks tend to be higher. These expenses can be painful, especially for smaller businesses.
The pandemic has made these cost concerns more of a priority in the retail space because it has prompted a greater share of shopping to take place online, where merchants face higher interchange charges and cannot ask consumers to pay using alternative methods such as PIN-based debit payments. A PYMNTS survey of nearly 9,600 U.S. consumers found that the share of shoppers making retail purchases from home doubled between summer 2019 and summer 2020. This trend was accompanied by a 25 percent drop in the portion of customers making in-store purchases, suggesting that many customers are going online to replace — rather than supplement — in-store shopping.
Many retailers have felt they have few options for avoiding interchange fees, fearing that customers will abandon them for competitors should they refuse to accept credit cards. Some analysts in the space expect that retailers will be able to find lower transaction fees by accepting A2A payments instead, however.
Card payments involve several parties, including the card network, the merchant acquirer and the card issuer, all working together to authorize the payment. Open banking-enabled services that facilitate A2A transactions may be able to trim the number of intermediaries involved in a payment by relying on existing bank infrastructure. This potentially allows app providers to charge merchants lower fees. One A2A payments provider boasted that its transaction fees are 1 percent, for example, which clocks in somewhat below the average credit card interchange fee. The provider asserted that avoiding card infrastructure enabled it to offer this lower price. Competition between A2A payment apps and credit card networks could potentially help push down fees as well.
Merchants stand to gain other advantages if shoppers pay them via A2A apps that leverage real-time rails. These transactions can settle immediately into sellers’ accounts, sparing them the multiday waits associated with accepting card payments. Instant payments are also irreversible, meaning that merchants do not have to worry about friendly fraud cases in which customers falsely report chargebacks. Consumers must first be persuaded to adopt A2A payments over their cards if merchants are to reap the benefits A2A payments offer, however.
Winning The Consumer Vote
Shoppers are unlikely to be swayed to adopt open banking-powered A2A payments just to benefit merchants if there is no incentive for them, however. Consumers do not experience the same frictions from card payments that merchants do because interchange fees are leveled on the sellers, while shoppers are loyal to the payment tools that benefit them, such as cards with cash back rewards. Many U.S. consumers have become accustomed to using cards and getting these rewards, and changing the course of such behaviors does not come easy. Another significant drawback for A2A payments from consumers’ point of view is that these transactions do not allow for chargebacks or easy dispute resolution. The iDEAL instant payment system currently in place in the Netherlands, for example, does not process refunds despite its high adoption rate, pushing the responsibility for processing disputes onto merchants.
Retailers eager to avoid interchange fees and instead accept irreversible, swift A2A payments may therefore need to provide new incentives to their customers. That might include offering their own discounts and rewards — paid for via some of the savings the merchants make from avoiding credit card fees — or otherwise adding features to make these payments particularly convenient and compelling. Retailers also need to ensure there is a comprehensive dispute process that allows consumers to confidently resolve such incidents without requiring payment reversals or chargebacks.
The accelerated growth of eCommerce driven by the pandemic has shifted how consumers and merchants transact. Retailers taking stock of the new realities may be interested in moving customers off credit card payments — allowing sellers to avoid the associated interchange fees — and onto the kinds of open banking-enabled A2A payment methods popular in other countries. Getting consumers to change long-ingrained purchasing habits can be tricky, however, and merchants will need be proactive and creative as they look for ways to win over shoppers.