A shorter version of this article appears in Business Finance Predictions 2022, Trade Ledger’s guide to the year ahead.
A super-hot issue for 2022 is that variable recurring payments (VRPs) are finally coming to market. This is a massive opportunity to change the way businesses manage their financial data and leverage it.
For SMEs, VRPs will transform ecommerce, the way payments happen (both incoming and outgoing), and cash forecasting. VRPs should be constructed to include analysis of the payment’s impact: not just, ‘Can we afford it?’, but also, ‘What is the consequence of making this payment right at this moment, and how does that affect my cash balance, my cash forecasting and my available funding (should I need it)?’
There will be a spillover effect into how we businesspeople analyse credit, because we'll have a better, more accurate real-time way to manage payments that we know are coming. For suppliers and vendors that we have relationships with, we can automatically fine-tune how and when we pay them, knowing the impact on our position. That will transform small businesses’ ability to access cash immediately because VRPs are done via Faster Payments, so it's near-instant settlement – no more waiting for 30, 60 or more days.
VRPs will start to make waves in 2022: the UK has a technical delivery standard already in place, and the APIs have to be live by July 2022, enabling account-to-account payments, leveraging open banking. For other jurisdictions, VRPs will arrive to market later on, probably late 2022 or 2023 – they’re not included in PSD2, for example.
They will transform the viability of real-time financing in a profound way. You won’t need a card to make this type of payment any more, which means that operational and administrative costs of using and accepting card payments will be cut significantly, as VRPs don’t attract the interchange and insurance fees that cards do.
VRPs will fundamentally change the way small businesses get paid, and the knock-on effect is that they’ll transform the way they finance and access credit.
Thanks to the near-instant settlement of VRPs, small businesses benefit from real-time insight into their cash positioning. With VRPs, they know their invoices will be paid immediately, so they can forecast their financing based on their roster of invoices going out over the next days, weeks or months, then compare their upcoming resource needs – payroll, rent, insurance, fleet and whatever – and identify whether they need finance. VRPs transform accounting information into more fine-tuned liquidity management by leveraging the dynamic nature of this new type of payment. They also mean better forecasting of risk associated with capital needs, meaning financing becomes more bespoke, timely, and accurate.
Risk becomes easier to assess for lenders. VRPs give a line of sight into billable income, which means that the probability of default is more accurately predicted, as well as affordability. And this means a lower cost of credit for the borrower.
Open banking offers other opportunities. PSD2 and open banking provide a real competitive alternative to cards. Cards come with high usage and scheme participation costs, as well as baked-in purchase and transaction insurance costs that drive up the per-transaction cost for card payment processing. There's the 1.5-3% interchange fee that's attached to every single transaction. The annual and interchange fees have been capped, but that’s not stopped billions being spent on card schemes, which is often passed on to the end customer. Card payments have different levels of insurance on, for example, purchase protection, that are not part of any other payment product. With open banking payments like VRPs, merchants and small businesses don’t have to be part of any scheme to accept payments, reducing their ‘cost of card acceptance’ to zero. Open banking payments also run on faster payment rails, meaning settlement is near real time, unlike cards, which require several days for the funds to land in the account. It's an entirely different commercial model, one with lower costs and faster processing times.
VRP technology is the last part of the roadmap for the UK's Open Banking Implementation Entity (OBIE). The Competition and Markets Authority (CMA) mandated VRP APIs as the means to deliver sweeping, which automatically moves funds between a company’s accounts. It’s typically used to move excess funds into a savings, loan, overdraft or pension account, thereby maximising earned interest and minimising paid interest.
UK banks can’t charge for sweeping. OBIE estimates UK benefits of sweeping at as much as £1.8 bn a year for consumers and SMEs. VRPs, on the other hand, fall into the commercial API space. This means that, for banks, VRPs will enable monetisation of open banking. They are one of the first viable premium API use cases, so banks will be able to recoup the investment in building APIs, and fintechs will pay to access them. Banks will also be able to offer different payment products that they can charge for, mitigating the reduction in revenues and profits from the reduced usage of cards.
VRPs are transformative. They will really unlock the value of open finance – they will get us from open banking to real open finance. They will change the way people engage with their own financial data and how financial data can be leveraged, so it's a big deal.
How can your organisation benefit from open finance, VRPs and their impact on business lending? Download your copy of the full report, Business Finance Predictions 2022. Or get in touch – we love to talk about any topic related to business finance. Discover more about open banking from our on-demand roundtable discussion.