Background: direct debit payments

A direct debit or direct withdrawal is a mandated financial transaction whereby a payer authorizes a payee to draw varying recurring amounts directly from the payer's bank account, commonly used for billing utilities, loans, and subscriptions. Formally, the organisation that calls for the funds ("the payee") instructs their bank to collect (i.e., debit) an amount directly from another's ("the payer's") bank account designated by the payer and pay those funds into a bank account designated by the payee.

Before the payer's banker will allow the transaction to take place, the payer must have advised the bank that they have authorized the payee to directly draw the funds. It is also called pre-authorized debit (PAD) or pre-authorized payment (PAP). After the authorities are set up, the direct debit transactions are usually processed electronically.

Direct debits are typically used for recurring payments, such as credit card and utility bills, where the payment amounts vary from one payment to another. However, when the authorization is in place, the circumstances in which the funds are drawn as well as the dates and amounts are a matter of agreement between the payee and payer, with which the bankers are not concerned.

In countries where setting up authorization is easy enough, direct debits can also be used for irregular payments, such as for mail order transactions or at a point of sale. The payer can cancel the authorization for a direct debit at any time, and the banker can decline to carry out a debit if the transaction would breach the terms of the bank account out of which payment is to be made, for example if it were to cause the account to overdraw. (Banking law does not authorize a bank to alter the payment amount.)

Origins

Alastair Hanton, a British banker and maths graduate, found that traditional banking methods of paying in cheques were incredibly costly. His answer was to gain permission from customers to take payment directly from their bank account. After six years of campaigning, the high-street banks finally agreed in 1964. By the end of the decade, the savings made using this method meant that direct debit had come into general use in the UK.

Authorization

One method involves only the payer and the payee, with the payer authorizing the payee to collect amounts due on their account. However, the payer can instruct their bank to return any direct debit note without giving a reason. In that event, the payee has to pay all fees for the transaction and may eventually lose their ability to initiate direct debits if this occurs too often. However, it still requires all the account holders (not merely the payer) to watch statements and request returns if necessary, unless they have instructed their bank to block all direct debits.

The other method requires the payer to instruct their bank to honour direct debit notes from the payee. The payee is then notified that he or she is now authorised to initiate direct debit transfers from the payer. While this is more secure in theory, it can also mean for the payer that it is harder to return debit notes in the case of an error or dispute.

Fees

In all countries, fees for direct debits are much lower than for credit cards. Credit cards charge a percentage of the transaction (2.5% to 3%) and sometimes a per-transaction fee (about $0.25). In contrast, direct debit fees are $0.15 to $0.20 per transaction on the U.S.'s Automated Clearing House (ACH) network, and £0.20 to £0.40 per transaction on the U.K.'s New Payment System Operator (NPSO) network. Fees vary between providers. Some offer flat rates while others have additional charges and monthly or yearly fees.

Europe

In Europe, the SEPA Direct Debit (SDD) and SEPA Credit Transfer are the standardised payment schemes used for euro-denominated transactions within the Single Euro Payments Area (SEPA) country for payments within the Eurozone.

These schemes are available across all SEPA member countries for cross-border and domestic payments in euros.

Initially, SEPA Direct Debit operated in parallel with national direct debit systems. However, as of 1 August 2014, SDD became the exclusive method for collecting euro-denominated payments within the EU, effectively replacing legacy domestic schemes.