🧠 Is Pay by Bank the next Payment Rail?

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Hey Fintech Nerds 👋

It feels like the market is thawing. Rounds are slowly coming together, and Plaid has a new president and is actively PR’ing like it’s testing the waters for an IPO.

Speaking of Plaid, they’re keen on Pay by Bank. Is that a payment method who’s time has finally come?

We’re in the middle of results season. Adyen keeps crushing, but PayPal is in a midlife crisis. Revenue growth is the cure for everything (as it always was). PayPal is growing slower than eCommerce overall. Can it turn around?

PS. Congratulations to Cascading* on the pre-seed. They’re reducing the manual work for complex SMB lending by 90%.

Here's this week's Brainfood in summary

📣 Rant: Is Pay by Bank the next Payment Rail?

💸 4 Fintech Companies:

1. Alina Invest - The AI Wealth Manager for GenZ Women

2. Bluelayer - The Carbon project funding platform

3. Akirolabs - Modern Procurement for enterprise

4. NeoTax - Automated Tax R&D Credits

👀 Things to Know:

1. PayPal’s Q4 Results are weak sauce / Adyen’s revenue up 22%

2. Iran used Santander and Lloyds Bank to evade sanctions.

📚 Good Read:

1. The Affinity Fintech Opportunity to serve Latinos

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Weekly Rant 📣

Is Pay by Bank the next big payment rail?

Thesis: 2024 will be the year major U.S. retailers embrace Pay By Bank (PBB) as an alternative to cards.

Cards dominate in-store, online, and mobile. Globally, many have tried and failed to make RTP over non-card rails work, but the US is always the exception. 

Retailers operating on tight margins are keen to remove cards and move to a lower fee mechanism like ACH.

ACH is a lower-cost payment method, but consumers aren't as familiar with it for everyday commerce as cards, and the 3-day delay is a poor experience.

I've heard 5 or 6 examples of major banks, open banking providers, and retailers putting significant budgets behind, making PBB a prominent part of the payments landscape in 2024.

It seems I'm not the only one.

Will 2024 be the year of Pay by Bank?

Let's do this.

1. What is Pay by Bank (PBB)?

2. Why now?

   1.  Merchants can get lower fees with an RTP rail

   2. Pay by Bank is well-suited to high-value and subscription payments

   3. Pay by Bank gives banks a competitive edge against new wallets and open finance providers

   4. Open Banking is now a regulatory mandate.

3. Lessons from the world of cards

   1. The UX is often flawless

   2. Every merchant accepts it

   3. Come with strong consumer protections

   4. Incentives for users

   5. Banks often benefit massively from cards and have channel conflicts when they start to compete.

4. Overcoming the pay-by-bank challenges

   1. A consistent, standardized (ideally open-source) UX would be a game changer.

   2. Merchant adoption rarely works if it's about cost and always works if it's about conversion.

   3. Consumer, fraud, and money laundering protections need to be baked in from the start.

   4. Connecting data and the transaction opens new loyalty and reward possibilities.

   5. Payments companies (PSPs), open banking providers, and standards bodies have a huge role.

5. The Revolution will be tokenized.

1. What is Pay by Bank?

Real-time payments (RTP) are best known for one-off or peer-to-peer transactions, but they're starting to emerge for consumer-to-business (C2B) payments with a few flavors.

Think of it like Open Banking Initiated Real-Time Payments. As a consumer, you would see an option at checkout, online or mobile, to connect (via Plaid or competitors) and share your ACH details to begin a transaction.

They feel like a consumer payment but are more suited to higher-order values.

This is especially acute in the USA, where credit card usage is high and even regulated debit can be expensive by European and global standards.

2. Why now?

a) Merchants can get lower fees with an RTP rail. Imagine you're a gym customer paying ~$200 per month on a debit or credit card. Assume a combined (regulated + unregulated) debit cost of ~1% per txn and a credit card fee closer to 2-3%. That means collecting monthly billing costs between $2 and $4 per user. Adding a new payment method is worth the lift if a merchant could see an average payment processing fee closer to regulated debit.

b) Pay by Bank is well suited to higher-value or subscription payments. ACH is often used for Autopay or large payments because it costs less. However, the poor experience for consumers meant they’d often prefer the card. ACH also meant the merchant had to wait 3 days to get paid with a degree of fraud risk (NSF returns are too easy). Pay by Bank offers something that feels instant to the consumer and the merchant.

c) Pay by Bank gives banks a competitive edge against new wallets and an anchor into RTP as a rail. Banks' consensus is that noncard rails are now an inevitable reality. The question is, who has the right to win? Will the change of rail be a change of who gets the revenue? Banks with massive merchant customers and large consumer bases have a unit economics advantage they can compete with.

d) Open Banking is now a regulatory mandate. The US had one major issue with open finance: it would break. There was no obligation to provide secure connectivity to account data, but that will change as the CFPB brings a new rule into force in ~2024. The Dodd-Frank Act section 1033 will ensure that connecting to your bank account to fetch bank account information and begin a payment can feel seamless. 

3. Lessons from the world of cards

a) The UX is well understood. Entering a card number and expiry is second nature. Consumer RTP for large one-off payments shows early signs of success in higher-order values, but it's a long way from a default. The Pay by Bank UX pattern isn't established for many consumers because open banking used to break at login and the experience lacks consistency (although this should change as 1033 passes).

💡 The FDX account linking flow experience needs to become a mark of quality via "pay by bank" or open banking, just as it does with cards.

b) They're widely accepted. It's incredibly rare for a debit card not to work at checkout. That builds a consumer habit that makes them a default option. Changing consumer behavior is hard, but if the goal isn't to compete with all card payments, just some use cases, some of the time? Then, PBB could find its lane.

💡 Pay by Bank is uniquely suited to use cases like bill payment, subscriptions, and higher order values. People already use ACH, but the open banking experience makes it faster.

c) Come with strong consumer protections. The real power of cards is the consumer protection mechanism. Disputes and chargebacks are a pain for most merchants but are a killer card feature. Pay by Bank rails lack protection and fall into a grey area. The incentives are set up with cards to give the consumer a natural advantage. 

💡 The quiet-part-out-loud truth about real-time non-card rails is they're a massive fraud, scam, and ML risk. More robust protection and controls must be invested to gain PBB adoption for these use cases.

d) Feature incentives for users to repeat use. People love a loyalty point or a discount. Much of the cost of credit card acceptance comes from funding points programs and cashback. But those incentives work to drive users back to the card. 

💡 As a lower-cost payment rail with instant settlement, merchants get earlier cash flow and savings. I imagine they'll want to offer discounts or other incentives to switch, but what about repeat use? 

e) Banks often benefit massively from cards and have channel conflict when they start to compete. I'm a veteran of banks attempting to offer real-time payment types via mobile with a large card business. I used to work for one of the largest card issuers in the UK, which closed its RTP payment app years after its launch because the business case never stood on its own two feet.

💡 The opportunity is likely for strategic corporate clients of banks or, more likely, the open banking providers and PSPs. Although the grip card issuing had on top tier banks is now starting to thaw as they see RTP is becoming a part of the landscape.

4. Unlocking Pay by Bank

a) A consistent, standardized brand or mark. Imagine if every authentication flow had a "pay by bank" logo from FDX. If we had this secure, two-factor authentication for transactions and it was frictionless, PBB really can compete with cards on experience.

b) Merchant adoption rarely works if it's only about cost and always works if it's about conversion. Most business cases trying to sell Pay By Bank, RTP, and Open Banking initiated payments focus on the cost of cards. Yes, that's an issue. But in higher-order values, conversion is critical. If someone is paying a $1,000 deposit to rent a home or lease a car, that kind of card transaction isn't always auto-approved. The best card conversion rates are rarely as good as the best ACH conversion rates.

c) Consumer, fraud, and money laundering protections need to be baked in from the start. RTP rails offer amazing conversion and super low cost, except for all the fraud risks. Fintech companies who offered to get paid early experienced these high fraud rates and have built controls, but most merchants lack them. For Pay by Bank, this must be thought through at the experience, network, and technology levels. If I were running FDX, I'd be tempted to grab this bull by the horns.

d) Connecting data and the transaction opens new loyalty and reward possibilities. Being a lower-cost rail, expect discounts for using Pay by Bank, but I think we can do a lot better. The best loyalty programs known to unlock incentives require data about users. Starbucks does it with an app, airlines with a credit card and online portal, and hotels do the same. What's unique about connecting to a bank account to complete a payment is that much more data travels with the payment. The merchant no longer just sees what came from the card scheme but could build much richer feedback loops with consumers. 

e) PSPs, open banking providers, and standards bodies have a huge role. To be anything other than a fad or a niche use case, the way we use open banking to make a payment needs to become a bona fide standard. In retrospect, it makes the original Visa and Mastercard network developments appear modern miracles. We know the DoJ won't let Visa play that role, so who will?

5. The cusp of a revolution.

Pay by Bank in the USA is a generational opportunity to create a new payment rail. 

That means we should learn the lessons of history. What makes cards so incredibly successful is their consistency for the cardholder. Pay by Bank needs a very clear payment mark, brand, and feel. This is something the whole industry has to work together on.

We have the technology with tokens and passkeys.

We have the regulation with Dodd-Frank 1033.

The US uniquely has the business case because it is obsessed with credit cards and the economics associated with it. 

This is a trend that has started, but it could turn into a secular shift in payments.

Maybe the DoJ blocking the Visa acquisition of Plaid was the best thing to ever happen to the payments industry after all?

ST.

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4 Fintech Companies 💸

1. Alina Invest - The AI Wealth Manager for GenZ Women

Alina is aimed at women under 25 who identify as beginner investors. They're an SEC-registered investment advisor that charges $120/year for membership. The service "buys and sells for you" and gives up notification updates of recent transactions like a wealth manager would.

🧠 This wins buzzword bingo, but don't immediately write it off. Getting people to invest early is crucial to building long-term wealth. One thing that holds them back is a lack of confidence and experience. Being targetted "for beginners" and people who live on TikTok should appeal. I love the sense of "we're buying and selling for you." Funds always do that, but making it an engagement mechanic is very smart. The risk here is that building a wealth business will take decades for the AUM to compound. But the next generations, Wealthfront or Betterment, will look something like Alina.

2. Blue layer - The Carbon project funding platform

Bluelayer allows Carbon project developers to take from feasibility studies to issuing credits, tracking inventory, and managing orders. Developers of reforestation, conservation, direct air capture, and other projects can also directly report to industry registries. 

🧠 Carbon investing and tax credits are heavily incentivized but need transparent data. By focusing on the developers, Bluelayer can ensure the data, reporting, and credits lifecycle is all managed at the source. This is smart.

3. Akirolabs - Modern Procurement for enterprise

Akiro is a "strategic" procurement platform aiming to help enterprise customers identify risks, value drivers, and strategic levers before issuing an RFP. It aims to bring in multiple stakeholders for complex purchasing decisions at multinationals. 

🧠 Procurement is a great wedge for multinational corporate transformation. Buying anything in an enterprise that uses large-scale ERPs is a nightmare of committees and spreadsheets. Turning an oil tanker-sized organization around is difficult, but the right suppliers can have a meaningful impact in the short term. That only works if you can buy from them. Getting people on the same page with a single platform is a great start.

4. NeoTax - Automated Tax R&D Credits

NeoTax allows companies to connect their engineering tools to calculate available tax advantages automatically. Once calculated, the tax fillings are clearly labeled with supporting evidence for the IRS.

🧠 AWS and GCP log files and data are a goldmine. Last week, I covered Bilanc, which uses log files to figure out per-account unit economics. Now, we calculate R&D tax credits. The unlock here is LLM's ability to understand unstructured data. The hard part is understanding the moat, but time will tell.

Things to know 👀

1. PayPal’s Q4 Results are weak sauce / Adyen’s revenue up 22%

PayPal issued low guidance and warned of a “transition year.” The stock is down 8% in extended trading despite PayPal reporting a 9% growth in revenue and 23% EBITDA. Gross profit is down 4% YoY. PayPal's total revenues were $29Bn for the year

Adyen reported 22% revenue growth and an EBITDA margin of 46% for the full year. Adyen's total revenues were $1.75bn for the full year. The margin was down from 55% the previous year, impacted by hiring ahead of growth.

🤔 PayPal’s Braintree (unbranded) is losing market share in the US, while Adyen is winning it. eCommerce is growing ~9 to 10% YoY, and PayPal’s transaction revenue grew by 6.7%. The higher interest rate environment meant interest on balances dragged up the total revenue figure. Their core business is losing market share. Adyen is outgrowing the market by ~12%.

🤔 The PayPal button (branded) is losing to SHOP Pay and Apple Pay. The branded experience from Apple and Shopify is delightful for users; it’s fast and helps with small details like delivery tracking. That experience translates to higher conversion (and more revenue) for merchants.

🤔 The lack of a single global platform hurts PayPal, but it helps Adyen. In the earnings call, the new CEO admitted their mix of platforms like Venmo, PayPal, and Braintree are holding them back. They aim to combine and simplify, but that’s easier said than done.

🤔 Making a single platform from PayPal, Venmo, and Braintree won’t be easy. There’s a graveyard of payment company CEOs who tried to make “one platform” from things they acquired years ago. It’s crucial if they’re going to grow that they get their innovation edge back. Adyen has one platform in every market.

🤔 PayPal’s UK and European acquiring business is a bright spot. The UK and EU delivered 20% of overall revenue, growing 11% YoY. Square and Toast don’t have market share here, while iZettle, which PayPal acquired in 2018, is a strong market player. Overall though, it’s yet another tech stack and business that’s not part of a single global platform.

2. Iran used Santander and Lloyds Bank to evade sanctions.

The two banks provided accounts to UK front companies secretly owned by an Iranian petrochemicals company. PCC has used these entities to receive funds from Iranian entities in China, concealed with trustee agreements and nominee directors. 

🤔 This is the headline every bank CEO fears. Oof. Shares of both banks have been down since the news broke, but this will no doubt involve crisis calls, committees, appearing in front of the regulator, and, finally, some sort of fine.

🤔 The "risk-based approach" has been arbitraged. A UK company with relatively low annual revenue would look "low risk" at onboarding. One business the FT covered looked like a small company at a residential address to compliance staff. They'd likely apply branch-level controls instead of the enterprise-grade controls you'd see for a large corporation. 

🤔 Hiring more staff won't fix this problem; it's a mindset and technology challenge. In theory, all of the skill and technology that exists to manage risks with large corporate customers (in the transaction banking divisions) are available to the other parts of a bank. In practice, they're not. Most banks lack a single data set and the ability for compliance officers in one team to see data from another part of the org. Getting the basics right with data and tooling is incredibly hard and will involve a multi-year effort. 

🤔 These things are rarely the failure of an individual or department; the issue is systemic. While two banks are named in this headline, the issue is everywhere. Banks need more data and better data to train better AI and machine learning. That all needs to happen in real-time as a compliment to the human staff. Throwing bodies at this won't solve the visibility issue teams have.

Good Reads 📚

1. The Affinity Fintech Opportunity to serve Latinos

Francisco discusses a failed attempt to bring Fintech to the Latinos, typified by this meme (which summarizes nearly all attempts at affinity in Fintech). Despite being ~19% of the population, the 5th largest world GDP, and 33% living in just four states, successful examples took a long time to gain recognition. Francisco highlights Finhabits, Crediverso, Opportun, and Maza as companies that quietly focussed on Spanish language support, education, and building good financial habits. Playing the long game wins.

That's all, folks. 👋

Remember, if you're enjoying this content, please do tell all your fintech friends to check it out and hit the subscribe button :)

(1) All content and views expressed here are the authors' personal opinions and do not reflect the views of any of their employers or employees. 

(2) All companies or assets mentioned by the author in which the author has a personal and/or financial interest are denoted with a *. None of the above constitutes investment advice, and you should seek independent advice before making any investment decisions.

(3) Any companies mentioned are top of mind and used for illustrative purposes only. 

(4) A team of researchers has not rigorously fact-checked this. Please don't take it as gospel—strong opinions weakly held 

(5) Citations may be missing, I've done my best to cite, but I will always aim to update and correct the live version where possible.