Direct debit, also referred to as direct withdrawal, electronic checks, and direct payments is a type of payment system that allows businesses to debit funds directly from customers’ bank accounts. The debits are made utilizing an electronic funds transfer method. Direct debit is widely used by organizations worldwide and is recognized as one of the most efficient methods for collecting payments.
All types of organizations can utilize direct debits and today, many insurance companies, utility companies, banks, local authorities, telecommunication suppliers, and charities utilize direct debiting. Direct debt processing is much the same as credit card processing. Authorization and bank information is typically required, received by fax, phone or internet, and then submitted to the bank or payment processor where the payments are to be processed.
Direct debits are generally set up in one of two ways. The first method requires the consumer to provide an authorization to one’s bank allowing the debit note to be withdrawn from one’s bank account. The second method requires the consumer to provide authorization to the organization that is to make the debit from one’s bank account. The types of methods used by organizations vary worldwide and the rules that govern direct debit do vary from country to country. Depending on the country the consumer lives in and the form of authorization provided, direct debit can be utilized to arrange for recurring payments, to prepay orders, or to pay a particular invoiced amount.
Benefits of Direct Debit
- Ensures timely payment(s)
- Eliminates need for checks
- Reduces administrative costs
- Enables auto-recurring billing
- Reduces customer attrition and increases renewals
- Allows for payment to be received by phone or online
If using a direct debit provider, an agreement is made between both organizations. Bank account information is then collected from customers by fax, mail, telephone, or Internet, and then submitted for proper authorization and processing. Once the processing is complete with proper authorization, then the bank is allowed to debit consumers’ accounts accordingly. In most countries, it is necessary to include a direct debit permission (authorization) or mandate.
In the United States, typically an Automated Clearing House (ACH) will be utilized to transfer monies from a consumer’s bank account to a collector (billing) organization. The ACH is an electronic network that processes large volumes of both debit and credit transactions. The ACH network is governed by the Federal Reserve and the NACH-The Electronic Payments Association, which formerly was known as the National Automated Clearing House Association.
United Kingdom and Republic of Ireland
The United Kingdom caters to almost 40 million direct debit users; however, it has a much more rigorous set of requirements compared to other countries for merchants seeking to process direct debits. Organizations seeking to utilize direct debits in order to collect payments from consumers must have an Originators Identification Number (OIN). If an organization wishes to utilize direct debiting online, the United Kingdom mandates the utilization of a CyberSource processor. Furthermore, before direct debits can be set up, the consumer must complete a Direct Debit Instruction to his or her bank, which then must be properly vetted by the bank. This is required in order to avoid the defrauding of consumers and to ensure that proper protocols are in place that follow governing regulations.
In Germany, direct debiting (Lastschrift, Bankeinzug) is provided by banks after a direct debit authorization is obtained. In Germany, two methods are used for direct debits. The most common method is known as “Einzugsermächtigung.” It authorizes the organization to debit the consumer’s account either for a fixed amount, for a future invoice, or for recurring payments. Authorization is obtained from the consumer who then sends it to the organization that is collecting the payment. Before authorization is given, the organization must sign an agreement that it will only process direct debits where it has obtained the appropriate authorization.
The second method, “Abbuchungsauftrag,” is rarely utilized by private consumers, but on occasion is used between businesses. The difference with this method is that the payer provides authorization to his or her bank to honor direct debit requests from a particular organization. The bank then checks for incoming direct debits that are flagged as “Abbuchungsauftrag” and verifies that there is a matching authorization held on file. If such an authorization is not on file, then the direct debit is returned.
In Australia, direct debits can be authorized when the consumer provides such an authorization to the organization that is seeking to collect payment(s). Notification to the consumer’s bank is not required.
As with Germany and Australia, in the Netherlands consumers do not need to notify their banks, but simply provide authorization of the direct debit to the payee. Authorization may be for a one-time charge or a recurring charge.
In Japan, direct debit services are offered on the basis of a tri-party agreement and authorization between the consumer, the payee, and the consumer’s bank. The payee sends the authorization obtained, along with instructions to the bank on a paper basis, on magnetic tape, or through online transmission.