How virtual bank accounts differ from physical bank accounts

January 26th, 2023

This is the first article in a three-part series about the ins and outs of virtual bank accounts and how they benefit Fintech startups.

Virtual bank accounts just sound like the online version of bank accounts, right? Well, they're actually so much more than that. What if we told you that virtual accounts aren't anything like a traditional bank account at all?

In this article, we'll define what a virtual bank account is, as well as its rise in popularity, and its necessity in an ever-changing and connected world.

What are virtual bank accounts?

In most cases, virtual bank accounts function and operate similarly to traditional bank accounts. For example, depending upon which payment scheme and virtual bank accounts they are housed in, they can have a standard Bank Identification Code (BIC) and International Bank Account Number (IBAN) just like a real bank account. Furthermore, if virtual bank accounts are connected to a local scheme they may also include the corresponding jurisdictional format.

Similar to standard bank accounts, virtual bank accounts have their own unique account numbers and can be used to receive and send funds. However, regardless of the marketing, hype, or wording from a financial institution, virtual accounts are not bank accounts.

The key difference is that virtual bank accounts cannot hold funds – they do not hold balances. They are, in fact, conduits, acting as routing points, channelling money to flow through. They are tributary channels to the traditional/physical accounts that house them.

Virtual bank accounts cannot act in isolation and are always tied to master or omnibus accounts.

In practice, a virtual account hierarchy is typically underpinned by a single physical account header, with as many virtual accounts as needed sitting underneath. Pay-ins and payouts can be processed via each virtual account while the actual fund movements take place through the physical header account.

Virtual bank accounts were built with a specific use in mind, namely to help businesses reduce the number of errors and pain caused due to the management of multiple physical accounts.

The function of virtual bank accounts

Virtual accounts were designed to provide Fintechs with several additional benefits, namely:

To reduce the amount of bank accounts users needed to maintain.
Simplifying cash management and reconciliation.
Provide the same level of control and reporting as traditional accounts.

One key advantage of virtual accounts is that they can simplify the process of making payments by requiring only a name or unique identifier for a transaction, rather than a recipient's full name, account number, branch code, account type, and bank name. This reduces the margin for error and makes the process more efficient.

In addition, virtual accounts allow funds to pass through them, acting as conduits for fund transmission. This makes it possible for businesses to collect millions of payments in separate, unique virtual accounts and have those payments automatically transferred to a central operational account, streamlining the reconciliation process and reducing the cost of operation.

What can virtual accounts actually do?

They have two functions. The first is that they serve (just like a physical bank account) as a referencing system. The second (and increasingly more popular) function is that they enable editing of the sender/receiver name on an individual transaction.

Referencing system

A bank account number acts as an identifier. This identifier, given to each customer, ensures that a bank has no two customers using identical credentials or accounts. Thus when the bank receives a credit to its network with the appropriate reference identifier, it understands who that money is for.

Virtual accounts allow the neobank to give their customers this same level of control for precisely the same reasons, effectively daisy-chaining the functionality of account creation. Where a bank previously would issue one account per customer, now they can give customers a range of account numbers for them to reissue with their own decisions.

Account sender/receiver editing

Virtual accounts are increasingly being employed as a payment function as well.
For example, when a virtual account holder is sending money to another virtual account holder they can see the name of the individual to whom they sent the money instead of the third party who issued the account.
In other words, the recipient does not see the third party who is supplying the virtual account (e.g. a bank or a Non-Bank Financial Institution – NBFI), instead, they see the name of the (user) sender in their account statement. The ability to edit account sender and receiver provides users with a customised experience that allows them to manage their finances more efficiently.

Virtual bank accounts are also used as collection methods and are a convenient way to receive funds more easily at lower costs. Virtual accounts facilitate transactions from geographies or platforms where companies have a commercial presence but not a banking one.

The influence of eCommerce

Virtual accounts and their various functionalities have seen an explosion in necessity due to the rise of ecommerce. Ecommerce means that even the smallest of businesses can sell and buy products and services internationally. And with virtual accounts, now these small businesses can have accounts internationally, too.

For example, if you are a small American business selling in Japan, this solution is perfect. Ten years ago, a small business receiving a foreign bank wire was just too complicated, slow, and costly to make it worth anyone's time.

However, with virtual accounts, the SME can have a local account in Japan. Now they can collect payments as if they were a local business.

Fintech is empowering businesses to play globally and compete locally.
In the next article, we will look at security and protection for consumers, why Fintechs love virtual accounts, and why there is still a need for traditional banking.

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