Virtual accounts: the ins and outs of a traditional system going virtual
Welcome to the second article in a three-part series about the ins and outs of virtual bank accounts and how they benefit startups.
In the first article, we explored the definition of virtual bank accounts, touched on their function, and how they gained traction due to the rise of ecommerce.
In this article, we will explore further differences between virtual and traditional accounts, the relationship with fintechs, and how to get started with virtual solutions.
Virtual vs. physical accounts: security and protection for consumers
As discussed in part one of this series, one of the key differences between virtual and "physical" bank accounts – in other words, a traditional account – is that the latter can hold funds. Any amount held in a physical bank account is legally recognised as money. Whereas a payment service provider issuing virtual accounts would have to recognise those funds (at least in Europe) as E-Money.
The second key difference is the protections and licences that are in place. For example, in the United Kingdom, banking authorities mandate assurances that an account with a balance of up to £85,000 will be protected in the event of the institute failing.
Conversely, a Nonbank Financial Institution (NBFI) issued account with an E-Money balance does not have the same security. However, the majority of NBFIs incorporate rigorous safeguard policies to protect against the most drastic of eventualities. Regulators in the UK and Europe also do not deem these types of accounts to be compliant with rules around safeguarding either.
Since virtual accounts are conduits, they generally don't have the ability to go in the negative, limiting application for credit insurance.
How to issue standard accounts to my clients?
How to charge account maintenance fees?
Why fintechs love virtual accounts
Virtual accounts give fintechs the capacity to offer a much greater client experience than traditional financial institutions more easily and cost effectively. The majority of players are specialists in one aspect of what a bank does, and the ability to issue virtual accounts to users is a key foundational layer in any product. In addition, as mentioned in chapter one issuing virtual accounts allow companies to give customers complete control over their accounts with a modern and highly customisable user interface technology, which is far more user-friendly than the traditional banking systems/technologies.
Furthermore, some banks may perceive virtual accounts as a risk and choose not to offer them, especially if they would give a third party control over their banking licence. And finally, some banks may see offering virtual accounts as competition and choose not to offer them, while others cannot provide the same level of modern tech offered by Neo-Banks.
These negatives open up vast opportunities for companies to specialise in areas where a bank cannot. But, banks still sit at the heart of almost every aspect of finance.
There's still a need for traditional banking
Regulators around the world are working to lower barriers to entry in the banking and payments industry with initiatives like PSD2 and Open Banking. As a result, we have seen a rise in Neo-Banks that are directly integrating with domestic payment schemes.
However, even if a business bypasses a traditional bank, it still needs to connect to a central bank in order to access the payment network. Additionally, bypassing a bank is often not a practical or economical choice.
Instead, fintechs often use Directly Connected Non-Settling Participants (DCNSPs) to send payments directly to the scheme without having to front the required funds. This means that in most cases, a partner bank is still needed to access payment networks and issue IBANs.
Establishing a virtual account solution
So, how can companies actually issue virtual accounts? Deciding whether to build or buy depends on a number of factors.
Buying can be a cheaper and quicker way to launch a product, especially if the company has no experience building a Fintech product. Building requires a lot of time, experience, and resources, and there is no guarantee that the product will meet market needs. Thus, investing upfront costs and resources into building the foundation layers that need to be implemented to deliver customers the minimum service they expect might not be the right scale path for startups.
The ecosystem is becoming more collaborative and can help with virtual account solutions. Using a provider’s existing solution is a good option, as it eliminates the need to build from scratch. For example, CitiBank and ClearBank offer virtual account solutions, and there are many other providers that offer them as well.
Integrated Finance is another option for businesses who want to choose their own vendor and bank without having to worry about connecting multiple integrations on top of financial products. We offer a wide and ever-expanding range of APIs. Using our platform reduces the time and cost it takes to launch an MVP to market, allowing more time and resources to be spent on differentiating product offerings that solve problems in underserved market segments.
In the third and final part of this series, we will dive into how traditional banks view virtual accounts and the rise of Neo-Banks.
