25 February 2024 |

Premium Neobank. Discount AmEx.

By Alex Johnson

Winter, Monadnock (ca.1900) Abbott Handerson Thayer.

3 FINTECH NEWS STORIES

#1: Premium Neobank. Discount AmEx.  

What happened?

As you may have heard, Capital One is buying Discover:

Capital One’s recently announced $35.3 billion acquisition of Discover Financial isn’t just about getting bigger — gaining “scale” in Wall Street-speak — it’s a bid to protect itself against a rising tide of fintech and regulatory threats. 

The deal, if approved, enables Capital One to leapfrog JPMorgan as the biggest credit card company by loans, and solidifies its position as the third largest by purchase volume. It also adds heft to Capital One’s banking operations with $109 billion in total deposits from Discover’s digital bank and helps the combined entity shave $1.5 billion in expenses by 2027.

But it’s Discover’s payments network — the “rails” that shuffle digital dollars between consumers and merchants, collecting tolls along the way — that [CEO Richard] Fairbank repeatedly praised Tuesday when analysts queried him on the strategic merits of the deal. There are only four major card networks: giants Visa and Mastercard, then American Express and finally the smallest of the group, Discover.

“That network is a very, very rare asset,” Fairbank said. “We have always had a belief that the Holy Grail is to be able to be an issuer with one’s own network so that one can deal directly with merchants.”

So what?     

The value of the Discover network will manifest – immediately and in option value for the future – on both the credit card and debit card sides of Capital One’s business. 

According to Capital One, debit cards will go first. It sounds like the bank plans to migrate all of its debit card business to Discover’s Pulse network, starting in Q2 of 2025. By issuing cards and providing the network over which they are processed, Capital One (which would become the 6th largest bank in the U.S. by assets after this acquisition) would believe it or not, become exempt from the debit interchange cap imposed by the Durbin Amendment. This would give Capital One a lot of flexibility to increase its transactional revenue margin and/or fund merchant and consumer incentives to drive increased utilization.

Capital One will essentially become a premium version of a modern B2C neobank (Durbin-exempt interchange, but with no revenue split with a partner bank), and it will gain the option to become a significant player in the banking-as-a-service space for other B2C neobanks, should it wish.

Credit cards will take a little more time to migrate to Discover’s network, and they may never transition fully off Mastercard and Visa. Capital One has a lot more to lose on the credit card side of the business, so it makes sense for them to be a bit more cautious, especially with their premium transactor customers.

However, for the portion of the credit card business that does get moved over – likely the customers who are a little riskier and more likely to revolve a balance, Capital One’s primary customer base – the bank will be able to capture significantly better unit economics by being able to avoid paying transaction fees to V/MC.

Capital One will become discount AmEx – an operator of an at-scale three-party credit card scheme, albeit one centered around a lower spending, higher risk customer segment. Should it choose, it will have the option to leverage its new scheme to get ultra-aggressive in going after top-shelf co-brand credit card partnerships (as AmEx has done over the years with companies like Costco and Delta).

One last point. Richard Fairbank spent a lot of time on his call with market analysts talking about this acquisition unlocking Capital One’s ability to work more closely with merchants:

Capital One aims to deepen relationships with merchants by showing them how to boost sales, helping them prevent fraud and providing data insights, Fairbank said Tuesday, all of which makes them harder to dislodge. It can use some of the network fees to create new loyalty plans, like debit rewards programs, or underwrite merchant incentives or experiences, according to analysts.

“Owning a network allows us to deal more directly with merchants rather than a network intermediary,” Fairbank told analysts. “We create more value for merchants, small businesses and consumers and capture the additional economics from vertical integration.”

This reminds me a great deal of the strategy that BNPL providers like Affirm and especially Klarna, which are also building out three-party schemes, have been pursuing for a while. And it’s a strategy that Capital One, which has made several commerce-focused acquisitions over the last 10 years (Paribus, Wikibuy), is already well-positioned to implement. 

#2: Well, Yeah.

What happened?

The CFPB released the results from a newly updated survey on credit card pricing and terms:

The Consumer Financial Protection Bureau (CFPB) today reported on the first set of results from the newly updated Terms of Credit Card Plans survey. The survey data reveal that large banks are offering worse credit card terms and interest rates than small banks and credit unions, regardless of credit risk. In fact, the 25 largest credit card issuers charged customers interest rates of 8 to 10 points higher than small- and medium-sized banks and credit unions. This difference can translate to $400 to $500 in additional annual interest for the average cardholder.

So what?     

The headline from the CFPB’s press release sounds scandalous. As does the quote from Director Chopra:

“Our analysis found that the largest credit card companies are charging substantially higher interest rates than smaller banks and credit unions,” said CFPB Director Rohit Chopra. “With over $1 trillion in credit card debt outstanding, the CFPB will be accelerating its efforts to ensure that consumers can access better rates that can save families billions of dollars per year.”

But I’m not exactly shocked by this finding, and I don’t think anyone else should be, either.

The credit card issuers that are the most successful at acquiring customers are the ones that spend the most money on marketing and rewards. As I’ve discussed in this newsletter previously, the dominant business model in the credit card space depends on a majority of users using the product in an irrational way. This irrational use funds those same rewards and marketing campaigns, which could not exist (at the same level) without it. 

This isn’t a conspiracy or anti-competitive price gouging. It’s simply the natural end result of the way that credit cards, as a business, work.

#3: Wallet Confusion 

What happened?

Google is Googling (emphasis mine):

Google Wallet continues to be the primary place for people to securely store payment cards used for tap and pay in stores, alongside other digital items like transit cards, driver’s licenses, state IDs and more. To simplify the app experience, the U.S. version of the standalone Google Pay app will no longer be available for use starting June 4, 2024. You can continue to access the most popular features — tapping to pay in stores and managing payment methods — right from Google Wallet, which is used five times more than the Google Pay app in the U.S.

So what?

If you’re unaware of the history of Google changing its mind on Google Wallet and Google Pay, check out this article from The Verge.

The jokes about Google’s product management/marketing foibles have been made plenty of times, so I’ll take a pass and instead focus on the larger point – Google seems to have no clear vision for how payments, banking, commerce, and identity should fit together in a digital context.

Should payments be a destination, or should it be an invisible enablement layer baked into the OS? Should digital wallets be able to do everything that physical wallets can do, even at the risk of over-complicating an already-complex UI? To what extent can we blend mobile banking and digital wallets together? To what extent, if at all, should we blend them together?

No one knows! And not just at Google. As I have written about before, Apple has also made a mess of its wallet app (although in a less Keystone Cops manner than Google).

Perhaps the larger issue is that we keep using the physical wallet as a design metaphor for the payments/commerce/identity applications we build. Why are we doing that? Apple’s and (to a lesser extent) Google’s control over their mobile ecosystems should allow them to dream up significantly better solutions from first principles.

Maybe Google needs to scrap Google Pay and Google Wallet and start from scratch.   


2 FINTECH CONTENT RECOMMENDATIONS

#1: The State of the Culture, 2024 (by Ted Gioia, The Honest Broker) 📚

Let’s do some non-fintech content recommendations today.

First, this excellent essay from Ted Gioia on the state of culture in 2024 and the terrifying transition from art to entertainment to distraction.

Yet another article for me to print off and give to my kids when they get older and ask why they’re not allowed to have smartphones until they’re 36. 

#2: Second Winds (by Trung Phan, SatPost) 📚

This one by my internet friend Trung is excellent. It explores a question I often think about – how do you avoid burnout and continue to challenge yourself professionally and creatively?


1 QUESTION TO PONDER

What does Pagaya do? Who does Pagaya compete with? Where can I learn more about Pagaya?

I may write about Pagaya (and the broader space it operates in) in an upcoming newsletter and would love to get a bit smarter about the company!