The Capital One-Discover Merger
TL;DR
Background: Capital One Financial Corp.’s proposed acquisition of Discover Financial Services could transform competition in the payments space and confer significant benefits to consumers, especially those underserved by traditional banks.
While the merged entity would be the sixth-largest U.S. bank by assets, those would account for just 3% of total domestic bank assets. More significantly, the merged company would be the third-largest credit-card issuer by purchase volume.
But… The deal requires approval from the Federal Reserve, the U.S. Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corp. In addition, the U.S. Justice Department (DOJ) has authority to block the merger under antitrust law.
However… The merger will likely increase competition, innovation, and financial inclusion. For example, it would likely facilitate expanded free checking for lower-income consumers and foster continued innovation in serving sub- and near-prime borrowers.
The merger will spark competition in payment networks by expanding Discover’s reach in both debit and credit cards to better compete with Visa, Mastercard, and American Express. This aligns with the frequently cited policymaker goal of increased competition in this space.
KEY TAKEAWAYS
GREATER COMPETITION IN PAYMENT NETWORKS
Discover’s credit-card network is the fourth-largest in the United States, accounting for only about 4% of payment volume. Discover has languished at that figure for roughly two decades, trailing far behind Visa, Mastercard, and American Express.
For years, consumer advocates and policymakers have expressed concern about a perceived lack of competition in the credit-card network market, referring to Visa and Mastercard as a “duopoly” and calling for legislation to expand competition.
Capital One may be able to use its innovative culture and marketing savvy to leverage Discover’s card network and allow it to compete more successfully.
A POSSIBLE RETURN TO DEBIT REWARDS CARDS
By switching its debit cards to Discover’s payment networks, Capital One might offer more attractive products to depositors. In particular, it could expand access to free checking accounts with no minimum balance requirements to a wider range of low-income consumers. It also could offer debit cards with cashback to lower-income consumers who would not qualify for credit cards. The benefits for this important underserved community could be tremendous.
A NOT-SO-MEGA MERGER
Critics of the merger note a combined Capital One-Discover would be the sixth-largest bank by assets and the third-largest credit-card issuer by purchaser volume. But the merged company would hold only 3% of all domestic bank assets, a trivial amount compared to such industry behemoths as JPMorgan Chase, Citibank, and Bank of America.
While the merged firm would be the largest holder of credit-card debt, accounting for nearly 22% of outstanding credit-card loans by dollar amount, that amount remains below the merger threshold of all conventional antitrust analysis.
IMPROVED DATA SECURITY AND FRAUD PROTECTION
The merger has the potential to improve fraud detection in several ways. When Capital One’s debit cards are moved to Discover’s networks, they will no longer be subject to routing requirements under the so-called “Durbin amendment.” As a result, all transactions on those cards will be monitored directly by Capital One’s systems. In addition, Capital One will be able to implement its highly innovative fraud-detection and prevention systems across all Discover networks.
WHAT ABOUT SUBPRIME BORROWERS?
Critics of the merger focus much of their concern on potential harms to “near-prime” or “subprime” segments of borrowers.
There is, however, little evidence that “near-prime” or “subprime” borrowers constitute a distinct market for antitrust purposes. In particular, a consumer’s credit status is rarely static over time. Due to changes in income and other circumstances, a subprime borrower today may be a prime borrower next year, and vice versa.
Moreover, Capital One gradually gained its market share in the “subprime” space through its data-driven strategy. This has enabled the company to identify lower-risk individuals in (otherwise) higher-risk groups, thereby serving otherwise underserved consumers, while limiting default risk. It also provides opportunities for these consumers to migrate toward a lower-risk category by gradually increasing the size of their credit lines as they demonstrate creditworthiness.
For more on this issue, see The Capital One-Discover Merger: A Law and Economics Analysis.