Payments Post #11: Closing the Loop: Cap None?

Payments Views

March 14, 2024

By Justin Pituch & Chris Uriarte

Just when our editors were thinking that the payments world was getting unusually quiet, we got the blockbuster announcement that Capital One intends to acquire Discover. So, while we usually take a number of news stories from the previous month and weave them into a story that offers clues into the state and trajectory of the industry, this month’s recap will be a little different: we’ll take a look at this single news story from the perspectives of the various ecosystem participants it affects. In summary, expect more pressure on issuers and rival networks as these two industry heavyweights join forces, which could be good news for consumers and merchants. But first, we have to see how regulators will respond. Let’s dive in.

We’ll start with issuers. Capital One and Discover are both huge issuers, with a combined $824 billion in 2023 purchase volume. Their combined entity would be both a behemoth depository institution and card issuer. Should the deal go through as proposed, the combined entity would become the largest credit card lender in the U.S., with balances 20% greater than JPMorgan Chase, and would trail only Chase and American Express in terms of purchase volume. With this combined heft, we see the organization as well positioned to offer strong everyday cards and to continue chipping away at the premium market with the Venture line and a host of snazzy new airport lounges. 

We’re also interested in Discover’s somewhat unique cashback debit card, enabled by their Durbin exemption. Discover’s debit product has experienced significant growth and, when combined with Capital One’s checking deposit base and branch network, the new entity will become one of the largest debit issuers in the country. Moreover, Capital One will quickly move to take advantage of its ownership of a Durbin-exempt closed loop network: it plans to move its entire debit portfolio (today supported by Mastercard) to Discover starting in Q2 2025, earning perhaps twice as much on its debit transaction as any other large issuer It also plans to migrate some of its credit card products, which are now a mix of Mastercard and Visa, when feasible. In the nearer term, domestic-focused Capital One credit cards will likely move to the Discover network, but travel cards (like the Venture X card) that require true global reach will probably remain attached to the Visa and Mastercard brands until the reach and branding of the Discover network has been enhanced globally. Although this threatens big banks, Jamie Dimon seemed fine with a bit of added competition in the days after the announcement, saying “I’m not worried about it, really.”

Next, let’s take a look at rival networks. Though at parity in terms of acceptance locations, Discover is still by far the smallest of the U.S. credit card networks. Still, its network capabilities are an invaluable asset, especially when considering that the organization also controls the PULSE debit network and has access to a number of international networks (perhaps most significantly China UnionPay) through reciprocal agreements. I believe this is the first time we’ve seen an issuer control its own closed loop network while maintaining the ability to issue some of its card portfolios on the open loop networks. 

Where do merchants fit into all this? They can reasonably expect more PULSE and Discover volume in the coming years as Capital One moves cards off of Mastercard and Visa. One of the most important things to consider is that a significant portion of debit cards issued by this new player will earn unregulated interchange, potentially resulting in a higher total cost of card processing for debit-heavy merchants. It also brings Capital One “closer to the merchant,” something my colleague Chris Uriarte, a Partner here at Glenbrook, pointed out. “Becoming more closed loop means that they can, perhaps, offer the merchant better financial incentives, more effective fraud detection, and better authorization performance. This deal introduces a huge new credit issuer that might be open to direct negotiation and collaboration with merchants,” he explained. 

Likewise, consumers will likely see some benefit if Capital One is able to leverage its acquisition to expand its breadth of offerings while retaining Discover’s beloved (and highly rated by J.D. Power) customer service model. And maybe the Discover cashback card will inspire a debit rewards renaissance. Points connoisseurs like us Glenbrookers might even be inspired to dust off our debit cards for some cashback. And fans of Samuel L. Jackson and Jennifer Garner may also be in for a treat, as it’s estimated that the newly combined entity will have a marketing budget that rivals Amex’s ad spend. You’ll likely be asked, “What’s in your wallet?”: the new Capital One will hope that it’s a closed-loop Discover credit card and a Durbin-exempt Discover debit card.

But all this depends on regulatory approval. I’m of two minds here, as are many industry onlookers. On the one hand, regulators are eager to curtail what they view as the outsized influence of Mastercard and Visa. On the other hand, antitrust regulators might view this as an inappropriate consolidation of industry might in a sector like credit card lending. We’ll see what the next few months hold. Stay tuned. 

In the meantime, as always, reach out with any thoughts or payment questions. We’re here to talk.

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