Is the Capital One/Discover Deal Good or Bad For “Competition”? Yes.
Is the Capital One/Discover Deal Good or Bad For “Competition”? Yes.
CFPB To Use Once-"Dormant" Authority On World Acceptance, WI Congressman Introduces Federal EWA Bill, OCC's Hsu Suggests Federal MTL Framework
Hey all, Jason here.
If you missed Friday’s special breaking news edition covering Lineage’s consent order and potential implications for banking-as-a-service and fintech, I highly recommend giving it a read here.
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One thing the order made overwhelmingly clear: if you are on the board of bank engaging in BaaS or fintech partnerships, you need to have an understanding of and visibility into those relationships at a fairly detailed and sophisticated level.
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Is the Capital One/Discover Deal Good or Bad For “Competition”? Yes.
Given that Capital One’s acquisition of Discover holds the potential to drive a once-in-a-generation shake up of the US payments space, I’m basically legally obligated to write about it.
But I’m also cognizant that much ink has already been and will continue to be spilled on the topic (by people who are much smarter than I), so I will try to keep my thoughts brief and highlight other analysis on the acquisition I’ve found helpful.
In acquiring Discover, Capital One is getting (at least) four things: Discover’s credit card network, its debit card network, PULSE, a top ten credit card issuer, and the rest of Discover’s banking business: deposits, checking accounts, mortgages, personal loans, and so on.
The question of whether or not the acquisition is harmful to competition is one that will surely be an intense battle in the coming months. The complexity of the multifaceted deal arguably has elements that are both “good” and “bad” for competition.
Politicians from both sides of the aisle are already weighing in — and not, necessarily, on the side you might expect. Sherrod Brown (D-OH) and Elizabeth Warren (D-MA) were joined by Josh Hawley (R-MO), who called on the Department of Justice to block the acquisition, writing, “This is destructive corporate consolidation at its starkest. If consummated, this merger will create a new juggernaut in the credit card market, with unprecedented powers to extort American consumers. That cannot be allowed to happen.”
On the network side, Capital One’s acquisition of Discover and stated plan to shift issuing of some of its credit cards to Discover over time is the most substantial market threat Visa and Mastercard have faced to their duopoly possibly ever. Though while Capital One would certainly bring greater heft to the Discover card network, it isn’t immediately clear to me how this increased “competition” would result in Visa or Mastercard reducing their pricing.
It certainly doesn’t hurt that by acquiring and issuing on Discover, Capital One would retain the network fees it would otherwise have to pay to Visa or Mastercard. And, should the Credit Card Competition Act become law, Capital One would stand to benefit from the requirement that card issuers with over $100 billion in assets enable merchants to route transactions on a network other than Visa or Mastercard. (If the CCCA passes, it should make credit/charge card issuers with less than $100 billion in assets more attractive partners than covered issuers for co-brand programs, but that’s another topic altogether.)
The Durbin amendment, which regulates debit interchange, doesn’t apply to three-party networks like Discover — meaning that Capital One, despite being well over the $10 billion threshold at which Durbin applies, could issue Durbin-exempt debit cards as a result of the acquisition.
This would have the result of increasing the fees merchants pay vs. if Capital One continued issuing debit cards that operated on Visa or Mastercard. The cost of payment processing for merchants, and the perception that reducing this cost will be passed along as savings to end consumers, has been a frequent talking point in the debate about payment network regulations.
In theory, the fact that Durbin doesn’t apply to three-party networks could enable Capital One, post-Discover acquisition, to play in the fintech sponsor bank space for debit programs, not that that appears to be a consideration driving the acquisition.
If the story on the card network side is theoretically supportive of increased competition, the impact on the banking side pretty clearly is not.
Capital One is currently the country’s 9th largest bank by assets. Discover is the 27th largest bank by assets. Post-acquisition, absent any divestments, the combined entity would become the 6th largest bank by assets. And while the resulting size alone doesn’t automatically block such an acquisition, regulators have generally telegraphed that they don’t want to see already large banks become even larger.
By payment volume, Capital One is currently the fourth largest card issuer, while Discover is the sixth. From a credit card lending standpoint, post-acquisition, Capital One would be the largest card lender, jumping ahead of JPMorgan Chase and Citi:
The proposed acquisition also comes at time when banking regulators are revisiting how to review and consider whether or not to approve such acquisitions. The OCC, Capital One’s primary federal banking regulator, has proposed amending its rules for considering such business combinations, including a proposed policy statement for how the OCC reviews applications governed by the Bank Merger Act.
Michele Alt, a former OCC regulator and co-founder and managing director of financial services advisory firm Klaros Group, analyzed how Capital One’s proposed acquisition fares under the criteria the OCC considers to be “consistent with approval.”
Beyond the size consideration, there are a number of potential road blocks, including Discover’s outstanding consent order (though Discover plans to divest the private student lending business that contributed to that enforcement action), the potentially negative impacts on competition from greater concentration in card issuing, the potential for the OCC to take issue with the application of the Durbin exemption, and concerns from consumer advocates about Community Reinvestment Act and consumer compliance considerations.
Additional reading and analysis on the deal:
Bloomberg Law: Capital One’s Discover Buy Puts Antitrust Regulators to the Test
Zarik Khan: Capital One buys Discover — now what?
Marc Rubinstein: The Third Network (partially paywalled)
Fintech Blueprint: Long Take: Can the $35B mega-merger of Capital One and Discover succeed? (partially paywalled)
TWIF Signals: What’s in your wallet? (paywalled)
American Banker: 5 key drivers of the Capital One-Discover merger (paywalled)
Wall Street Journal: Capital One Is Buying Discover Financial for $35 Billion (paywalled)
CFPB To Supervise World Acceptance Corp Under Once-“Dormant” Authority
Late Friday, the CFPB announced it has used a once “dormant” authority to supervise nonbank entities that pose a risk to consumers to establish supervisory authority over World Acceptance Corp, a high-cost state-licensed installment lender.
In 2022, when the Bureau announced it would begin using this authority, it also issued a procedural rule “to increase the transparency of the risk-determination process” by enabling the CFPB to unilaterally release information about the agency’s decision on whether or not to bring a nonbank entity under its supervisory authority on the grounds that it “poses a risk” to consumers.
The Bureau’s exercise of this supervisory authority over a specific company is supposed to take into account:
(A) the asset size of the covered person;
(B) the volume of transactions involving consumer financial products or services in which the covered person engages;
(C) the risks to consumers created by the provision of such consumer financial products or services;
(D) the extent to which such institutions are subject to oversight by State authorities for consumer protection; and
(E) any other factors that the Bureau determines to be relevant to a class of covered persons.
Friday’s announcement is the first time the CFPB has publicly released such a designation “in a contested matter,” according to the Bureau’s press release on the matter. This suggests the possibility that the Bureau may be supervising other nonbank entities under this authority, and that those companies did not seek to fight the designation.
Per Dodd-Frank, the CFPB’s supervision of nonbank covered persons is for the purposes of:
(A) assessing compliance with the requirements of Federal consumer financial law;
(B) obtaining information about the activities and compliance systems or procedures of such person; and
(C) detecting and assessing risks to consumers and to markets for consumer financial products and services.
The CFPB’s 22-page order lays out its justification for initiating supervision of World Acceptance Corp.
World Acceptance has over 1,000 storefront locations across 16 states, through which it issues installment loans between $500 and $6,000, with an average term of 20 months. The average loan has principal of $600 and an interest rate of 46%, though World Acceptance issues loans at rates as high as 100%.
The CFPB lays out four risks that World Acceptance’s conduct poses to consumers to justify supervising the company:
that World Acceptance does not adequately explain to borrowers that credit insurance it offers with its loans is optional;
that World Acceptance engages in “excessive, harassing, and coercive collection practices”;
that the CFPB has reasonable cause to determine that World Acceptance furnishes inaccurate information to credit reporting agencies or fails to adequately respond to consumer disputes about inaccurate information;
and that the CFPB has reasonable cause to believe that World Acceptance’s business model depends on it “serially refinancing” its loans, which can harm consumers in a variety of ways (this is often an example of what advocates mean when they refer to a lending product as a “debt trap” or “predatory”)
In fighting the CFPB’s effort to exert supervisory authority, World Acceptance made a number of arguments:
World Acceptance questions whether “unverified” consumer complaints were an adequate basis to designate the company for supervision
World Acceptance argues that its volume of complaints is not “materially different” from other lenders
World Acceptance argues that the CFPB should consider the company’s “handling and resolution” of complaints
World Acceptance argues that the CFPB cannot rely on “generalizations” that would apply to any lender and must supply a “specific basis” for its risk designation
World Acceptance argues that prior CFPB and state investigations that did not result in enforcement actions demonstrate the company’s practices do not pose a risk to consumers
World Acceptance argues that the CFPB failed to adhere to the proper process in designating the company for supervision
The Bureau rejected these arguments, concluding that Dodd-Frank expressly states that a risk designation may be based on consumer complaints or information from other sources. Nothing in the statue specifies a threshold volume of complaints, and that World Acceptance responds to and in some cases disputes the facts of consumer complaints does not make those complaints an invalid factor in supporting the designation, the Bureau argues.
Nothing in Dodd-Frank requires the CFPB to demonstrate the risk posed to consumers is unique to the company, the Bureau says. Prior investigations into World Acceptance that did not result in actions are not a valid basis to refrain from designating the company for supervision, as law enforcement agencies generally have “broad discretion” in choosing whether or not to pursue an enforcement action. Declining to do so is not necessarily exculpatory, the Bureau argues.
Finally, the Bureau rejected World Acceptance’s argument that it did not follow the proper process in making its determination.
Wisconsin Republican Proposes Federal EWA Legislation
Rep. Bryan Steil, of Wisconsin’s first district, introduced HR 7428, the Earned Wage Consumer Protection Act, which would establish a federal regulatory and disclosure framework for earned wage access. The bill address both “employer-integrated” and “direct-to-consumer” models.
Notable elements of the draft bill include (emphasis added throughout):
defining “consumer-directed wage access services” as offering EWA “based on the consumer’s representations and the provider’s reasonable determination of the consumer’s earned but unpaid income”
defining “employer-integrated” as basing access on “employment, income, or attendance data obtained directly or indirectly from an employer”
excluding voluntary “tips” and “donations” from the definition of “fee,” though such payments are subject to certain conditions
service providers that facilitate but do not fund EWA, like payroll providers, would not be considered EWA providers.
employers that directly offer such services would not be considered EWA providers
financial institutions that permit “early access” to funds associated with an electronic transaction the institution has received information for but not yet settled (eg, “2-day early pay”) would not be considered EWA providers
the bill would prohibit discrimination with respect to any aspect of a transaction on the basis of race, color, religion, national origin, sex, pregnancy, marital status, or age — this is necessary as, because the bill explicitly defines covered EWA products as not being credit, the non-discrimination protections of ECOA wouldn’t apply
providers must have a consumer dispute policy and process
providers do not have recourse (eg arbitration, debt collection, reporting to CRAs, lawsuits) in the event of non-payment, except in cases of fraud
providers must give consumers clear and conspicuous disclosures, fully informing consumers of their rights and all applicable fees
providers may not charge late fees
if providers accept “tips” or “donations,” it must clearly disclose to consumers before each transaction that such payments are voluntary, may be zero; providers may not condition the amount a consumer is eligible to access on whether or not they “tip” or the amount of any “tip”
providers cannot share the proceeds of any “tips” with employers
if providers take repayment from a consumer’s deposit account, the provider must comply with the protections of EFTA/Reg E and must reimburse consumers in the event the provider causes an overdraft or non-sufficient funds fee
empowers the CFPB to promulgate regulations applicable to EWA providers
explicitly clarifies that proceeds provided to consumers in compliance with the bill are not considered “credit,” that providers of such products are not considered “creditors,” and that any fees, “tips,” or “donations” are not considered “finance charges”
The bill, in the unlikely event it is passed, would go along way to providing a consistent framework for regulating earned wage access — at least at the federal level.
The bill would not preempt state regulations, like the proposed regulations in California, for instance, which would explicitly define EWA products as “loans” and fees and “tips” as “charges,” for the purposes of California law.
Acting Comptroller Hsu Suggests Federal MTL Framework
In a speech he gave last week on the “blurring” between commerce and banking, Acting Comptroller Michael Hsu focused on potential risks from the growing role of non-bank companies in the bank-like areas of payments and credit.
Hsu also argues the creation of a “comprehensive, federal money transmitter regime” could “better balance innovation and financial stability” than the status quo patchwork of state-by-state regulation (though, as some on X have pointed out, state MTL regimes, especially for MSBs that must register with FinCEN, are reasonably well harmonized.)
In his remarks, Hsu reiterates the idea that banks are “special,” owing to their ability to hold deposits, to provide liquidity to the economy, and to serve as a mechanism for the transmission of monetary policy.
On the other hand, “commerce,” is, well… everything else, including the unbundled components of banking, such as nonbank firms that provide credit or payments.
Hsu argues that excessive “blurring” between banking and commerce has, historically, been associated with financial crises, using the Panic of 1907, the Great Depression, and the 2008 Global Financial Crisis as cautionary tales.
In the payments space, Hsu uses the examples of peer-to-peer payments (Venmo, Cash App, PayPal) and point-of-sale terminals to illustrate how some “commercial” firms have pushed further into offering bank-like products and services.
Hsu argues this “rebundling” of banking capabilities by commercial firms warrants close scrutiny, saying (spacing adjusted and emphasis added):
“As importantly, from a macro-prudential perspective, the prospect of banking being rebundled by nonbank entities outside of the bank regulatory perimeter bears careful monitoring because of the financial stability implications.
By rebundling I mean the recombination of payments, lending, and deposit-taking by a single firm. Arguably, some fintechs are already doing this, blurring the line between banks and nonbanks (and raising concerns about level playing fields).
Companies that started off simply facilitating payments now offer customers the ability to deposit paychecks directly into their accounts, earn yield on the cash held there, and access credit, all with a few clicks of a mouse or taps on a phone.”
Of areas of potential concern, Hsu highlights non-banks that are engaging in deposit-taking-like activity that opens them up to the potential of a run.
In examining what tools regulators have today to monitor and mitigate such risks, Hsu notes that “most roads lead back to banks eventually.” He notes that non-bank firms offering bank-like services generally rely on a sponsor bank, either directly or through a banking-as-a-service provider, meaning, somewhere, there is a bank in the “supply chain” that is overseen by a federal regulator.
Hsu also notes that regulators have a number of tools to directly supervise non-banks, including the CFPB’s authority and powers granted to banking regulators to directly examine certain third-party bank service providers under the Bank Service Company Act.
Perhaps the most surprising piece of Hsu’s remarks was his call for a federal money transmitter licensing regime, which, he argued, would allow for a “comprehensive federal oversight regime” for non-bank companies in the payments space.
He floated a federal MTL regime in contrast to the idea of a national “fintech” or “payments” charter some have advocated for, saying (emphasis added):
“[The OCC] will not, however, lower our standards, create a special regime, or take an overly expansive view of banking to entice new entrants or in the hope of bringing a particular activity into the bank regulatory perimeter…
Rather than contort bank charters and blur banking and commerce (à la 1929), a better solution would be for Congress to create a federal framework for payments regulation, as recommended by the U.S. Treasury in its report on the future of finance. Doing so would provide a clearer path for innovation and growth in payments with less risk of blurring and to financial stability.”
Other Good Reads
Corrected Link: Stabilizing Fake Banks (Todd Phillips and Matthew Bruckner)
Top Management and Performance Challenges Facing the Federal Deposit Insurance Corporation (FDIC Office of Inspector General)
Fintech Franchises (Fintech Takes)
Listen: Interview with CapStack’s Founder/CEO Michal Cieplinski (Fintech Business Weekly)
Listen: M&A and AOBA 2024 (Breaking Banks)
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