Within the US credit card industry, non-bank institutions have always been a fundamental part of the system. They occupied a small space that the major bank issuers could not serve, or indeed did not want to serve. Non-banks dominated the store card industry – Sears and Federated Department Stores were two of the largest US retailers with sizable credit card programmes. The profitability of such store card portfolios made the bank issuers envious, and soon they were acquired by JPMorgan and Citi respectively.
Also, the acquisition by Bank of America of the largest non-bank issuing institution in the US – MBNA – demonstrated how lucrative non-bank card portfolios could be. Such acquisitions, however, do not suggest that non-banks are under threat from their more established bank competitors. It could be that the reverse is slowly coming true.
Expansion and diversification
Non-bank players have built upon their success to expand their operations into the mainstream credit lending space. The rise of non-bank players correlates with the general shift towards electronic payments and card products, instead of cash and cheques, particularly with regard to payments made at POS locations. At the same time, non-bank players have also increased and diversified their activities, such as the operation of ATM networks, and have benefited from the rise in the use of debit cards in the US.
Electronic funds transfer (EFT) networks, used for ATM and online debit card transactions, have a large non-bank presence. Non-banks also are important operators of ATM terminals and are prevalent in private-label credit card issuance. Debit card issuers comprise an important third category. The majority of debit cards are issued by banks belonging to one or more of the regional or national EFT networks or offline debit card networks, but some non-banks issue debit cards as well.
New entrants, such as card payment network Tempo Payments, previously known as Debitman, have made their bank issuing competitors sit up and take notice. In the prepaid card space, non-bank players are even more prominent.
Increasingly, non-bank players are taking away market share from their bigger bank rivals, and as such they are becoming an even more important part of the retail and consumer credit payment systems, due to the competitiveness they have brought to the wider payment industry.
A look at the activities of some of the best-known non-bank players over the past year indicates how proactive they have been in increasing their presence in the wider payment industry.
GE Money is the world’s largest non-bank financial institution. With $163 billion in assets, GE Money provides credit services to consumers, retailers and auto dealers in approximately 50 countries.
In 2006, it teamed up with online auction website eBay to launch the PayPal Plus credit card, a MasterCard-branded card incorporating a rewards programme. The Plus Card is an expansion of the relationship originally created in June 2004 for GE to offer PayPal Buyer Credit, a private-label revolving credit line available to registered PayPal customers. The PayPal Plus Credit Card is part of a new multi-year credit agreement in which GE also plans to launch an eBay-branded credit card. GE Money Bank will be responsible for issuing the PayPal Plus Credit Card, and providing customer service, billing and credit management.
In January 2006, GE announced that it would issue American Express-branded credit cards in the US, enabling retailers to have more choice and flexibility. The first product to be offered under the new agreement was a card for retailer Dillard’s. Under the terms of the agreement, GE is responsible for issuing the cards, managing the customer relationships and providing customer service, billing and credit management.
Tempo Payments operates a PIN-based payment network that uses retailer-issued and branded debit cards. The Tempo Payment Network requires no merchant changes at the point of sale because retailer-issued cards are accepted through existing payment terminals and processor networks. Retailers issuing and accepting Tempo-enabled debit cards are charged lower interchange rates, reducing their payment processing costs. Participating retailers can pass on a portion of the savings to consumers in the form of incentives and discounts, which increases customer loyalty and drives more frequent and larger purchases.
In November 2006, Tempo signed an agreement with Fiserv EFT to provide access to the Tempo Payment Network beginning in early 2007. Fiserv EFT operates one of the largest debit authorisation gateways in the US, providing ATM and debit services to more than 2,700 financial institutions across the US, and the agreement provides expanded processor access to the Tempo Payment Network for merchants issuing and accepting retailer-branded debit cards. Fiserv EFT currently processes approximately 435 million ATM and debit transactions per month, making it one of the largest EFT processors in the US.
Over the past year, Tempo has expanded its processor relationships, raised $12.3 million in financing, and worked with grocery, pharmacy and convenience store chains to issue retailer-branded debit cards. Retailer-branded card programmes are available through Homeland Stores, Wesco and Wawa.
Discover Financial Services, a business unit of Morgan Stanley, operates the Discover Card with more than 50 million cardholders, and the Discover Network, with more than 4 million merchant and cash access locations. Discover Financial Services also operates the Pulse ATM/debit network, which serves more than 4,200 financial institutions and includes nearly 250,000 ATMs and approximately 3.4 million POS terminals. Discover acquired the Pulse ATM/debit network in January 2005.
In February 2006, Discover announced that it had become the first credit card services company to compete directly with Visa and MasterCard in the rapidly growing US signature debit market with the launch of Discover Debit. This marked the first new signature debit programme to be offered to financial institutions since the ruling in the Department of Justice anti-trust case in October 2004. The ruling enabled financial institutions that already issue credit or debit cards from the bank card associations to issue additional cards from other brands.
First Data Debit Services, part of global payment processor First Data, provides ATM, PIN-secured and signature debit card processing, ATM terminal driving and monitoring, fraud prevention services and PIN-secured debit network access via the Star Network. Approximately 5,500 financial institutions participate in the Star Network, offering cardholders access to their deposit accounts at approximately 2 million ATM and retail locations in the US. There are approximately more than 140 million cards carrying the Star logo.
Star has a broad footprint of distribution points across the US, including the acceptance of the Star card at approximately 5.1 million POS terminals. In 2005, First Data Debit Services processed 9 billion transactions.
MasterCard considering non-banks
Visa and MasterCard, being bank-owned membership associations, are also watching the rise of the non-bank issuers intently. Recent speculation in the US alluded to MasterCard considering authorising non-banks to be card issuers on its network, which would have wide-ranging implications not only for MasterCard and its bank customers, but also for the wider payment industry. If non-banks were to become issuers, banks would be eliminated from the payment processing side of the business, resulting in a significant dent in profits.
Also, the recent spate of interchange-related lawsuits in the US, brought by disgruntled merchants, would be threatened – instead of paying interchange to banks, merchants would receive interchange themselves. This too would have a major impact on bank profits.
There are significant obstacles in the way, however. Any merchant would have to have an official bank or an industrial loan company (ILC), via a Federal Deposit Insurance Corporation (FDIC)-insured loan company, but this would have the potential to bolster the merchant’s profits.
The world’s largest retailer, Wal-Mart, has been thwarted by regulators in its efforts to buy a US bank, but it has been successful in forging alliances with other non-bank players. In its latest move, announced in January 2007, it linked up with Discover and GE Money to launch a fee-free Wal-Mart Discover credit card, offering 1 percent cashback. Wal-Mart already has bank branches in its supercentres across the US, and is planning to expand the number of Wal-Mart-branded money centres, which offer payroll cheque-cashing services, money transfers and money orders at significantly lower costs than its banking competitors.
In March 2007, Wal-Mart was foiled again in its plans to open a bank, after intense opposition from consumer groups and politicians scuppered its 2005 application with the FDIC, forcing Wal-Mart to withdraw its application. Wal-Mart said its application had been surrounded by “manufactured controversy” since its submission, and it was dropping its bank plans in order to focus on rolling out financial services through its store network.
Wal-Mart said that it was looking to use the bank to internalise credit card and cheque transactions, enabling it to save money on more than 140 million credit and debit card transactions carried out each month at its stores, but opponents to the plan insisted that it was just the first step towards Wal-Mart becoming a fully featured retail bank.
Other non-banks, such as retailer Target and auto manufacturer General Motors, had previously received approval from the FDIC to operate banks.
Another large US retail chain, Home Depot, is ploughing ahead with plans to acquire an existing bank, EnerBank USA. Home Depot said that the Wal-Mart decision would have no effect on its plans, but it has yet to receive FDIC approval. In the wake of the Wal-Mart decision, it is unlikely to gain approval, and this will undoubtedly deter other retailers from pursuing similar applications. Another stumbling block was the January 2007 decision by the FDIC to delay reviewing applications for ILCs. There has also been pressure in the US Congress to bar non-banks, such as retailers, from owning banks.
Other companies that will be blocked by the moratorium include DaimlerChrysler AG and American Pioneer. However, the FDIC did lift the freeze it had put on applications by financial companies for new ILCs.
There are also other risks exclusive to the non-bank players. In the US, there is increased concern about the possible associated operational risks facing non-bank issuers, and that has led to a renewed focus on their supervision.
According to a recent paper from the Federal Reserve Bank of Kansas, non-bank issuers that rely on outsourcing their card operations to third parties run the risk of fraudulent card purchase liability being placed on merchants, which merchants argue discourages issuers from implementing stronger anti-fraud systems.
Also, critical software and payment processing services are sometimes outsourced so that the issuer does not face liability in case of failure.
Another risk is that of security. Electronic payment networks are vulnerable to viruses, worms and other types of computer hacking. Processing transactions over these networks is also at risk – online debit transactions are processed in real-time, making it impossible to reverse a fraudulent transaction. Many security incidents relate to the use of databases and computer systems for the execution of transactions and storage of payment information.
Recently, several high-profile PIN debit fraud incidents in the US have focused attention on the safety of such information.
According to the paper by the Federal Reserve Bank of Kansas, the risks tied to the participation of non-banks in the payment process interact with risks associated with electronic networks. Non-banks can add another link in the chain of information flows in payment clearing and settlement, resulting in yet more complexity.
Non-bank payment providers in electronic networks pose challenges even if they are supervised, because they have risk profiles that are different from those that concern supervisors of banks. The supervisory process that governs oversight of non-banks has evolved over time, but is it sufficient to manage the risks that have accompanied the trend towards more non-bank players providing electronic payment services? This is something that the Fed is evaluating.
A combination of regulatory obstacles and capital requirements may certainly restrict the ability of non-banks to take on their bank counterparts in offering comprehensive retail banking services, but in the cards sector, for the time being at least, banks will continue to monitor the developments of their non-bank rivals closely.