In Payments, Facebook Isn't Friending Banks

Facebook Inc. is known globally for taking the social media world by storm. What's gotten far less attention is how its payments revenues have been growing gangbusters and how its digital currency could soon threaten banks as it moves into traditional channels.

Facebook generated about $557 million, or roughly 15% of its revenues, from "payments and other fees" last year, according to the S-1 it filed Wednesday in advance of a planned initial public offering. That figure is a five-fold increase from its $106 million in payments revenues in 2010, which was itself up from the $13 million the year before.

The burgeoning payments revenues come from selling Facebook Credits, a digital currency, for 10 cents each. Users can exchange the credits for digital items to display on their Facebook pages or to upgrade games played on the social networking site.

As Facebook nurtures the platform "Facebook Credits might grow and banks might lose some of the relationships they … now have," says Gwenn Bezard, research director at Aite Group.

If consumers adopt Facebook Credits for more of their spending, it would distintermediate banks, distancing them from valuable spending data that could be used to cross-sell products and deepen customer relationships. Facebook could also become a prominent brand on checkout pages and eventually at the point of sale, further displacing credit and debit cards.

And that future might be closer than bankers realize.

With its exponential growth in payments, the Menlo Park, Calif., company is already confronting regulatory complications. "Payments on the Facebook Platform could be considered a financial product … we could be deemed a financial institution," it said in its securities filing.

This doesn't necessarily mean Facebook plans to become a bank. But it is applying for state money transmitter licenses, which would put it in the same league as PayPal Inc. Facebook might likewise displace banks and payment networks in the process. (Facebook did not respond to an interview request Thursday.)

PayPal was acquired by eBay Inc. in 2002 and had its initial success among merchants who used the online auction site. PayPal later aggressively went after business with traditional retailers. It recently began testing a point of sale payment system that invades the home turf of traditional credit card issuers.

"Like with PayPal and with eBay, people might end up using a Facebook Credit Wallet," Bezard says.

Eventually, Facebook could, like Google, serve up personalized ads and marketing intelligence, says James Van Dyke, the president and founder of Javelin Strategy and Research. "This is where Facebook could uniquely deliver," Van Dyke says. "The network effect could be huge, give a Google-like advantage to Facebook that trumps even Google itself, because [Facebook] runs … a much more personalized and activity-intensive network than does Google."

Facebook has been aggressive in enforcing the use of its payment system on its site. In recent years the social network cracked down on third-party payment systems and largely forced them out. As of July 1, 2011, nearly all game developers accepting funds in a Facebook app must use Facebook Credits.

A deal with Zynga, the game developer behind the hit Facebook game Farmville, grants Facebook up to 30% of the face value of purchases made within any Zynga games that are played on Facebook's site, Facebook said in its filing.

Despite the growth of Facebook's payment system, it has obstacles to overcome, particularly with regulators. To keep its Credits system running, Facebook might have to come into compliance with regulations in multiple countries at once.

"[To] what extent could it have a ripple effect on the rest of the business?" Bezard says. Facebook is often criticized for how it exploits its users' personal information, but financial companies "have restrictions in how they can use their customer information."

If Facebook is willing to forge alliances with traditional players, there may yet be an opportunity for banks to benefit from the growth of Facebook Credits.

"How about a Facebook cobranded card … is anyone doing that?" says Aaron McPherson, a research manager for payments at IDC Financial Insights. "If they aren't, they should be."