Picture a new megabank with all the advantages and dangers of a "too big to fail" institution. Now imagine it had the market power to bully merchants through its ownership of a payment network for debit and credit cards. Finally, throw in a track record of gouging its own customers.
That's exactly what we will have if Capital One succeeds in taking over Discover Financial Services. Federal regulators need to make sure this merger never happens and tackle a long-overdue rethink of how they evaluate bank mergers.
The numbers alone raise alarms about the potential for consumer and merchant abuse, and blatantly anti-competitive behavior. Together, the two banks would, with assets worth about $625 billion, be the sixth-largest bank in the United States. It would be the largest credit card issuer.
Capital One and Discover would also combine, horizontally and vertically, interrelated business lines around debit and credit cards. Together, the two would preside over a quarter-trillion dollars in outstanding credit card balances, about 22% of the national total. And Capital One would control the payment network currently used by Discover's 300 million cardholders.
Capital One Founder and CEO Richard Fairbank has boasted about the market power that this vertical integration would bring. A payment network would be "the Holy Grail," he said, because controlling it would bring payment processing in house — and dodge the fees it currently pays the payment duopoly of Mastercard and Visa — while creating leverage to raise its own fees on merchants.
No retailer could realistically refuse to accept cards from the largest issuer in the United States. Already, Capital One has announced plans to migrate its existing debit card customers onto Discover's Plus network. Merchants accepting Capital One debit cards would immediately pay higher fees than the currently capped 22 cents plus 5 basis points of transaction value for bank debit cards.
In size and scope, the new Capital One would be another bank, alongside Bank of America, Wells Fargo and others, that enjoys the implicit backing of the U.S. government, as it would control a vast deposit and lending franchise.
With that perk would come the advantages — in wholesale borrowing, for example — that "too big to fail" banks enjoy.
The Bank Merger Act warns regulators not to approve combinations that presage "greater or more concentrated risks to the stability of the United States banking or financial system." This merger would increase Capital One's outstanding credit card loans by over 70% and raise the concentration of credit card loans among its assets to about 40%.
A Capital One-Discover merger would make it easier to impose higher prices on credit card consumers. The merger would mean that the top four firms hold nearly 70% of outstanding credit card debt. And the takeover would suddenly shift Discover credit card customers to a bank known for some of the highest interest rates in the industry, with top rates approaching 32%, according to data compiled by the Consumer Financial Protection Bureau. A more concentrated market allows the biggest firms to tacitly collude on prices merely by monitoring their tiny group of rivals.
The people most vulnerable to pressure from a combined Capital One and Discover would be precisely those with the fewest options, since the merged bank would be the largest issuer of subprime and near-prime credit cards. Twenty percent of Discover's credit card lending goes to cardholders with near-prime credit. Near-prime and subprime cardholders are about one-third of Capital One's outstanding card balances.
The merger of two major players in this submarket would decrease options and lock in higher prices for consumers with weaker credit scores, which would disproportionately harm Black and Latino households that tend to have lower credit scores because the scoring algorithm replicates the racial biases of the financial system.
There are ample grounds for regulators and the Department of Justice to bar the merger. But those grounds also highlight the shortcomings of relying on bank merger guidelines that date from 1995, a time when dial-up modems were our gateway to the internet. Those woefully outdated rules focus merger scrutiny solely on the impact on bank branches and deposits, which are critical considerations, but insufficient to assess mergers that could curb competition in payment processing, online banking, card issuer concentration or other more complex business mash-ups.
The 2008 crisis that brought the financial system to its knees also wreaked economic havoc on families and ushered in reforms aimed at fighting consumer abuse. Wall Street's responsibility for the crisis also helped rejuvenate a dormant antitrust movement. With public opinion and the law on their side, federal authorities should reject this merger
