As federal regulators review Capital One's merger application to buy Discover Financial Services, they will need to untangle a host of regulatory issues, across multiple competitive dimensions. All of this will be done against the backdrop of fierce criticism of the deal from powerful coalitions in Washington.
The regulators that are most likely to have the power to scuttle the acquisition are the Federal Reserve and the Office of the Comptroller of the Currency under federal banking laws and the Department of Justice under antitrust statutes. The likelihood of approval will depend on their relative satisfaction with whether the transaction will not substantially lessen competition and how a combined Capital One-Discover would prevent damage to the broader economy in the event of its failure or financial distress.
Capital One is subject to examination and regulation by the Federal Reserve and the OCC. The banking regulators work in parallel with the DOJ when evaluating bank mergers. But if they disagree over the competitive effects of the transaction, the DOJ may still challenge the proposal in court, though these disagreements are rare. The DOJ and the banking agencies both assess the competitive effects of the proposal, but the banking agencies also take into account other banking-specific factors, including the supervisory views of other agencies, such as the Consumer Financial Protection Bureau, and whether the merger could increase risk to the stability of the U.S. financial system.
Although the DOJ released revised merger guidelines that shift away from completely relying on the concepts of "horizontal" and "vertical" mergers, that framework is still helpful. "Horizontal mergers" refer to mergers that occur between firms in the same industry, and "vertical mergers" refer to mergers that occur between companies at different stages of the production process. The deal has components of both and they should be analyzed separately.
Capital One and Discover are both credit card issuers, which has horizontal merger implications. Capital One would become the largest credit card issuer in the country, with a 22% market share. There are at least a dozen sophisticated, well-capitalized businesses competing as credit card issuers. Federal regulators may conclude that there is insufficient evidence that the merger should be blocked over antitrust concerns.
But federal regulators might find other reasons to block the deal. Discover is a payment network, which has vertical merger implications. In its updated merger guidelines, one of the factors the DOJ considers in assessing whether a merger could substantially lessen competition is if there is an industry trend toward consolidation. There is a reasonable possibility that Capital One's purchase entices American Express to seek a buyer in the long term. In addition to its plans to migrate all of its debit spend away from Mastercard's network, Capital One is also considering moving its credit spend as well. That would total possibly $606 billion dollars worth of credit card volume moving to Discover's payment rails.
Any increase in revenue as a result of fees charged to new cardholders, more processing activity from merchants or income from any applicable customers in the broader payments ecosystem could significantly increase Discover's ability to invest in upgrades and enhancements that improve its service. While it is unlikely Discover will ever exceed Mastercard or Visa in market share given the scale of their respective networks and their significant lead in overseas markets, Discover may become the third largest credit card network in the United States, overtaking American Express.
Regulators should also gather information about whether the merger would bring any decrease in credit and debit swipe fees charged to merchants and assess if Discover will continue to be exempt from rules that cap debit interchange pricing set by the Durbin Amendment.
Additionally, regulators should evaluate Discover's supervisory records with the CFPB, which has issued multiple consent orders against Discover for issues in student loan servicing. They should also question plans to improve Discover's compliance with consumer protection laws, as required by a consent agreement with the Federal Deposit Insurance Corp.
Regulators should also determine whether the failure of the combined company could inflict damage on the broader economy. Under the Dodd-Frank Act, Capital One must create a living will that describes how it would address bankruptcy or dissolution. The Federal Reserve recently extended the deadline for a living will to March 31, 2025.
But given the overlapping timelines for the merger and the new deadline, federal banking regulators should explore whether Capital One can proactively describe how the combined entity would handle financial stress. Importantly, regulators would need to ensure the American people do not pay for it.
