In February 2024, Capital One agreed to buy Discover Financial Services for more than $35 billion, in a deal that would unite two of the largest U.S. credit-card companies.
The proposed acquisition comes at a time when consumers are shifting more of their payments from cash to credit cards. Cash payments in retail stores declined 25 percent from 2017 to 2022, with shoppers now paying for 70 percent of all retail purchases—including in-person and online—with credit or debit cards.
If regulators approve the deal, it could chip away at the dominant role Visa and Mastercard have held in consumer credit-card payments. Visa held a market share of 48 percent of credit cards in circulation at the end of 2021, while Mastercard accounted for about 36 percent of cards in use, according to the U.S. Consumer Financial Protection Bureau. Discover and American Express together made up the remaining 16 percent of credit cards. If Capital One transitions current Visa and Mastercard customers to Discover—and brings new customers in as Discover cardholders—that could lead to a realignment of the industry.
The proposed combination of two major players has drawn scrutiny from regulators. If approved, Capital One would become the sixth-largest bank in the United States, with more than $450 million in deposits, while owning the fourth-largest credit-card payment network.
“We will be monitoring all developments to ensure that this merger doesn’t enrich shareholders and executives at the expense of consumers and small businesses,” Sen. Sherrod Brown (D-Ohio), the chairman of the Senate Banking Committee, said in a statement.
Lulu Wang, an assistant professor of finance at the Kellogg School who studies payment networks, says the deal will not result in a major industry consolidation. Together, Capital One and Discover account for less than 20 percent of consumer credit-card balances and around 10 percent of card spending. Nonetheless, the effects on Visa and Mastercard could be pronounced.
“The big play that’s going on here is thinking about the disruption at the network level,” he says.
If the acquisition goes through, here are some of the potential changes that Wang predicts for card networks, merchants, and consumers.
Card networks could ramp up competition
There are two main ways the credit-card industry operates—as banks and as card-issuing networks. Capital One and Discover are both banks that earn income by providing credit, lending to consumers at interest. Discover also has a proprietary card network, like American Express, that charges merchants a fee for processing credit-card transactions.
Capital One issues credit cards on the Visa and Mastercard networks, but it plans to move some of its card-issuance business to Discover—while still trying to maintain good relations with the two giants. If the proposed acquisition goes through, Capital One may shift about a quarter of its 100 million cardholders to its Discover network.
In its capacity as a bank, Capital One might also be able to extract better terms from Visa and Mastercard to use their networks, Wang says.
“If you’re Visa, one of the things you really want to do is make sure Capital One keeps issuing Visa cards and not just Discover,” he explains. “One way to convince them to do so is to give them discounts on the network fees that banks pay credit-card networks.”
The Capital One–Discover deal, Wang says, also could induce Visa and Mastercard to pay banks that are card issuers larger interchange fees for customer purchases to stay ahead of Discover.
“Instead of offering you 2 percent to issue Visa cards, I could offer 2.1 percent, for example,” he adds. “This could dramatically increase competition between networks.”
Merchants could face higher fees
Larger interchange fees would be better for banks, but they could hurt the merchants who pay them, including small businesses.
“Given my research, increased competition among networks is actually bad for merchants,” Wang says, “because competition among networks really is about competing to make sure issuers want to use the cards, not that the merchants pay low fees to accept them.”
While higher fees would be a negative, the overall effects on merchants may be more ambiguous. This reflects the tension for merchants between new technology and traditional price competition. For example, merchants could benefit in other ways, such as by having increased access to Capital One’s sophisticated antifraud technology, which could be built into the Discover payment-processing network.
“The history of credit cards is the history of how to manage fraud,” Wang says. The issue has become even more challenging in an era of widespread ecommerce, as it’s now much more difficult to verify that the person entering a credit-card number is the actual card holder.
In addition, if its acquisition of Discover is approved, Capital One might persuade more merchants to purchase its antifraud software to use for all ecommerce purchases, because it will have a larger consumer base providing more data to continue improving the technology, Wang says.
Consumers could get more benefits
Thanks to a unique loophole in the credit-card industry, Discover is allowed to give consumers something that Visa and Mastercard are not: cash-back rewards on their debit cards. This is courtesy of the 2010 Durbin Amendment, passed as part of the Dodd-Frank reforms in the wake of the financial crisis, Wang explains.
The amendment capped the interchange fees on debit cards for large banks. With those fees capped and profit margins crunched, banks stopped giving debit-card customers rewards for purchases. But the law only applies to open networks like Visa and Mastercard that work with many banks and not to proprietary networks like Discover and American Express. So Capital One could conceivably issue rewards debit cards through Discover, which would make Discover more attractive to a new customer base.
“You can easily imagine Capital One saying, ‘For every customer who signs up for a new checking account, we’ll give you a Discover debit card, and we’ll even give you a 0.5 percent reward on all your spending on that card,’” Wang says. “That could effectively implement a kind of regulatory arbitrage.”
The banking system is not at risk
The effects of the proposed Capital One acquisition of Discover are complex, affecting participants in the credit-card ecosystem in different ways. But while regulators are giving the big deal a close look, Wang doesn’t necessarily see a threat to the stability of the overall banking system.
There are two reasons for this lack of concern. First, the card industry is not so concentrated that the acquisition would result in a lack of consumer or merchant options. Second, the real risks to banks lie elsewhere.
“If you think about the regional banking crises that we’re having now, it’s not about banks that made a bunch of credit-card loans that went bad,” he says. “It was about banks that were pretty thinly capitalized that loaded up on real estate or long-term Treasury bonds that went sour. And it’s not that transparent to me how a merger of mainly consumer-finance companies with low sensitivity to interest rates can combine to make that kind of problem.”
