The Fed Is Behind the Credit Card Merger

July 24, 2024 | John Mudd

THE LEVER, Matt Stoller, March 2, 2024

If Capital One is allowed to acquire Discover, it’ll gain access to a government loophole allowing it to raise prices and reduce competition.

It’s an obvious point, but credit cards in America generate a lot of cash for banks. In 2022, I wrote up how the business works, with the observation that the industry generates close to a quarter trillion dollars a year in revenue. This revenue comes from fees for connecting merchants and banks, as well as fees charged to consumers for access to credit.

Every credit card network is also a data sieve, connected to advertising data brokers, anti-fraud features, and analytics firms. In addition, being able to reject someone from the payments system is a core sovereign power, and the stated reason the right is so afraid of a central bank digital currency.

There are many barriers to entry in the credit card business, and significant pricing power among incumbents. As the Consumer Financial Protection Bureau found, margins for credit cards are persistent, increasing, high, and tilted towards the larger firms in the industry. (And this is true even when you take higher interest rates into account.)

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Capital One’s recently announced attempt to buy the credit card company Discover hits at all of these elements of the business. While the merger looks like a credit card bank buying another credit card bank — and it’s certainly that — it is more like a Big Tech merger, where a bank is trying to turn itself into a platform with an app store-like power over a class of customers, in this case merchants. The key quote from Capital One co-founder and CEO Richard Fairbank on the call announcing the deal was this: “The holy grail is to be an issuer with our own network.”

Here’s what Fairbank meant. An issuer, aka a bank, is regulated like a bank, while a credit card network is regulated like a network, which includes price caps on debit cards. But thanks to the Fed, a bank that owns a network isn’t regulated at all on its own network. And because of that, Capital One, if allowed to buy Discover, can set prices in ways its rivals can’t. Fairbank also made clear that’s a key rationale for the deal, as I’ll discuss after I’ve explained the industry and the regulatory framework.

Let’s start with the basics of credit/debit cards. Banks make money in two ways. They issue cards to consumers, and charge those consumers credit card interest charges and various fees when they buy things with merchants and don’t pay the money back immediately.

But banks also make money from the merchants themselves. In between the bank and merchants sits a network utility, usually Visa or Mastercard. The network operator takes a swipe fee, known as an ‘interchange fee,’ from the merchant, roughly 1.5 to 3.5 percent of every transaction, and then splits that fee with the banks. Banks send some of that money back to the consumer in the form of rewards to keep consumers locked into using that card.

Here’s an illustration of how credit card networks function.