Nothing solves problems like a good free market.
The challenge has been that the US only pretends to have a free market.
It’s why our healthcare is so expensive (a socialized health system that masquerades as a free market one, getting the best of neither and the downsides of both).
And why, at least as it relates to this periodical, the incumbent banking system is a shit show.
It took Square four years from its first public attempt to final banking approval, and it kept hitting walls because the FDIC – the bank approval body – received industry pushback from community banks and banking trade groups, arguing that letting a tech company run an ILC (industrial loan company) would create unfair competition and regulatory loopholes.
Uh yea, that’s how innovation happens, morons.
Uber had to break a ton of nonsensical “rules” but when was the last time you suffered through a taxi trip?
You’re welcome.
Here’s an example of how dumb rules are:
It’s 3 AM.
You’ve been shot in your left leg.
You climb into your car to drive yourself to the emergency room.
And the stoplight turns red.
No other cars are on the road.
If you follow the rules, you’ll bleed out in the car.
Rules exist to box people in cages and treat them like imbeciles.
If you’re a free thinker, you don’t need rules.
Most people, unfortunately, are incapable of critical thinking… but that’s actually not why rules exist.
Rules exist so elected officials can pander to their special-interest base and remain in power.
The special interest group wants something that they cannot achieve on their own in the free market, so they seek legislators to act on their behalf.
The US banking system is a poster child for these problems.
Look no further than credit card payments, a slice of the banking underbelly which are a massive tax on the US (and global) economy.
And in total irony, the oligarchs that benefit the most from payment racketeering openly violate their own “rules” because they know that they’re the most wealthy special interest of them all, buying a blind eye from legislators.
While third world countries have modernized with free, instant payment infrastructure, the US is held back by crony legislators suckling at the teet of incumbent payment oligarchs.
Slowly, however, large US retailers have pushed back.
In 2007 the retailer Target launched the Redcard, a loyalty program for Target shoppers. As the card matured it connected directly to shoppers’ bank accounts and added a 5% discount for doing so.
Today Redcard has expanded as a cobranded Mastercard credit card, allowing Target shopper to accrue points outside of Target, but in its original embodiment it was a cash discount: connect your bank account and get 5% cash back on Target purchases.
Specs, a ~$2B chain of liquor stores, offers a 5% cash discount.
Online jewelry retailer Blue Nile offers a 1.5% cash discount.
Just about every international airline explicitly surcharges credit cards, too.
No, seriously:
- Lufthansa
- Ryanair
- Virgin Atlantic
- Air New Zealand
- Quantas
- Virgin Australia
- Jetstar
- Tigerair
- Air India
- Singapore Airlines
- Cathay Pacific
- Emirates
There are two reasons surcharges are employed more than cash discounts.
First, some consumers lack the necessary bank balance to make purchases outright.
They need financing, even if it costs 30% APR from their bank.
Second, ACH is a slow, antiquated system of funds transfer. It takes at least 24 hours to know if the buyer is good for the funds. Another 2-3 business days to actually receive the funds.
That creates real risk for the retailer.
But surcharging also presents a non-zero risk to the retailer’s reputation.
JD Power found that,
…satisfaction with the overall cost of payment processing services among small businesses that implement these credit card surcharges is 24 points lower (on a 1,000-point scale) than among those that do not add a credit card surcharge.
Yet given the above, there are clear benefits to paying by bank.
First, consumers don’t have to worry about racking up debt, and there are protections that prevent overdrafts and therefore overdraft fees.
Second, adding additional payment modalities reduces cart abandonment: in a PYMNTS survey, every single merchant that added pay by bank saw a decrease in cart abandonment.
This was particularly the case for younger generations who prefer more digital payment options.
Third, a Plaid study found that consumers were interested in paying by bank.
Consumers have shown a willingness to pay with their bank accounts. Plaid’s Fintech Effect 2023 reported that 86% of fintech users see the benefits of pay-by-bank options and are open to using them to purchase. Half of consumers already use pay by bank more often than they use cards, and 67% of consumers are open to using pay by bank, even when paying by card is an option.
And lastly, merchants hate card payments and are looking for any frictionless alternative that reduces costs:
Plaid internal research found that offering just a 1% discount at checkout for high-value e-commerce purchases increases pay-by-bank adoption from 20% to 67%.
Consumer predilections aside, technology for real time bank-to-bank payments has also been NOMINALLY released, which if were made available as described it would reduce the real concerns of fraud, or funding delays for pay-by-bank.
Sensibly, large retailers are starting to roll out pay-by-bank in some form, including Walmart and Kroger.
Instant bank payments presents perhaps the biggest opportunity to actually disrupt the stranglehold of card duopolies.
The real economics question, however, is how will large retailers incentivize pay by bank?
The wars for consumer wallet share are heating up.
Robinhood’s gold card offers 3% cash back on every purchase for a token $50 annual fee.
Coinbase offers a 4% bitcoin back on every purchase for $50 a year with a $200,000 account balance.
A large number of consumers are not going to pay by bank without incentives.
Let’s take Walmart as an example.
Walmart prices in the cost of payments acceptance into their goods for all shoppers.
That’s because the management at Walmart isn’t totally inept and they recognize payments as a material COGS that their public shareholders don’t want the retailer eating.
Walmart’s cost of acceptance is a competitive advantage over other grocers due to the interchange discounts they receive for being a scaled merchant.
Same with Amazon and Costco.
Let’s say Walmart’s cost of acceptance is 1% (grocers on average pay an average cost of acceptance of 1.5% we’d estimate).
If Walmart were to drop their prices by 1%, why would a rational cardholder pay by bank when they’re getting 3% cash back on their Robinhood card?
Or 2% on a standard rewards card?
Extending this logic, why would a card-carrying consumer pay by bank if they get NO discount?
And by the way, the argument that a debit user will just pay by bank is increasingly suspect as even debit cards now offer cardholder rewards.
If retailers want to decrease their costs of acceptance, they need to dual price.
End of discussion.
Provide the consumer an incentive for enrolling their bank account.
We’d love to see large retailers band together like they attempted with their MCX effort and offer a consistent, concerted push to move cardholders off card and onto REAL-TIME bank payments.
The number of cardholders that switch will ultimately be a function of perceived value (ie the magnitude of the discount) and ability to pay by bank (ie are they living on a credit treadmill because they overspend their income, or are RTP and FedNow even ready to allow seamless, real-time consumer payments as opposed to push-only nonsense?).
There will be some consumers that do move to pay by bank with the right incentives, and if smartly executed could become a real windfall for retailers and consumers both.
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