How the Capital One/Discover deal could boost competition

The writer is a former chair of the US Federal Deposit Insurance Corporation and a senior adviser to the Systemic Risk Council

US federal bank regulators are worried about concentrations in the banking sector, as they should be. JPMorgan Chase alone accounts for one-sixth of all US banking assets. Unfortunately, one proposed cure — discouraging regional banks from growing through acquisitions — is worse than the disease. To curb big banks’ dominance, regulators need to let regional banks achieve the scale they need to compete with them.

A case in point is Capital One’s proposed acquisition of Discover. On every dimension, this merger is pro-competitive, positioning Capital One to challenge entrenched behemoths such as JPMorgan, Visa and Mastercard.

Mega banks like JPM Chase have grown significantly in size and market share over the past decade. Regulators themselves are partially responsible. Past bailout policies have created investor and depositor perceptions that the mega banks are “too big to fail”, making it easier for them to attract low-cost capital. By preventing mid-sized banks like Capital One from growing, regulators would widen the defensive “moat” around the mega banks.

Critics argue that we have enough “too big to fail” banks and shouldn’t allow more. But Capital One would remain significantly smaller than the banks that regulators categorise as systemic. A better way to address industry concentration is to dramatically increase capital requirements for the largest banks. This would create pressure to downsize and impose a higher hurdle for systemically consequential mergers but without entrenching the current market dominance of the “too big to fail” banks.

There are no barriers to entry in the credit card business: with nearly 4,000 issuers of all sizes, consumers have thousands of product options. Capital One is currently the third largest card issuer by purchase volume. After the merger, it will still be third with about $824bn in annual purchase volume, compared to JPM at $1.16tn and American Express at $1.12tn. Critics of the merger say it would present antitrust issues. I say, wouldn’t it be nice if there was at least one area, credit cards, where the mighty JPM would have a viable challenger to its top position?

Critics also cite as a concentration issue Capital One’s scale in serving consumers with below-prime credit scores. Some have unfairly characterised the higher average interest on Capital One cards as evidence of “a lack of competition”. The reality is very different. Capital One remains unique among large banks in choosing to serve the full spectrum of US consumers. Its average interest rates are higher than some cards because of the higher risk profile of its customers. If compared with other subprime cards, its rates are not out of line with rival products. Capital One cards are also devoid of the junk fees that so frequently accompany others.

I suspect Capital One’s subprime market share is relatively substantial because other banks simply have less (or no) interest in serving subprime customers. Subprime lending involves higher capital requirements, greater regulatory scrutiny and more resources to underwrite and manage those accounts. Any concentrations in the subprime market are the result of banks’ conscious investment decisions, not barriers to entry. 

Capital One should also be commended for the deposit accounts it offers those with limited incomes. It was the first major bank to eliminate all overdraft and insufficient fund fees, even while continuing to offer free overdraft protection. Its core checking account product is certified as compliant with the “BankOn” programme that seeks to increase access to banking with no fees and no minimum balance requirements. BankOn was inspired by a programme launched by the Federal Deposit Insurance Corporation in 2010 while I was its chair. Unlike some rivals, Capital One has fully embraced BankOn as its main checking account offering. With the acquisition of the Discover debit network, it can continue to expand these accounts.

Merchants could also benefit from the merger as it would provide more competition for Visa and Mastercard. Critics have argued that allowing a card issuer to also control a network for processing credit card transactions would lead to higher pricing. More likely, the efficiencies Capital One could achieve by using its own network would enable it to improve services and even reduce fees.

A combined Capital One/Discover could challenge the biggest banks’ supremacy, while providing competitive benefits to credit card users, merchants and subprime borrowers. Disapproving it will, at best, simply preserve the status quo, and at worst, chill regional mergers and acquisition activity, further insulating the mega banks from competition.