Analysis: Antitrust and Banking Agencies Must Block Capital One-Discover Merger

Antitrust and Banking Agencies Must Block Capital One-Discover Merger
Reinforcing megabank monopoly power not what American economy needs

Capital One recently announced its plans to purchase the Discover Financial Services. What’s in your wallet, indeed.

The $35 billion takeover bid would vault Capital One into 6th place among the biggest U.S. banks and create the largest U.S. credit card lender, ahead of current leader JPMorgan Chase. This new company could raise prices for cardholders, especially lower-income consumers and Black and Latine households and give Capital One the power to jack up debit card fees on merchants. In short, it would reinforce the megabank monopoly power that is already a serious problem in the American economy. The Biden administration must stand up for consumers, communities, and small businesses and block the Capital One-Discover merger.

A Capital One-Discover merger would entrench consolidated market power in banking, payment networks, credit card, and small-business services. The takeover is a horizontal merger of credit card lending rivals with $250 billion in credit card lending between them. It also combines two of the nation’s biggest banks — Capital One’s 260 branches and Discover’s digital savings bank that both offer deposit accounts, auto loans, mortgages, and small business loans. The merger also is a significant vertical combination of complex and interrelated business lines that joins Capital One’s debit and credit cards to Discover’s payment processing network now used by Discover’s 300 million credit and debit card holders. This joining of banking and payment network would give the merged company the ability and incentive to raise prices (rates and fees for consumers and merchants) to bolster the profits of a bank that had $24.7 billion in net income over the last three years. It is a dangerous horizontal and vertical combination.

The merger raises a host of antitrust and bank merger red flags. It would create a dominant credit card lender that could easily raise prices, including for subprime and near-prime borrowers that would disproportionately harm Black and Latine consumers. It would allow Capital One to evade regulatory caps on debit card interchange fees (harming merchants and consumers). And, it creates a too-big-to-fail bank that could pose systemic risk to the financial system. The companies also have a checkered regulatory compliance record, including problems complying with anti-money laundering regulations, consumer protection rules, a significant data breach, and tens of thousands of consumer complaints filed with the Consumer Financial Protection Bureau.

Capital One has suggested the vertical merger will benefit consumers and merchants by challenging the Visa-Mastercard payments duopoly and driving down fees, a thesis contradicted by Capital One’s posturing. Founder and CEO Richard Fairbank stated that grabbing a payment network was “the Holy Grail” that could give it an advantage over rivals by bring its payment processing in house and allowing it to negotiate directly with merchants to raise transaction-processing prices.

The size and complexity of the proposed merger highlights the critical importance of action by the bank regulators to update the 30-year-old bank merger review process. The current guidelines are woefully unsuited to evaluate mergers in today’s economic realities and out of step with the Biden administration’s efforts to promote competition.

The proposed merger would create a credit card lending behemoth that would increase prices for consumers. The credit card lending market is already significantly concentrated and the proposed merger would create the nation’s biggest credit card lender that could easily raise consumer prices.

Some basic numbers tell the story. Today, the four biggest credit card lenders (JPMorganChase, Citibank, American Express, and Capital One) control 60 percent of the outstanding credit card debt. The merger between the number four Capital One and number five (Discover) would create a firm that would be the largest in the market and that would hold more than one fifth (22 percent) of the nation’s credit card debt. The top four firms together would hold 69 percent of all credit card debt.

A takeover of this size would harm consumers, especially current Discover cardholders, who would likely face higher interest rates almost immediately. Capital One has among the highest credit card interest rates, with top rates approaching 32 percent according to data from the Consumer Financial Protection Bureau. Discover offers lower interest rate cards than Capital One (about 28 percent and 29 percent for purchases, respectively). Capital One charges about 2 percentage points higher interest rates than Discover on average and at comparable credit scores for cardholders with good or great credit scores (credit scores between 620 and 719 and scores 720 and above, respectively).

The bigger-is-better merger proponents contend that bigger firms have the scale and scope to offer their products at lower prices. Theoretically, larger credit card lenders could use their larger set of more granular data on borrower risk and repayment rates combined with efficiencies of scale to offer better interest rates and lower fees to entice customers away from their rivals.

But it turns out that bigger credit card lenders generally charge higher interest rates and higher fees, according to a CFPB survey, because they have the market power to impose higher prices. A more concentrated market allows the biggest firms to tacitly collude on prices merely by monitoring their tiny group of rivals. The proposed merger would increase concentration and make it easier for the credit card oligopoly to mirror one another’s prices and stifle competition.

The proposed merger would especially disadvantage Black and Latine subprime and near-prime credit cardholders. The proposed takeover would create the largest lender to subprime and near-prime cardholders. Discover grew out of the Sears retail card that provided credit for middle-income families to purchase appliances and home furnishings on credit, and 20 percent of its outstanding balances are held by cardholders with near-prime credit (with credit scores under 660 according to its SEC filings). About one-third of Capital One’s outstanding credit card debt is held by near-prime and subprime cardholders.

The subprime and near-prime credit card market has comparable levels of concentration as the total credit card market. Some firms (such as Amex) do not offer credit cards to subprime borrowers and other firms (such as Chase) are more focused on prime and super-prime customers. The proposed Capital One-Discover merger would represent $67 billion in outstanding credit card loans to these middle-income borrowers. The merger of two major players in this submarket could significantly decrease the options — and lock in higher prices — for consumers with lower credit scores.

A more consolidated near-prime and subprime credit card market would have a disproportionate impact on Black and Latine households that tend to have lower credit scores because the scoring algorithm replicates the systemic racial inequities  of the broader economy and the financial system. Black and Latine households with lower incomes, more medical debt, lower homeownership rates, fewer assets, and less credit history are more likely to have lower credit scores and more likely to have subprime scores.

The merger would eliminate competition between two major issuers of near-prime and subprime credit cards and because these consumers have fewer options and it is harder to switch (they do not qualify for the prime or super-prime products offered by other major credit card issuers), they would be vulnerable to price increases through higher fees and interest rates.

The proposed merger would allow Capital One to extract higher debit card fees from merchants. The vertical integration of Capital One’s deposit accounts with Discover’s debit card network (known as Pulse) would allow Capital One to evade the debit card transaction fee caps that apply to banks and raise prices on consumers and merchants.

Because it owns its own payment network, Discover’s stored-value, prepaid debit cards are exempt from debit card interchange fee caps, thanks to a Federal Reserve loophole that only applies to Discover and American Express debit transactions. So, Discover can charge higher fees to merchants, which ultimately get passed on to consumers as higher prices. Capital One has announced it will immediately shift its entire debit card network to Discover, allowing it to take advantage of the loophole created by the Fed.

This regulatory arbitrage would give Capital One the ability and incentive to impose higher interchange fees on merchants who could not avoid the fees without declining Discover debit transactions. Capital One’s CEO Fairbank specifically mentioned to investors when discussing the merger that the regulatory loophole “explicitly exclude[s] networks like Discover,” so it is not governed by the fee cap. The implication was that the takeover would allow Capital One to shift its debit card business to Discover’s network to evade the fee cap.

Capital One debit cards use the Mastercard network, which is subject to regulatory fee limits of 22¢ plus 0.05 percent of the transaction value. Discover’s debit cards are charging far more than that, according to current Federal Reserve data. The average $36 Discover debit transaction collects a 51¢ interchange fee (more than double the regulated interchange fee of 24¢). Discover collected more than $300 million in debit interchange fees in 2023 according to its Securities and Exchange Commission filing. Capital One reported $589 million in non-interest revenues primarily from debit interchange fees. Increasing those fees could generate an instantaneous revenue bump of hundreds of millions of dollars that it could extract from merchants.

Bank regulators should reject the proposed merger’s accumulation of systemic financial risk. The proposed Capital One-Discover takeover could elevate potential systemic risks to the financial system by increasing the asset concentration of credit card loans that could pose heightened risk in a time of economic stress or downturn.

The Bank Merger Act requires banking regulators to consider the financial resources, future prospects of the proposed merger, and the potentially “greater or more concentrated risks to the stability of the United States banking or financial system.”

Unfettered bank mergers contributed significantly to the systemic fragility that led to the 2008 financial crisis according to research papers from the International Monetary Fund, University of Pennsylvania, Harvard, and more. For example, Washington Mutual ballooned into one of the biggest banks in the country through more than 60 mergers. Federal regulators forced the sale of WaMu in 2008 after its surging size and concentration of imploding predatory subprime mortgages created the largest U.S. bank failure in history. JPMorganChase snapped up the (formerly) $300 billion failed bank for less than $2 billion.

The Capital One-Discover takeover essentially dumps a $100 billion pool of credit card debt onto Capital One’s books, making it a quarter-trillion-dollar credit card lender. The merger would increase Capital One’s outstanding credit card loans by over 70 percent and raise the concentration of credit card loans in its assets to about 40 percent. Both Capital One and Discover have had steeply rising credit card delinquencies, charge offs, and provisions for credit card losses.

These risks would be concentrated in what would be the nation’s newest too-big-to-fail megabank: the ninth largest Capital One with the 23rd largest Discover would create the sixth-largest bank, behind only JPMorgan Chase, Bank of America, Wells Fargo, Citibank, and (barely) US Bank. Federal regulators must carefully examine the potential risks to both the merged firm and the broader banking and financial system.

The Capital One takeover bid underscores the urgent need for updated bank merger rules. Many parts of the American economy have become hyper-consolidated into a handful of powerful firms that can raise consumer prices, lower quality, and suppress workers’ wages. The trend toward monopolization is strong in banking: the four biggest banks control nearly half of all U.S. deposits and on the local level the concentration can be far higher.

But banking regulators are notably behind the curve.

The Biden administration has rejuvenated antitrust enforcement to prevent the kind of megamergers that have created today’s non-financial monopolies. The Federal Trade Commission and the Justice Department have blocked the Simon & Schuster-Penguin Random House publishing merger and the JetBlue-Spirit airline mashup, and have challenged the Kroger-Albertsons merger of a supermarket looted by private equity as well as private equity’s roll-up of statewide anesthesiology monopiles. Major cases against tech platforms are underway.

Importantly, the DOJ and the FTC have modernized their merger enforcement guidelines to confront current economic realities, including digital platforms and data and how companies amass entrenched market power.

But the banking merger guidelines have not been updated for nearly three decades and this proposed takeover demonstrates the urgent need for modernizing those reviews. The current rules are mainly designed to evaluate mergers of banks that compete for depositors in the same city, just one small part of the picture. Bank regulators must evaluate the anticompetitive impacts of bank mergers beyond local deposit markets.

The Capital One-Discover combination presents an accumulation of market power in more complex dimensions than were considered under the 1995 rules. It would join a major credit card lender with a powerful payment platform that strengthens Capital One’s leverage to extract fees from retailers and consumers. It entrenches Capital One’s market power by joining the credit card, digital account, small business lending, auto lending, and mortgage lending business lines of two major banks.

This new Capital One could impose price hikes or reduce quality on its customers and merchants, and both groups would have little recourse – which is why federal authorities need to act now to block this dangerous merger.