The structure of consumer payments markets
The key difference between consumer payments markets and B2B payments markets is that spread is the major revenue source, not transaction fees
Credit Cards and DDA account for the bulk of Retail banking profits. We think of these as payments products, giving payments outsized importance in the minds of banking executives. In fact, payments are just a feature to capture balances: spread income accounts for the bulk of profits. Nevertheless, payments provide the utility that make the products worth having.
Credit cards. Non-interest income, net of rewards, is typically only ~20% of Net Revenue. Some of this fee income is lending-related, such as late fees.
DDA:
Most DDA payment methods don’t incur fees at all, such as Zelle, checks, ACH, bill pay and on-us ATM usage
Payment methods that do incur fees are typically rare, such as wires, official checks, cashiers checks, FX, off-us ATM usage, etc.
Debit cards earn interchange from merchants (not consumers). Usage is concentrated in low-balance segments where spread income is low
High-balance DDA accounts may earn no fee income at all
Credit Card users typically use their debit cards only for ATM transactions, so debit generates no revenue from high-balance accounts
Most of those accounts pay no fees, or those fees are waived
All payment methods work the same at every bank. They use the same networks, clearinghouses, and often, the same processors. They are governed by the same regulations and technical standards. So how do consumers choose their providers? Credit Cards have different competitive dynamics than DDA accounts so we will discuss the two separately.
Credit cards
All credit cards have identical payments functionality. They all ride a network using the same ISO messaging standard and are subject to the same consumer protection rules. They are all used at the same POS devices and authenticated under the same EMV standard. Their experience is the same online and in payments wallets.
Differentiation is either on the credit terms or on rewards proposition:
Credit terms (APR & line size) depend on an issuer’s cost of funds & credit appetite and the borrowers credit profile. On top of these can be fees that disincent bad usage behavior (e.g., late fees)
Rewards propositions differ by currency type and earn/burn ratios
The Currency may be a points programs or cash-back
Earn/burn ratios determine the rewards earned per dollar spent and, for points programs, the value of a point when redeemed. The redemption rate may vary based on the redemption category (travel, gift cards, etc.)
Annual fees are typically imposed on Affluent cards, but the fee is often offset with amenities, such as lounge access
Distribution models vary by the channel and the brand as these factors influence the cost to acquire a customer (CAC):
Bank cross-sell. Most bank issuers distribute cards to their primary DDA relationships, e.g., this is Bank of America’s primary channel. Banks stress the convenience of having a credit card and DDA with the same bank. For a typical regional bank 90%+ of cards are held by DDA customers. The CAC is low for cross-sell as the most of the marketing cost is in captive channels, but the total opportunity is limited by the size of the deposit base
Cobrand. Cobrands use a partner brand and rewards proposition. The biggest cobrands are from Airlines, Hotels or big retailers – although Apple now has the single biggest program. The partner brand gets a revenue share of spend and may also get a break for on-us interchange. Private Label cards are a variation on Cobrand that is on-us only and doesn’t route by MasterCard or Visa. In cobrand, the issuer’s revenue is largely from revolve – on the bigger programs, issuers may even have negative spend revenue (after rewards costs and revenue share). Cobrand cards may have a lower CAC by leveraging retailer channels, but then have lower revenue per card due to revenue sharing
National brands. The biggest issuers market beyond their deposit base under their own brand.
American Express & Discover have a limited deposit base and therefore rely primarily on marketing spend
Capital One & Citi are underweight on DDA relationships, so they had to develop national brands to get bigger
Chase is big in all three channels, it has a large DDA base, many large cobrands, and it has a national brand
These issuers spend big on marketing, but the trade-off is they don’t have to share revenue with a partner. So the national brands have high CAC, but keep all revenue for themselves.
“Affiliates” are another important distribution channel. These are comparison sites that help consumers choose among competing cards. Credit Karma is the best example. By focusing on card features (like rewards and APRs) they undermine the importance of brand, but all major issuers participate anyway.
Being a Cobrand issuer or National Brand is expensive, so only the largest half dozen issuers pursue these strategies. For the big cobrands, most of the net spend revenue (after rewards costs) is captured by the partner. The issuer needs to get by on the spread revenue, although the very biggest partners may share in this as well. Two of the largest programs recently parted ways as these economics didn’t work for the issuers (Apple/Goldman, Walmart/Capital One).
The cross-sell strategy also faces challenges. These cards often have generic rewards and few special features. Regional bank issuers typically use a third-party processor that makes it difficult to differentiate technologically or on rewards proposition. Cross-sell cards have difficulty obtaining primary status (a.k.a., “first-in-wallet”) and therefore may not generate much spend or revolve. Furthermore, the size of the credit card business is constrained by the size of the depositor base.
High marketing and technology costs has led to concentration in both Spend and Revolve. The top six issuers capture 75-80% of most metrics. If Capital One succeeds in acquiring Discover, the top 6 will shrink to a top 5. The private label card business (PLCC) is even more concentrated with Synchrony and Citi Retail collectively capturing ~80% share.
Yet, there are still hundreds of issuers. Some focus on narrow propositions. Synchrony & Bread focus on Private Label and retail cobrands. Barclays is a cobrand specialist. Credit One is lend-centric, focusing on a segment rather than a distribution model. US Bank’s Elan unit issues bank-cobranded cards so small banks can have a cross-sell product. Most banks issue to their DDA base.
The key here is that the networks and processors level the playing field. The long tail can issue cards that work just as well at the point of sale or online. The big difference between the big six and everyone else is the scale and skill advantage they have in marketing, credit management, distribution & servicing.
The credit card proposition of an interest-free grace period, rewards, acceptance ubiquity, and borrowing capacity has been hard to beat; however, eCommerce installment loans have opened a beachhead. Lenders like Affirm positioned themselves in the eCommerce purchase journey, well before checkout, and get first crack at the borrowers.
In their infancy, these loans were also interest-free – subsidized by the merchant. The interest-free version has become rare, but overall volumes continue to grow. Some consumers prefer the installment model to the revolve model as it imposes discipline on payback. Affirm also differentiates on credit terms like simple interest and no late fees. While growing fast, installments still have low share.
An even bigger innovation was the Apple Card, issued by Goldman Sachs. This grew from nothing to the 10th biggest US issuer in less than 5 years. The Apple Card succeeded by opening a new Channel: the iPhone with Apple Pay. The program cross-sells a credit card that rewards behavior in the Apple ecosystem. But, the cobrand terms were so favorable to Apple that there was no issuing profit for Goldman. Goldman and Apple are now parting ways.
DDA payments
Whereas consumers often have several credit cards, they usually have one primary DDA – from which they do their payments. As a result, competition among banks is not for transactions but for accounts. There is so little difference between the debit cards, ACH, or Zelle services from most banks that payments really don’t differentiate DDA accounts at all.
This extends to the plastic: Debit Cards are often plain, whereas credit cards are colorful and shiny to stand out from the crowd. I once visited a factory that manufactured cards and I recall that a debit card might require fewer than 10 steps while a high-end credit card required close to 30. The resulting cost difference could be as high as 5 to 1 (credit to debit). This was purely for esthetics as the two card types had identical functionality.
Similarly, ACH and Zelle are commoditized. Consumers must use these payments from their primary DDA bank so there is limited incentive to differentiate them. Further, banks don’t charge for the main payment types, and the types they do charge for are only used occasionally. There is just no business case to differentiate in DDA-payments as it is hard to measure a return.
As a result, consumer DDA-payments are less concentrated than Credit Card payments. Whereas the top 6 credit card issuers capture 75-80% of their market, the top 6 consumer DDA banks have under 60% share. Unlike credit cards, the three biggest DDA banks face a national deposit cap which leaves them at 10-15% share each.
These constraints have not stopped Fintechs from innovating around DDA payments. In fact, most DDA transaction types now face fintech competition:
P2P (e.g., Venmo, Cash App)
FX (e.g., Wise, Remitly)
Bill Pay (e.g., Paymentus, Bill Go)
Cash replacement/micropayments (e.g., Starbucks App, ParkMobile)
Commerce,
BNPL pay-in-four (e.g., Klarna, Afterpay). 90%+ of BNPL users are debit-centric
A2A commerce (e.g., Trustly)
P2P is the best example as Venmo & Cash App pioneered the space until banks deployed Zelle. Since Zelle generated no revenue, the business case was hard to make. Ultimately, Zelle was justified by check & cash replacement (cost-reduction) and digital engagement (viral marketing).
Arguably, Neobanks are also a DDA innovation. They provide free DDA-like accounts but monetize on “Exempt” Debit Interchange, which accounts for 75%+ of their revenue. A Neobank earns 2-3x more debit IC per transaction than a Durbin-capped bank. Those free services attract debit-centric, low-balance consumers who don’t generate spread income for incumbent banks to offset the lower interchange revenue. Neobanks also innovated advance payroll which accelerates Direct Deposit by two days. Many incumbent banks have now copied this.
Since most DDA payments are free, why would customers take Fintech alternatives? Generally, the fintech product offer some kind of economic advantage: In FX, a better exchange rate and lower fees, in Bill Pay the ability to pay with credit cards and earn rewards, and in BNPL, credit availability. In some cases, the advantage is convenience, for example both P2P and micropayments displace cash — the consumer doesn’t have to carry any for situations where their debit card isn’t accepted.
To summarize, payments are foundational to DDA accounts, but not the major revenue source. Payments are mostly commoditized across banks due to shared networks, processors, standards bodies, and regulators. Fintechs have found ways to monetize some of those transactions, but are not yet a threat to the balances.
Key insights
Payments are a key feature in Credit Cards and DDA accounts, but the value of those accounts is in their balances: Loans for Credit Cards and Deposits for DDA
Payments functionality is almost identical across providers. They share common networks, regulators, message standards, and processors. As a result, banks compete on other features of the underlying accounts:
In Credit Cards, that is usually credit terms and rewards proposition
In DDA, that is locational proximity, digital assets and account fees
In both products, brand also distinguishes among otherwise similar products
Consumers often have several credit cards but usually have one primary DDA account. So, Credit Card issuers must compete for transactions as well as relationships. This drives structural dynamics in the respective products:
In Credit Cards, the high marketing costs has led to concentration
The top 6 issuers have 75-80% share
Most other banks only cross-sell to their primary DDA customers
A few specialists focus on narrow niches
In DDA, share is still mostly driven by locational convenience, although this is changing as remote banks take share using digital techniques and resonant brands:
Affinity brands, e.g., USAA, Navy Federal, other Credit Unions
National brands built from other products, e.g., Capital One & Citi from cards, Schwab from wealth
Neobanks targeting low-balance, debit centric segments (e.g., Chime)
Fintech competition is limited in Credit Card but widespread in DDA payments
In Credit Card, installment models are capturing balances in eCommerce, due to their preferred position in the purchase journey and merchant subsidized APRs – but, share is still low
In DDA, most payment types face fintech competition as banks have not invested heavily beyond Zelle. Fintechs offer consumers better economics or lower friction