Why you won’t pay for Netflix with your Amex next year

The disruptive potential of Pay by Bank in the U.S. — a challenge to the dominance of card companies

Could Pay by Bank finally come to the U.S. in a meaningful way?

Picture this: You’re a savvy business owner, and your customer is ready to hand over a crisp $100 bill for your products or services. But just as the transaction is about to be completed, an unseen middleman swoops in, pockets a cool $3 or $4, and nonchalantly hands you the remainder a few days later.

Welcome to the reality of paying merchants with credit or debit cards in the U.S., a system that, despite its nuances, essentially boils down to card companies — including heavyweights like Visa, Mastercard, and Amex — taking a slice of the transaction pie in exchange for facilitating payments.

Now, these card companies argue that their lofty fees are justified by the purported benefits of enhancing payment speed, curbing fraud, and fostering innovation. But for most merchants, it’s not a matter of choice; they’re shackled to these high fees because that’s how their customers prefer to settle transactions.

The ascent of card companies to dominance in the U.S. payment landscape is a tale of convenience, efficiency, and the allure of rewards. Cards have become integral to everyday life, offering a seamless way to make purchases, eliminating the need for cash, and expediting transactions. To sweeten the deal, card companies shower cardholders with points, rewards, and cashback, creating a seemingly irresistible incentive for consumers to exclusively wield their plastic.

However, the dirty secret behind these rewards is that merchants foot the bill. The fees extracted by card companies from every transaction end up financing credit card rewards and opulent airport lounges, masquerading as “innovation.”

Figure 1: Interchange fees are one of the fees merchants pay when processing card payments. The card networks set the interchange rates and have generally increased them over the past decade. Source: The Federal Reserve.

Figure 2: Network fees are another cost merchants pay when processing card payments. Like interchange, the cost of network fees has risen over the past decade. Source: The Federal Reserve.

This wasn’t always the case, and it isn’t the norm in other countries. In the pre-card era, people relied on cash and checks to pay merchants. While these methods incurred minimal costs, they presented their own set of challenges, such as counterfeiting and the inconvenience of depositing checks. An alternative payment option, paying directly from one’s bank account, is substantially cheaper but has historically lacked the convenience and rewards that card payments offer.

Enter Pay by Bank, a revolution already sweeping through Europe and other regions. Here, government regulation keeps card processing costs low, limiting the funds available for lavish rewards programs. Additionally, open banking regulations make it easy for customers to link their bank accounts to payment platforms.

Figure 3: Most countries outside the U.S. and Canada have regulated card processing costs, which leaves card companies with less money to fund rewards programs and incentivize consumers to pay by card. Source: Clearly Payments.

Contrastingly, the U.S. payment landscape operates differently, with low regulation allowing card processing fees to soar. However, recent technological advancements and proposed open banking regulations could shift the tide, making Pay by Bank more user-friendly and cost-effective than card payments.

But, will Pay by Bank disrupt the U.S. payment scene in 2024 or 2025? Unlikely. The allure of rewards programs keeps consumers tied to cards, and the transition to bank payments poses friction for both consumers and merchants. Any change will be gradual, with consumers adopting Pay by Bank for specific transactions while retaining their card loyalty.

Looking ahead, if card processing fees continue to escalate and open banking regulations ease the adoption of bank payments, Pay by Bank might gain traction. The looming credit card debt crisis, especially among Gen Z, could expedite this shift towards alternative payment methods.

Already, consumers use Pay by Bank for significant recurring payments, such as rent and utilities, with the Target RedCard Debit Card leading the way, offering a 5% discount for this payment method. Merchants, however, face the challenge of convincing consumers to relinquish their cherished card rewards. Solutions may lie in one-time discounts or in-house rewards programs, especially for debit card users who lack traditional rewards.

In this evolving landscape, the card networks and banks have a choice: embrace the Pay by Bank revolution or resist it to protect the status quo. The question remains — will they seize the opportunity for innovation, or will they staunchly defend their turf against potential disruption?

About the Author

Gary M. Ludorf is a fintech strategist. He has spent 7 years in finance & strategy roles at investment banks, publicly-traded tech companies, and fintech startups. He currently works at Astra, a fintech startup with expertise in instant payments. Before that, he was a part of the fintech strategy team at Toast (NYSE:TOST) where he also worked on the 2021 IPO.

This article originally appeared on LinkedIn.