What Happens if Wal-Mart Gets a Bank?
Jane Adler
Most bankers worry that the giant retailer will open branches in its stores. But payments executives wonder whether the
relentless cost-chopper will morph from a limited-function acquirer into a processor or card issuer.
Wal-Mart Stores Inc.’s controversial application for an industrial bank charter could be a wake-up call for the merchant-acquiring
industry. If the application wins approval from regulators—a big if—Wal-Mart likely would reduce its ties with its processors—a
blow to those companies. And while Wal-Mart says at least for now it won’t issue its own credit card or process its transactions, the
move to open a bank is heightening anxiety about Wal-Mart’s broader objectives in the payments arena.
Most of the uproar about Wal-Mart’s proposed Utah-based industrial loan corporation centers on fears by the banking industry,
consumer groups, and legislators that the No. 1 retailer, which has 3,700 stores in the U.S., wants to run a banking operation that would
compete for consumer deposits.
But whether those fears will be confirmed is off in the future. In the here and now, the merchant-acquiring industry faces the most
direct threat as Wal-Mart ramps up its long-thwarted financial-services strategy. Acquiring executives wonder if Wal-Mart could
establish an alternative payments system. Also in question: Will other big merchants do likewise, leading to a wider payments
shakeout?
“Wal-Mart has the potential to be a formidable force in the payments business,” says John Hamby, senior vice president and
manager, Merchant Services Center, at Manchester, Conn.-based NewAlliance Bank. “Wal-Mart has a big footprint and when they start
marching, the rest of us take notice.”
Fairly or not, any action by Wal-Mart generates strong reactions across a wide swath of stakeholders. For the first time in its history,
the Federal Deposit Insurance Corp., which must approve Wal-Mart’s application if the proposed Wal-Mart Bank were to get federal
deposit insurance, held public hearings on such a request. In April, the FDIC conducted two days of hearings in Arlington, Va., and
heard another day of comments in a suburb of Kansas City, Mo. And in another unprecedented move, the FDIC has devoted a portion of
its Web site to the review process.
The FDIC has received about 3,600 comments on Wal-Mart’s application so far. Most deposit-insurance applications, by
comparison, receive no comments at all, an FDIC spokesperson says.
Broad Strategy?
In addition to consumer groups and labor unions, community banks generally are opposed to the Wal-Mart bank application, too. While
most of their concerns reach beyond the acquiring business, some community bankers whose institutions serve as acquirers for local and
regional merchants testified at the FDIC hearings that Wal-Mart could create one of the largest payment systems in the country, and the
company might force its vendors to use that system. The bankers argued that the entire payment-processing system could be at risk if
Wal-Mart encountered financial problems.
“Wal-Mart has major forces aligned against it,” notes consultant Paul R. Martaus, president of Martaus & Associates, Mountain
Home, Ark.
Wal-Mart’s processors, the companies that would be most immediately affected by approval of the application, have been quiet so
far on the subject. Wal-Mart’s main acquirer, Chase Paymentech Solutions, wouldn’t comment for this story. (Chase Paymentech is
51% owned by money-center banking giant JPMorgan Chase & Co. and 49% by processor First Data Corp.)
Despite the outcry, not everyone thinks a Wal-Mart bank is a bad idea. The American Financial Services Association, a trade group
of non-bank financial firms, for instance, said in a letter to the FDIC that the bank could enhance competition and consumer choice.
Though other industry watchers remain skeptical about Wal-Mart’s real motives, they also believe that, because of Wal-Mart’s clout
and ability to cut costs, it could find new ways to streamline the payments business. “I think they have a broad financial-services
strategy in mind and I am OK with that,” says C. Marc Abbey, a partner at First Annapolis Consulting Inc., Linthicum, Md.
Bentonville, Ark.-based Wal-Mart has been pursuing a retail banking strategy for years without success. Several past attempts by
Wal-Mart to secure bank charters have failed. In 2002, for example, California legislators passed a law preventing Wal-Mart from
buying an industrial bank there.
This time around, Wal-Mart has applied for an industrial loan charter in Utah, one of only three states that grant such charters to
commercial entities. Such a charter would allow its sponsor to provide commercial and consumer loans, according to Darryle Rude,
supervisor of industrial banks at the Utah Department of Financial Institutions in Salt Lake City. Utah currently has 33 industrial loan
corporations, or ILCs, according to Rude. These include both large and small entities, such as BMW Bank, GE Capital Financial,
Merrill Lynch Bank USA, GMAC Automotive Bank, and Pitney Bowes Bank.
The group’s only retailer is Wal-Mart’s archrival, Minneapolis-based Target Corp. During the review period before the approval of
Target’s charter, the FDIC received no comments about Target’s application, the FDIC spokesperson says.
Addressing the widespread belief that Wal-Mart has ulterior motives, Jane Thompson, a former top payment-service executive at
Sears, Roebuck & Co. and now president of Wal-Mart Financial Services, testified at the April FDIC hearings that “the purpose of the
bank would be to sponsor credit card, debit card, and electronic check transactions—nothing more.”
She went on to explain that the bank charter would allow Wal-Mart to eliminate the sponsorship fees paid to third-party banks. (Visa
and MasterCard rules require transactions coming into their networks to come from banks.) She added: “The [Wal-Mart] bank would
not have computers and systems to perform the actual processing of payments.”
Capital Question
In short, Wal-Mart’s bank would submit transactions into the payment networks, but the remainder of the processing would continue to
be handled by outside processors. The so-called sponsorship fee—the amount Wal-Mart currently pays to its acquirer to submit the
transaction into the payments system—on each transaction amounts to fractions of a penny, Wal-Mart spokesman Marty Heires says.
But he notes that, “We have 2 billion transactions a year. It’s not an insignificant sum.” Heires figures annual sponsorship fees total
somewhere in the “single-digit” millions of dollars.
That doesn’t seem like much for a company that posted $312.4 billion in sales in its fiscal year ended Jan. 31, up 9.5% from the year
before. But Heires says sponsorship fees matter to Wal-Mart for two reasons. First, the company expects electronic forms of payment to
grow, which in turn will increase sponsorship fees. Electronic payments are currently growing at 12% a year. Also, he says, “Saving
money is our culture. We watch pennies like no other company.” The money saved on sponsorship fees will be passed on to customers
in the form of lower-priced products, he adds.
Heires insists the retailer’s bank application is not an effort to reduce its interchange expenses. He argues, however, that interchange
fees are high and Wal-Mart would like to see those fees reduced. Wal-Mart led a merchant class action challenging certain Visa and
MasterCard policies that the associations settled for $3 billion in 2003 and resulted in lower debit card fees. But it’s not participating in
the pending crop of merchant suits against Visa and MasterCard over interchange.
Industry watchers continue to question whether Wal-Mart will be satisfied for long with such a self-circumscribed role in financial
services.
“It’s unlikely [Wal-Mart] is doing this because of payment processing,” says First Annapolis’s Abbey. “The amount they have at
stake by displacing an acquirer is nothing. It’s peanuts.” He adds: “Consider the amount of capital [Wal-Mart] has to have in the bank
and the only upside is the avoidance of the fees they pay the acquirer? That’s a real suboptimization of capital. It’s too expensive.”
The proposed bank’s initial capitalization would be $125 million, according to an amended business plan the company submitted
March 31 to the FDIC. Asked about the wisdom of allocating $125 million to recoup only several million dollars a year, Wal-Mart’s
Heires emphasizes that the company expects all forms of electronic payments to grow. “The savings will increase,” he says.
Heires also notes the company’s margins on retail sales are razor thin—3.6% last year—and he expects the bank to earn a better
return on the company’s money than the chain would from its retail operation. “We will put the money [in the bank] to work,” Heires
says. “This is not as onerous as you might think.”
“I’m skeptical,” counters payments consultant Allen Weinberg, managing partner at Glenbrook Partners LLC, Menlo Park, Calif.
“It’s not clear they’ll save any money.” He believes it’s a pretty safe assumption that Wal-Mart, because of its size, gets the lowest
possible processing fees. “The overhead of setting up a bank and dealing with regulators will cost millions. To go through all that hassle
for a couple million bucks? It makes me want to take a closer look at the numbers.”
Though the payment processors and banks with whom Wal-Mart currently works likely will take a hit, the full impact on them
remains unclear. Wal-Mart says it uses about a half dozen banks as sponsors, though it refuses to name them.
“For the major acquirers who support Wal-Mart, the economics for them is marginal,” says consultant Abbey. “It won’t put Chase
Paymentech out of business. They price Wal-Mart to just increments above the variable cost so Wal-Mart generates almost nothing.”
A New Network?
The outcome for processors may depend on Wal-Mart’s wider plans. The company says it doesn’t plan to acquire transactions for other
merchants. “The bank will have one customer and that will be Wal-Mart,” Heires says.
At the hearings, FDIC chief operating officer John Bovenzi asked Wal-Mart opponents whether they might be satisfied if any
changes Wal-Mart made to its plans would be subject to review. But even if a promise is extracted from Wal-Mart to do what it says it
wants to do, many remain skeptical. “I can see the possibility that [Wal-Mart] may take small-business clients away from community
banks as a merchant acquirer,” says Linda F. Echard, president and chief executive at ICBA Bancard, an Arlington, Va.-based payments
processor and a subsidiary of the Independent Community Bankers of America trade group.
Echard is even more worried about Wal-Mart’s larger goals. “If they get into financial services, they will do to Main Street banks
what they have done to Main Street [retailers].”
Wal-Mart defenders stress Thompson’s statement that Wal-Mart doesn’t plan to process its transactions. And few outside observers
believe Wal-Mart would actually want to become its own processor. They say the company has already negotiated the lowest possible
price for such services and note the huge expense involved in starting a processing business.
But consultant and former Visa USA executive Norman G. Litell, of Berkeley, Calif., thinks Wal-Mart might want the entire
processing chain under its umbrella in order to gain further control over payment operations and technology. “They can try and squeeze
a bank and a processor, but there is a limit,” he says. “The biggest argument [for a bank charter] might be that they will have the
flexibility of being able to try different technologies and control the pace of adoption.”
Veteran acquiring executive Hamby of NewAlliance Bank believes Wal-Mart is capable of setting up an entirely new, low-cost
payments system. “There’s an opportunity there for someone to create a payments system without all the fluff,” he says, noting that the
current system is expensive for merchants. “An entity like Wal-Mart has the clout to be the catalyst.”
Getting more control over payment processing might just be Wal-Mart’s first step in reducing interchange, by far the biggest single
expense in accepting bank cards. “I assume Wal-Mart is trying to find a way to reduce fees by bringing transaction processing in house,”
says attorney K. Craig Wildfang, a partner with Robbins Kaplan Miller & Ciresi LLP, a Minneapolis-based firm co-leading the
interchange lawsuits against Visa and MasterCard. “If they can establish their own network, then they can argue that they should not pay
full interchange fees.” Or, he adds, Wal-Mart could possibly eliminate interchange fees altogether.
Of course, by becoming its own card issuer, Wal-Mart could not only generate more revenue but also collect a portion of its own
processing fees. Wal-Mart’s Heires is careful to say the company has not stated any plans to have a self-issued credit card, begging the
question whether such a plan exists but hasn’t been announced. Wal-Mart currently has a private-label credit card issued by General
Electric Co.’s GE Consumer Finance and a GE-issued Wal-Mart Discover Card in which transactions flow on the network of Morgan
Stanley’s card unit, Discover Financial Services. And while Wal-Mart has not officially launched a debit card, Heires says the company
currently has a small test under way with a GE debit card in four locations.
Target has already made the bank model work. Most of its $6.1 billion portfolio consists of a Visa credit card, supplemented by a
private-label card. Both of those card programs are issued through Target National Bank, a limited-purpose bank based in Sioux Falls,
S.D. In 2004, Target received approval for its industrial bank charter in Utah. That bank, called Target Bank, issues business cards.
According to the retailer’s fiscal 2005 financial reports, Target earned $645 million from cards before interest and income taxes. Thirdparty merchant fees, the interchange Target earns when its Visa cardholders spend on their cards outside of Target, totaled $124 million.
“There’s money at stake on the issuing side,” says consultant Abbey. (Target didn’t return phone calls for this story.)
What’s next? State and federal regulators say no timetable is set on Wal-Mart’s
bank application. For now, that leaves the
payments industry to watch and wait. Says consultant Martaus: “We don’t know
who will win.”
Behind the Wal-Mart Bank Brouhaha
Wal-Mart Stores Inc.’s proposed Utah-chartered industrial loan corporation, Wal-Mart Bank, would have only one job under the
retailer’s current plans—to sponsor payment card and electronic check transactions into financial networks. This function would save
Wal-Mart less than a penny per transaction, but with Wal-Mart’s 2 billion-plus electronic payment transactions a year, the savings could
be considerable.
The effect on Wal-Mart’s payment-services providers is unclear. Wal-Mart’s merchant acquirer is Chase Paymentech Solutions, and
the retailer uses about a half-dozen unnamed banks as transaction sponsors. Wal-Mart says it has no plans to take on broader processing
functions.
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Utah ILC charters permit their holders to offer a broad range of financial services, leading Wal-Mart critics to wonder if the retailer
has bigger plans such as branch banking. Wal-Mart also could issue cards directly through its Utah bank, though it hasn’t said it plans to.
GE Consumer Finance currently issues private-label and Discover-branded cards for Wal-Mart.
Utah requires the bank to get federal deposit insurance. Wal-Mart’s application to the Federal Deposit Insurance Corp. generated by
far the biggest response to such a request in the agency’s history—some 3,600 comments and three days of hearings. The FDIC hasn’t
said when it will make a decision.