Payment processors evolved over the years from their core purpose of handling the financial aspect of a transaction. A look at the top UK payment systems shows payment processors offer value-added services including loans, inventory optimization tools, and even a Mastercard-branded business debit card.
So what’s the point of having a relationship with a bank? Soon enough, it may not even be required.
What Do Payment Processors Do?
Payment processors like Square, Shopify, Stripe, PayPal, and others simply manage the credit or debit card transaction process. They perform the duty as a mediator between the e-commerce business and the client’s financial institution. Then, the payment processor remits the funds it collects to the business owner — minus the fees they keep, of course.
Up until maybe 15 years ago, this was the sole service that payment processors provided. But the surge in e-commerce activity over the years presented processors with a compelling opportunity to profit from new revenue streams from loyal customers.
This strategy certainly paid off for Shopify. The Canada-based company displaced mega-bank Royal Bank of Canada to become the country’s most valuable company in 2020 after years of strong momentum.
Processors Do What Bank’s Do, But Better
It is difficult to think of a particular product or service offered by banks that payment processors haven’t copied over the years.
Small business loans? Check. Shopify offers small business loans that are paid back through a percentage of sales. Since Shopify already has access to the necessary financial information, the approval process is much faster than banks. Gone are the days of a lengthy approval process and unnecessary credit checks.
Debit Cards? Check. Square launched in early 2019 a free Square Card business debit Mastercard that is linked to their account balance. The card can be used anywhere Mastercard debit cards are accepted or to withdraw funds at ATMs. The best part? Square Card gives the user a 2.75% instant discount on purchases made at other Square sellers.
The Square Cash App, a payment app that facilitates peer-to-peer payments through a mobile device, can be accompanied by an optional Visa debit card.
Point of Service Terminal? Check. PayPal offers business owners a choice of several physical point of service (POS) terminals to handle the physical retail portion of a business. PayPal backs its hardware up with software for inventory management, e-commerce, and customer loyalty.
Should Banks Be Worried?
Mega-banks should very much be worried that the fate of their industry is in jeopardy. Sure, banks aren’t poised to disappear but it could undergo a fundamental revolution.
The bank industry thrived over the decades by offering outdated products and assumed their massive size would deter anyone from challenging their dominance.
At the head of processor companies are some of the brightest minds of our generation. Jack Dorsey splits his time as CEO of the two companies he founded, Square and Twitter.
Tobias Lutke transformed Shopify from its roots as an online snowboard website to offering a service that helps mom-and-pop online businesses to compete on an equal level playing field as Amazon operates from.
PayPal boasts a unique advantage: it is more trusted among the younger generation than banks.
Technically, Square Is Now A Bank
So if payment processors are more valuable than banks and offer superior services, why not make it official?
Square is technically a bank as it was granted conditional approval from the FDIC in early 2020 to act as a bank charter, Industrial Loan Company, or ILC. The approval allows Square to further entrench into banks’ core businesses, including loans and deposits to businesses and consumers.
Square’s Cash App is also stealing market share away from banks as customers use the app to deposit tax refunds, and work paychecks. Did we mention the Cash App allows customers to buy and sell stock with no investment-related fees.
How much momentum is Square seeing right now? As a public company, we know a lot of details. Here are some highlights from Square’s second quarter earnings report that makes it clear it is gaining momentum against banks:
- More than 7 million customers used their Cash Card in the quarter, up two-fold from the same period last year.
- Cash Card spend in the quarter rose nearly 50% from the first quarter.
- Direct deposit customers used two times to three times more than Cash Card customers.
- Square’s financial arm, Square Capital, facilitated $873 million in Paycheck Protection Program (PPP) loans to 80,000 small businesses.
- Encouragingly, the company may have established goodwill as 60% of PPP borrowers had never received a loan through Square.
Conclusion: Are Bank Executives Acknowledging Their Fate?
Perhaps the most telling sign that payment processor companies and other fintech startups are poised to seriously challenge banks comes from bank executives themselves.
According to the Concernstone Advisor’s 2020 “What’s Going On In Banking” study, more than half of bank executives acknowledged big tech companies represent a significant threat to their industry.
Approximately one out of three executives specifically named Square as a threat. The other two-thirds have yet to come around this eventual conclusion and recognize the obvious.