Capital One–Discover Proposed Merger: Systemic Risk and Market Competition Considerations

Capital One–Discover Proposed Merger: Systemic Risk and Market Competition Considerations

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Updated March 28, 2024
Capital One–Discover Proposed Merger: Systemic Risk and
Market Competition Considerations
In February 2024, Capital One announced a merger deal
structured as BHCs) and the Office of the Comptroller of
with Discover. This In Focus explores the policy issues
the Currency (because Capital One is a national bank). In
raised by the potential merger that may be of interest to
addition, the Department of Justice has the authority to
Congress, with particular attention to the competition and
block any merger on antitrust grounds. It and the bank
systemic impacts on the banking system.
regulators review proposals for their effects on market
power on the national and local levels. Bank mergers are
Capital One is the ninth largest depository institution in the
also subject to numerical statutory concentration limits to
country, with the 12th largest parent bank holding company
curb market power—the merged entity may not hold more
(BHC) by assets ($478 billion). It is also one of the largest
than 10% of total deposits nationally or 30% of deposits in
issuers of Visa- and Mastercard-branded credit cards.
any state, and for BHCs, the merged entity cannot hold over
Discover is the 27th largest depository, with the 33rd largest
10% of all financial company liabilities nationally.
BHC ($152 billion in assets). Discover also operates one of
According to the application, the merged entity would hold
the four largest card payment networks in the country and is
2.6% of national deposits and 2.3% of liabilities—not close
a major issuer of payment cards. If the banks do not divest
to the national limits. However, their combined deposits in
any current assets, the merger would result in an insured
Delaware would be 65% of the state total. The merger
depository institution with over $600 billion in assets,
application requests an exemption from the state limit, in
making it the sixth largest depository and eighth largest
part because they are largely online deposits.
BHC in the country. As shown in Figure 1, the institution
would be significantly smaller than the six largest BHCs
Bank regulators must also consider other aspects of a
but comparable in size to four banking organizations
merger, such as whether the merged institution would have
currently in the next tier (over $500 billion in assets).
adequate financial, capital, and managerial resources.
Additionally, it would combine two of the five largest card
Regulators consider the “convenience and needs of the
issuers and one of the largest card networks into one
community” and the banks’ Community Reinvestment Act
institution.
(P.L. 95-128) ratings. As of the date of the latest rating,
Discover held a satisfactory rating and Capital One held an
Figure 1. Comparing Capital One and Discover to the
outstanding rating. Regulators also consider the banks’
10 Largest Banking Organizations
effectiveness in combatting money laundering. According
December 31, 2023
to the Fed, “deficiencies that have resulted in the issuance
of a formal or informal enforcement action generally are
considered to be less than satisfactory.” In 2021, Capital
One paid a $390 million civil money penalty for violating
anti-money laundering regulations. More broadly, issues
resulting in enforcement actions or supervisory downgrades
are expected to be resolved before a merger is approved.
Both Discover and Capital One over the past several years
were subject to enforcement actions in various areas,
although this is not uncommon for large banks. While these
specific actions were resolved, regulators do not make
information about outstanding supervisory concerns at any
bank publicly available. However, Discover noted in its
recent Form 10K that it expects an enforcement action to
result from a recent card product misclassification issue.

Source: CRS calculations based on data from Federal Reserve.
The time regulators take to review a particular merger
varies, and it is not uncommon for several months to pass
Note: TD is an intermediate holding company. Others are BHCs.
between a large merger announcement and approval, as
Regulatory Approval Process
shown in Figure 2 for four recent proposed mergers by
banks currently closest in size to a merged Capital One-
Statute requires bank regulators to review merger
Discover entity. Those review periods took between 179
applications for, among other things, their effects on
and 430 days, with three approvals and, in the longest case,
competition and grants them authority to block mergers that
a withdrawn application (TD–First Horizon). To gain
do not meet certain standards. This merger is subject to the
regulatory approval, applicants often make changes to their
approval of the Federal Reserve (because both banks are
activities or holdings, such as divesting branches in
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Capital One–Discover Proposed Merger: Systemic Risk and Market Competition Considerations
overlapping markets to allay concerns about market power,
assets. According to Capital One’s regulatory filings, it was
which creates uncertainty about how a merger will affect
the third largest issuer of Visa and Mastercard payment
factors such as competition and systemic risk until
cards. Capital One credit card users purchased around $587
approved.
billion in transaction value in 2022. Discover credit card
holders purchased around $224 billion, with an additional
Systemic Risk Issues
$550 billion run through Discover proprietary and affiliated
Regulators must also consider whether the merger poses
debit card networks. Absent changes, the merger would
systemic risk to the U.S. banking or financial systems.
result in a depository institution with a retail card issuer that
Although there does not seem to be a standard formula for
accounts for over $1 trillion in annual transaction volume.
determining this, the factors considered overlap with those
used to classify Globally Systemically Important Banks, or
The competition consideration in merger reviews generally
G-SIBs. G-SIBs are classified on the basis of size,
focuses on deposit concentration, but regulators also
interconnectedness, substitutability, complexity, and cross-
sometimes consider competition in product markets,
jurisdictional activity. To mitigate systemic risk, large
notably for mergers involving specialty banks, such as
banks are subject to enhanced prudential regulation (EPR).
credit card banks. Capital One and Discover are both
Under EPR, banks are placed in four categories and subject
among the largest credit card issuers in the country, and
to progressively more stringent regulations. Capital One is
Discover operates a large card network that processes credit
currently a Category III bank and Discover is a Category IV
and debit cards. Further, Discover’s debit card network
bank, and the EPR category of the merged entity is also
structure is currently not covered by certain provisions of
likely to be Category III, so it would not be subject to more
Regulation II, which regulates debit card transaction fees.
stringent EPR requirements than currently apply to Capital
(Regulation II implemented the “Durbin Amendment.”)
One (but more stringent requirements than currently apply
to Discover). The merged entity is unlikely to meet the
According to the application, Capital One plans to integrate
definition of a Category I (i.e., G-SIB) or Category II bank.
its card issuance with Discover’s network. It is uncertain
The entity would not initially meet the asset or cross-
whether this would drive prices (i.e., “swipe fees”) down,
jurisdictional activity threshold for Category II banks. The
by creating economies of scale and helping the Discover
merged entity would also score relatively low on all of the
network better compete with Mastercard and Visa in retail
metrics used to identify G-SIBs except size, intra-financial
payments, or drive prices up by reducing competition
system assets, and securities outstanding. All of the other
through the vertical integration of two major actors in the
banks in Figure 2 also remained Category III banks
different parts of the market. Competition in this market has
following their mergers.
perennially drawn congressional attention, and promoting
competition in the credit card market is one of the primary
Figure 2. Duration of Recent Merger Applications
goals of legislation such as the Credit Card Competition
Act of 2023 (S. 1838/H.R. 3881). Regulation II caps
permissible debit transaction fees. Currently, Capital One
does not have a large debit card business, but its debit card
issuance is covered by the regulation, meaning the revenue
it can generate from a transaction (i.e., “interchange”) is
limited by the price cap. In its February 2024 8-K securities
filing, Capital One noted that it would benefit from moving
its debit portfolio to Discover networks, which are not
covered by Regulation II price caps.
CRS Resources
CRS In Focus IF11956, Bank Mergers and Acquisitions, by
Marc Labonte and Andrew P. Scott

Source: CRS calculations based on data from S&P Capital IQ.
CRS In Focus IF11893, Merchant Discount, Interchange,
Notes: The post-merger bank is not in parentheses. For TD–First
and Other Transaction Fees in the Retail Electronic
Horizon’s merger proposal, figure shows length of time from
Payment System, by Andrew P. Scott
announcement to withdrawal.
CRS In Focus IF12548, How the Credit Card Competition
Retail Payment Issues
Act of 2023 Could Affect Consumers, Merchants, and
While making loans and accepting deposits are the core
Banks, by Andrew P. Scott
operations of a bank, there is a third critical function banks
serve: payments. Banks are crucial in the facilitation of
CRS Report R47876, Enhanced Prudential Regulation of
retail and wholesale payments. For example, banks are the
Large Banks, by Marc Labonte
institutions that issue payment cards (retail) and settle
transactions (wholesale) at the Federal Reserve.
Andrew P. Scott, Analyst in Financial Economics
Marc Labonte, Specialist in Macroeconomic Policy
At the end of 2023, more than a quarter of Capital One’s
Graham C. Tufts, Research Assistant
total assets and nearly half of its loan portfolio were credit
card loans. Credit card loans were 68% of Discover’s
IF12607
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Capital One–Discover Proposed Merger: Systemic Risk and Market Competition Considerations

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