Battle Between Big Banks and Third-Party Payment Services

With increasing inflation, higher interest rates, and slowing economic growth, the competition for consumers' money and their payment methods is more intense than ever. 

What’s happening in the online payment market now? 

The rise of third-party payment options has been leading banks to worry about losing control of their customer relationships. In response, in January 2023, major international banks including Wells Fargo, Bank of America, JPMorgan Chase, and four others are planning on creating a new digital wallet, which will be managed by Early Warning Services LLC (EWS), a company co-owned by all the aforementioned banks that also operates the money transfer service, Zelle. A digital wallet is an app or online service used to make payments electronically or to store electronic tickets, documents, etc. With the increased prevalence of mobile phones, almost 30% of all Americans use digital wallets, and the number is quickly closing in on the use of cards, which is around 45%. 

The new digital wallet aims to compete with third-party wallet operators and peer-to-peer payment services like PayPal and return control to banks for online purchases. Upon online checkout, the merchant will send a request to EWS, which will use its connections to the banks to determine which of the consumer's cards can be loaded into the wallet. Any consumer who has made timely payments, used their card online recently, and provided an email and phone number

is eligible to sign up for the digital wallet. This gave the banks a confident estimate of 150 million active credit and debit cards in the digital wallet platform following its launch. 

The prospects for this new digital wallet is optimistic. With 150 million projected users, it will have a consumer pool of more than double of that of the Apple Pay ecosystem, which has 65 million, and almost half of that of PayPal with 377 million in 2020. The only concern is that these digital wallets and payment platforms are not exclusive, meaning that many users will end up using more than one. Therefore, it is difficult to predict market share of the digital wallet before launching. 

Why are P2P and third-party platforms so popular? 

There are a variety of reasons that consumers prefer P2P services over the technology services that big banks are beginning to offer. First, as illustrated by the graph below, aside from a few exceptions like Zelle, non-bank-owned P2P platforms generally enable customers to make more frequent payments. 

P2P services offer more frequent, lower-value transactions than bank-owned technology platforms.  This feature is highly advantageous when customers want to make a series of smaller payments. However, one downside to P2P platforms is that they often have lower transaction amount limits than the technological platforms offered by big banks. To break into the fintech market, big banks can take advantage of the weaknesses in existing P2P technology. For example, big banks can promote themselves as digital check payment platforms. The average P2P cash transaction amount ($32) is much closer to the overall average P2P transaction value ($35) than the average P2P check payment ($128). Check payments make up approximately 10% of all P2P transactions, so banks can take advantage of this opportunity to streamline the check payment process via digitization. 

Another reason that there is significant competition between big banks and P2P platforms is that younger age groups, who are increasingly entering the payment market, tend to prefer mobile services like PayPal over traditional banking services. As shown in the graph below, the proportion of Millennials (65%) and Gen X (72%) people who use PayPal far exceeds the proportions amongst Baby Boomers (55%) and Matures (37%). However, bank apps were the second most popular payment platform out of those surveyed, which is a promising sign for big banks as they introduce more technological innovations. 

One such example of this technological innovation is FedNow, a digital, instantaneous payment platform that the Federal Reserve is planning to launch in the coming months. FedNow will allow users to instantaneously send money between bank accounts, making the process of transferring money much more efficient.  The use of different payment services varies by age group. 

Trust barrier to big banks entering FinTech

In order to break into the FinTech space traditional banks need to establish trust in their digital platforms. This has been an ongoing hurdle for banks beginning with their mobile banking apps. These apps, which allow people to deposit checks, transfer money between accounts, and check bank statements, are used by 72% of Americans but trust still plays a big factor in people’s decision-making process, according to a NerdWallet survey. Of the Americans who don’t use mobile banking apps, 42% express distrust in digital banking. Similarly, even among the people who do use mobile banking apps, 46% are concerned about the apps’ safety. 

Overall, the trust with digital banking lies in a mutual agreement of trust between the bank and the customer: the bank trusts the customer and the customer trusts the bank. A customer wants to trust that a bank will protect them from fraudsters and alert them if suspicious activity is occurring on their account. The bank needs to trust that the customer is who they are and that they are able to purchase what they are buying so the bank doesn’t need to constantly intervene with their account. A bank that worked to achieve this mutual agreement is Capital One, who was rated the most trustworthy bank of 2022. The bank eliminated overdraft fees, offered 24/7 mobile banking, easy cancellation of lost cards, and worked to create a personalized digital banking experience for customers. These policies are becoming more commonplace, are helping people gain trust in digital banking as a whole and will increase customer faith in future FinTech products. 

One step that could increase customer trust in digital platforms is to cut down on fraud. Customers using their new bank-owned digital wallets wouldn’t have to type in their card numbers when paying, which can raise the risk of fraud and rejected payments that result in lost sales. However, Senior Industry Analyst at Bankrate Ted Rossman revealed that the new digital wallet “will likely have some sort of two-factor authentication like a code sent via text message.” One of the top discerning factors between third-party payment and bank-owned credit card payment is the extensive use of two-factor authentication (2FA) in the former category. 2FA adds an additional layer of security to the authentication process by making it harder for attackers to gain access to a person's devices or online accounts since a password alone is not enough to pass the authentication check. 

The future of online payment and digital banking 

In a time when financial institutions are no longer required to carry out 

transactions, both banks and card companies prioritize remaining relevant in an evolving ecosystem. Over time, they should aim to succeed in the transformed environment by identifying new opportunities and restructuring their offerings. To achieve this, a thorough examination of the future challenges and possibilities for financial institutions is necessary. By utilizing digital technology, they can transform from traditional, isolated entities to open, collaborative organizations that prioritize customer experiences. This will allow big banks to compete with— or one day even surpass—popular third-party P2P platforms like PayPal.

Authors: Lynn Kang, Mina Derebail, Ian Hicks