The spotlight is once again on Wal-Mart Stores (WMT) and its financial services. A recent Bloomberg article has given details on the Federal Advisory Council meeting held in December 2012, which strongly opposes Wal-Mart's prepaid card business. This latest meeting marks the latest chapter in the long fight between the financial services market and the retail market on whether the retail companies should be allowed to provide financial services.
The nation's largest retailer has been accused of shadow banking as it provides various financial services, which are exempt from regulatory norms. Wal-Mart's tryst with providing financial services started in 2005 when the company had applied for a charter to open a bank in Utah. However, it had to pull out of the proposition after two years due to strong opposition from various banks and lawmakers. Currently, Wal-Mart provides various in-store services like check cashing, money orders, bill payments and money transfers through its Money Centers. Further, its latest experiment is providing insurance in collaboration with Metlife Inc. (MET) in South Carolina and Georgia.
Wal-Mart's key product and the subject matter of the council discussion is its pre-paid card. In October 2012, in collaboration with American Express (AXP) it launched a new pre-paid card - Bluebird. The Bluebird card did not require a minimum balance or monthly/annual fees and did not impose fees for transactions done within the network of American Express. The card works just like a debit card but it is not connected to a regulated bank account. So customers can set up direct deposit for paychecks or even deposit checks just by taking a picture from their smartphones.
For Wal-Mart it gave access to a number of unbanked (i.e. consumer who use few bank services) and low-income customers, which is estimated to be $45 billion (Source: Center for Financial Services Innovation). As for American Express, the arrangement came as a surprise to many as it generally caters to the affluent bunch. But I guess it wanted a slice of the pie that many banks are eyeing.
Why are banks opposing?
In its latest meeting, the Federal Advisory Council, which is a body of bankers like PNC Financial Services (PNC) and BB&T Corporation (BBT), has urged the Federal Reserve to prevent Wal-Mart from providing financial services. According to the minutes of the meeting, the council described Wal-Mart's actions as a step to gain back door entry into the financial services space, without the required regulatory framework. Further it also suggested that the Fed should consider limiting payment-related services only to the traditional banks and should supervise non-banking companies that provide financial services.
One of the main excuses the bankers are using to pick on Wal-Mart and other retailers is the lack of federal regulation on its products. These cards are alternatives to the traditional debit and checking accounts, allowing retailers to provide financial services and without regulatory control. However, Wal-Mart claims that all services offered are regulated through its financial services partners.
The most important reason for opposition is that banks are losing out a large chunk of fee revenue in two ways - losing customers to these alternative financials services and loss of interchange fees.
There is a huge portion of the American population that remains "unbanked". According to a 2011 survey by the Federal Deposit Insurance, around 10 million American households do not have a savings account because they do not want to pay the large amount of ATM fees, overdraft fees and other bank fees. Further around 24 million American households have accounts but rely on alternative financial services like on-bank money orders, check cashing, etc.
According to Daniel Eckert, Wal-Mart's Vice President of financial service, the financial services that are provided prove to be a very viable and cheap option to the many unbanked Americans as well as low-income customers who otherwise would not be able to tap the traditional banking services.
Another example is The Home Depot (HD) that provides loans for its customers. Last year it provided its customers loans of up to $40,000 and this year has offered no-interest credit card payment terms. The interest rates on these loans are much higher as compared to those provided by other banks. But it still is favored over the traditional lenders, as loans are provided to people even with quite low credit scores, who would not be entertained elsewhere.
A number of retailers as well as banks are eyeing this large unbanked portion of the population that generates more than $78 billion annually in fee and interest revenue. But, retailers have an advantage over banks because they are able to provide these services with no/low charges.
Further, these pre-paid cards are exempt from the Fed's interchange fee rules. Interchange fee is an amount, currently capped at $0.21 per transaction, which is received by a bank from retailers whenever a customer swipes the concerned bank's debit card. For Wal-Mart's recent pre-paid card, American Express charges a so-called merchant discount rate but it is much lower than the interchange fee.
Wal-Mart is not alone
There are a number of retailers who provide various financial services right from check cashing and reloadable prepaid cards to small business loans and life insurance. Nordstrom Inc. (JWN) has its own card business and even reports it as a separate segment. Similarly, Costco Wholesale (COST) and Home Depot also provide various services to customers. Important to note, like Wal-Mart, Costco and Home Depot do not clearly bifurcate the revenues generated from these services. In its 10-K, Wal-Mart has mentioned that revenues generated from its financial and other services segment is classified as a component of net sales.
Nordstrom provides a private label credit card, two Nordstrom VISA credit cards and a debit card through its wholly owned federal savings bank, Nordstrom fsb. Through its credit card business, Nordstrom has been able to bring in new customers mainly due to its Fashion Rewards program attached with the card. The company has mentioned that its cardholders tend to shop more frequently as compared to its non-card members, which explains the 23% increase in sales from its members in 2012. In 2012, it was able to add 1 million new cardholders growing 27% year on year. During the recession this segment reported weak results mainly due to high delinquency and write-off trends but has seen a marked improvement in both ratios, rising to pre-recession levels.
Costco is also increasingly trying to attract customers who are not happy with the traditional banking system. The company sells auto and homeowner insurance and also offers credit card processing for small businesses. It also began making mortgages in 2010. Jay Smith, Costco's director of business and financial services, has stated that the idea is not to make money out of these small mortgages but to get the customers to renew their memberships with Costco, through which it derives majority of its revenues.
Wal-Mart has been trying hard to move into the banking business but has failed amid strong opposition from banks and lawmakers. Only time will decide if Wal-Mart will succeed in its endeavors but until then banks will have to come up with more innovative and probably free financial products to tap this large unbanked segment.For consumers, this might be good news in the sense that the banking sector will face competition from these retail giants and may have to think of offering some services for lower costs in order to tap the unbanked sector.