Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

My Thoughts

Are Digital Wallets a Threat to Banks?

One of Australia’s top bank executives has admitted that he agrees with a theory I’ve advanced before. Mike Hirst, the managing director (chief executive) of Bendigo and Adelaide Bank told his shareholders that he thinks digital wallets from non-bank competitors are a threat to traditional banks.

Hirst thinks that digital wallets, such as those offered by eBay Inc.’s (NASDAQ: EBAY), could lure large numbers of depositors away from banks and threaten the revenue banks get from deposit fees, The Sydney Morning Herald reported. Hirst made the admission in a message to his shareholders.

Banks currently make quite a bit of money from low cost deposits (checking and savings accounts), Hirst pointed out. Revenue from deposit fees allowed banks to weather the loss of income from other instruments such as mortgage loans, he added. Hirst even compared the situation with deposits to the Australian mortgage industry; he claimed that since the 1990s, banks Down Under have lost half their home loan businesses to lower cost online competitors.

The danger to banks is that a large portion of revenue could be lost if consumers shift all or part of their funds to non-bank repositories such as PayPal. Hirst specifically pointed to PayPal and Apple Inc.’s (NASDAQ: AAPL) Apple Pay as direct threats to banks.

Why PayPal and Company are Competitors to Banks

Hirst’s argument mirrors one that I have made before, that payment solutions like PayPal, Green Dot (NYSE: GDOT), Xoom (NASDAQ: XOOM) Google Inc.’s (NASDAQ: GOOG) Google Wallet, Apple Pay, and the privately held Square are competitors to traditional banks. Like banks, these solutions act as gateways to the banking and financial system. The difference is that they have a much lower bar of entry. All you need to do to activate Apple Pay is download it from the App Store. All you need to access PayPal is an email address; you can even purchase Green Dot’s solution at retailers like Walmart Stores Inc. (NYSE: WMT).


The threat that digital wallets pose to banks is fairly easy to see. You can do almost everything with a PayPal account that you can do with a bank account. For example, you can make electronic payments, transfer funds to and from bank accounts, make credit or debit card purchases, and even withdraw money from ATMs with a PayPal account. Green Dot even offers checking accounts, complete with paper checks, with its solution. PayPal even pays a small rate of interest on its accounts.

You can set up such accounts quickly and easily without filling out a lot of paperwork or getting a credit check. Such accounts are also open to individuals excluded from the traditional banking system, such as those with poor credit scores and the “unbanked.” That market could be huge; there are currently 68 million American adults who are either unserved or underserved by banks. Digital wallets give those people a cheaper and easier way to access alternative to bank accounts.

PayPal and Square Going After the Loan Business

It’s not just depositors that PayPal and Square are coming for. They’re also going after loans and business customers. PayPal and Square have entered the business-lending business in a very big way.

PayPal and privately held Square Inc. have extended $275 million in credit to businesses in the past year, Bloomberg reported. The loans are basically a line of credit on a PayPal or Square balance. PayPal charges around 12% in loan fees, while Square charges between 10% and 14%. The money is dispersed to borrowers through their PayPal or Square accounts.

Entrepreneurs prefer the PayPal and Square loans because there is less paperwork attached to them. That sounds like part of the business plan for PayPal’s digital wallet – all you need to get it is an email address. No credit report and no cash are required. Now borrowing money is just as easy as opening a digital wallet. All you need is a respectable cashflow through your PayPal account to get a line of credit.

The bottom line is that PayPal and Square are behaving a lot like banks and bringing out new products and services in direct competition with banks. They were competing with banks by taking deposits, but now they’re lending money. Apple, Green Dot, and Google are not making loans yet, but Google has invested in at least two online lenders, Lending Club and Lend UP.

So How Vulnerable are Banks Anyway?

Okay, so banks might be vulnerable, but how vulnerable are they to this threat? If PayPal’s metrics are anything to go on, the threat is greater than you might think.

PayPal reported that its TTM revenue grew by 20% between the third quarters of 2013 and 2014. PayPal also reported that its total volume of transactions increased by 29% between the third quarters of 2013 and 2014. Merchant Services, the arm of PayPal that deals with business customer, saw its total volume of transactions increase by 37% between the third quarters of 2013 and 2014.

Bank of America Corporation (NYSE: BAC) reported that its quarterly revenue growth fell by 3.10% between the third quarters of 2013 and 2014. JPMorgan Chase & Company (NYSE: JPM) reported a quarterly year-to-year revenue growth rate of -.7% between the third quarters of 2013 and 2014. In contrast, Wells Fargo & Co (NYSE: WFC) reported a year-to-year quarterly revenue growth rate of 2.20% between the third quarters of 2013 and 2014.

Judging by these figures, it looks as if revenues are flat or stagnant at these big banks, while they’re growing dramatically at PayPal. The big consumer banks have dismal revenue growth, but they’re still monsters when compared with PayPal.


PayPal reported revenues of $6.6 billion for 2013. On Sept. 30, 2014, Bank of America reported a TTM revenue of $87.01 billion, Wells Fargo reported a TTM revenue of $83.57 billion, and JPMorgan Chase reported a TTM revenue of $94.85 billion. PayPal has a long way to go before it matches the revenue of the big banks.

The threat to banks is best shown by PayPal’s growth rate. PayPal’s mobile payment volume increased by 72% between the third quarters of 2013 and 2014, growing to $12 billion. Mobile payments now make up 20% of PayPal’s payments. Venmo, a mobile payment App offered by PayPal subsidiary Braintree, saw its payment volume grow by 50% between the third quarters of 2013 and 2014.

What happens if other nontraditional payment solutions match PayPal’s growth rate? Anecdotal evidence indicates that Apple Pay’s growth rate is already rivalling that of PayPal. The Wall Street Journal’s Jennifer Booton noted that 200,000 U.S. retailers now accept Apple Pay, and one million credit cards were activated on the app within 72 hours of its rollout.

Apple Pay could also help boost other payment solutions. Square CEO Jack Dorsey told CNN that he wants to accept Apple Pay through its services. Dorsey said Square will start accepting Apple Pay sometime in 2015. Dorsey also said he wants to accept all forms of payments.

My prediction here is that banks could start seeing a significant loss of revenue to payment solutions within the next year. That poses a dilemma for investors, bankers, and regulators. One massive problem here is that digital wallets are not regulated and insured the way bank accounts are. There is no FDIC insurance, and what happens if one of the digital providers crashes because of bad loans? We’re moving into uncharted territory here – potentially very dangerous territory.