SECTOR SPOTLIGHT: State of Cards in Financial Services and FinTech
It’s only a year after COVID-19 changed our way of life, and the effects are visible in how we work, go to school, and shop. In gauging the deepest impact of the pandemic, financial services is at the top of the list — especially with banking and payments. The digital shift taking place from the 2010s feverishly accelerated in 2020.
Previous posts discussed how traditional banking and the retail branch model are becoming outdated. Due to restrictions from the pandemic, millennials and baby boomer usage of local branches was reduced further. About 70% of consumers now believe the same functionality can be achieved through digital or mobile apps. The ease, speed, and access from challenger and neobanks leveraging financial technology (FinTech) threatens the market share of incumbent institutions.
On a broader level, e-commerce increased its share of total spending as a result of COVID-19. About 46% of survey responses (from the Capgemini World Payments Report) said over half of monthly spend was online (up from 24% pre-pandemic). When in-person payments do take place at retailers or restaurants, contactless methods are commonly used. Cards have ‘tap and go’ functionality and smartphones have mobile wallets with virtual cards to be scanned. Both online and offline cashless trends are expected to climb higher even as the economy opens backs later in 2021.
In this new decade, fintech platforms are leveraging new card products to capture the opportunity created by consumers no longer using traditional banks and cash. Banks, payment networks, and card issuers care capitalizing on these dynamic growth trends with the latest tech and infrastructure partnerships, and innovative updates to prepaid, debit, and credit card offerings.
fintech for the next innovation wave in cards
The pace of new offerings and enhancements with payment cards is fueled by FinTech. Card programs and issuers (in particular) utilize tech for faster delivery of a highly personalized product at lower costs. New card enhancements are being delivered outside of outdated legacy systems. No minimum order size or volume needed for orders as card printers have on-demand offerings.
The most underrated advance comes from cloud technology, which has helped expand product and programs internationally. Platforms prototyping a new card no longer have to build their own infrastructure and system from scratch. Early market fit can be captured with less of an upfront investment to card issuers. Once a platform is ready to increase scale, comprehensive card programs provide the capacity on as needed basis.
It took time for financial institutions and payment networks to become comfortable with cloud managing and transferring data. Regulations and guidance have clarified what’s needed when it comes to security (such as cloud outsourcing and PCI compliance). Even banks feel more confident in cloud’s capability to securely store data (instead of their own servers).
Small-scale card providers are increasingly competing in the market to take on established players. As a result, new and compelling offers are available outside of mass-market bank cards and larger financial institutions.
current state of cards (by product type)
Besides the changing trends in banking and payments, card offerings as a whole were widely available and more sophisticated over the last year. Non-financial services companies are willing to test the waters with a new card for existing users. Neobanks looking to stay ahead of the marketplace have layered on innovative features (such as transaction decisioning, advances, installment payments) and high-earning reward programs that earn investments (such as crypto and stocks).
Here’s a review and comparison of the top 3 card categories and how builders (founders and product teams) can utilize each effectively:
PREPAID: A fast and lightweight offering (especially for small scale providers) with similar functionality to traditional debit cards. A user keeps a balance on the card available for spend at physical locations or online — some also have the ability to withdraw at an ATM for a fee. Unbanked individuals can quickly start transitioning away from cash with a prepaid card. This market continues to grow with a revenue projection of $5.5B in prepaid spend by 2027.
From an infrastructure perspective, prepaid card programs typically have an omnibus account under a company (platform) with numerous cards issued on top. No individual user account exists and ledgering/reconciliation needs to be managed by the platform themselves. Programs are limited to funding and spending on a card.
Need: Quickly issue a basic spend card with reload capabilities and minimal (or no) user requirements;
Common use cases: government benefits (such as stimulus or benefit payments), payroll, loan disbursement, access to tax refunds, monitor spending of children by parents, workplace benefits spending and tracking, and giftcards;
Benefits: Speed in issuing cards, less Know Your Customer (KYC) requirements of the cardholder, low program cost (usually a per card fee), easy way to prototype a basic card program;
Opportunities: Limited capability of spend or withdraw cash only, minimal interchange revenue share (generated from user’s card spend) for the platform, lacks ability to add banking functionality;
For companies exploring prepaid, this is typically the fastest and least expensive path to get to market. Card issuers may charge a small setup fee (less than $3K) and an ongoing per card fee ($1 - $5 monthly). With monetization, these programs provide the least share revenue share opportunities — passing back a small (or no) interchange (revenue earned from merchants when cardholder swipes their card). The lack of deeper functionality makes prepaid card more of a short-term offering.
DEBIT: As cash usage declines in daily life, debit card volume increased as a quick way to pay and deposit/withdraw at ATMs. Contactless and mobile wallet upgrades provided a further boost during the pandemic, especially for small, everyday purchases. In the UK, debit cards have 42% market share of all payments and almost all adults have at least one debit card in their wallet. The vast number of challenger and traditional banking options in the region has created tremendous market penetration.
Since debit cards are directly connected to a customer’s checking account, there’s active, ongoing activity in paying are for bills or collecting payroll. Banks and fintechs have direct insight on income levels, spending patterns, and balances. The data helps create custom loyalty rewards and incentive programs — features that make relationships with clients ‘sticky’ (and less likely that consumers switch banks).
Need: Provide payment access on top of a deposit account for consumers and businesses;
Common use cases: bank cards, prepaid card use cases that need deeper functionality (for users or payments);
Benefits: ease of use for all banking and payment needs, platforms can monetize quickly with more interchange revenue from card spend (up to 1% - 2%), ability to custom design cards and rewards based on target users;
Opportunities: more KYC requirements in onboarding (to set up user deposit account), requires working with a bank partner (and a higher program cost and commitment), program manager needed, card printing costs can be expensive;
Fintechs reviewing debit card offerings would need to setup a bank partnership — either directly with a bank or through a Banking-as-a-Service partner (integrated with a bank). There are higher setup fees and fixed costs in these programs over prepaid — in order to cover the compliance, program management, banking license, payments access, infrastructure, transaction processing, and card issuance. Monthly fixed fees are $5K+ and based on product scope and how much support a partner provides (from the above list). For each missing component, a platform would need to find a separate vendor or build out the functionality themselves. Total cost of ownership in the first year can be anywhere from $250K - $600K.
With monetization, there’s a larger revenue share as bank partners pass back the majority of interchange and deposit interest (earned on balances of users) to platforms. A company can also earn their own monthly fee for providing additional banking services (such as budgeting, expense management, or transfers).
The program design flexibility and enhanced functionality (to payments and user activity) make debit cards a strong long-term offering for platforms. Founders and product teams must closely consider what their roadmap looks like in the next 12-18 months and decide on a program and partner that can best meet those needs and balance unit economics .
CREDIT: As the new frontier for fintechs (due to the additional cost and complexity in lending regulation), new credit card offers are starting to emerge (outside of traditional banks). The offset in added cost comes from the highest interchange rates (out of all card programs) of about 2% - 3% (based on card network and transaction type). Interest (from APR) and fees are added revenue streams to cover the cost of capital used for lending.
For non-bank credit card platforms, a separate relationship must be established with a capital partner to fund the unsecured credit card. Early-stage or newly launched firms choose to started with a secured credit card (e.g. a credit limit tied to a cardholder’s funds on deposit) to avoid the need for a separate lending partner. After 6-12 months of on-time payments, platforms can make secured cards partially secured by increasing a user’s limit without an additional deposit.
Buy-Now-Pay-Later (BNPL) fintechs are pushing innovation further with their point-of-sale (POS) interest-free, installment loan structure. Adding a card on top of these offerings helps users make purchases across more merchants at checkout. The popularity of BNPL comes from young users avoiding debt but demanding credit-like functionality and rewards.
Need: Provide spending access (based on a secured/unsecured credit limit on a revolving or one-time basis) with higher rewards;
Common use cases: For general purchasing or specific transactions (travel, business expenses, gas/groceries, etc.) as an unsecured card, credit building card (for users that need to establish/repair credit profiles);
Benefits: users can spend now and pay later (no need to tie up cash in their account), customers are able to build positive credit history, higher cash rewards incentivize ‘transactors’ (card users that pay off balance monthly), consumers can make larger purchases; platforms gain higher interchange and revenue from APR and fees;
Opportunities: users must apply and be approved, mismanagement by clients can lead to increased debt and negatively impact credit profiles, expensive program costs for platforms to launch and maintain, risk of defaults and losses on negative user balances and delinquencies;
Launching a credit card program is best as an add-on to an existing platform. Startups are already challenged in fundraising to launch the card product. Confirming a capital partner in parallel for a pre-market offering becomes too difficult. Additionally, properly creating an underwriting model that fits lending regulation and revenue projections requires market experience. There’s added costs to hire legal and consulting teams to provide this level of industry expertise.
Similar to debit card offerings, a bank partner needs to be involved to issue the cards. There would also need to be a licensed lender (either the bank or a separate entity) registered in the US (or respective region) with regulators. Most platforms choose not to become a licensed entity due to the cost in application, time of review, and uncertainty in approval.
Ultimately the success of a credit card offering is on monthly user spend, number of users, and default rate. Business users can spend over $3K on expenses and consumers (based on demographic) can range from $300 - $2K. Simply put, card platforms used for higher spending can break-even with less customers (which applies to debit cards as well). This would offset total program costs in the first year of $500K - $1M (based on type of offering, target user, and capital partner costs).
OUTLOOK on the card sector in fintech
There’s a fierce battle for wallet space (physical and mobile) in today’s financial services landscape. Banks no longer exist as the main competitors. FinTech companies in the form of neobanks and challengers banks have become active players. Non-fintech firms with large communities of users are also starting to emerge as new competition.
Which programs and card offers come out on top? The ones most often used for primary spending (daily purchases, monthly bills, large transactions). It’s up to platforms to incentivize and maintain their hold as a customer’s main card for as long as possible. Basic cash back programs of 1% - 5% on miscellaneous categories are no longer competitive.
The next level of customer ‘stickiness’ for card programs comes from leveraging client data to deliver customized offers. With 60-90 days of transaction data, platforms should know and predict where a consumer or business will spend. Artificial intelligence and machine learning are tools making this happen now. Based on these insights, a matching reward for spend can be provided prior to a card being swiped. The user shouldn’t have to search for best-fit offers — recommendations should be made in-app.
The other opportunity openly available is with credit-building. Secured and partially secured have been around for over 15 years, but mostly from banks or expensive platforms with no added benefits. New secured offerings emerged last year that act like a credit card but feel like a debit experience. Fintechs should continue to push forward here by adding loyalty programs, education, and options to build/repair credit at a faster pace.
What is your primary card throughout the month and why? (don’t say your Starbucks card!)
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