Are online banks a new threat to credit cards?

The Federal Reserve recently announced that interest rates would once again remain flat. Despite no longer living in a rising rate environment, consumers are still in a higher-rate environment, relative to what they have experienced since the financial crisis a decade ago.

The rate increases since 2015 produced results that were expected and unforeseen. On one hand, borrowing has become more expensive, with APRs for credit cards, mortgages, and personal loans increasing in tandem with the Federal Reserve funds rate. On the other hand, saving has not become nearly as lucrative for the majority of depositors, as many traditional brick and mortar banks have kept their APYs near zero.

Similar to how fintech entered the scene to offer personal loans after many larger banks pulled back, they have now shifted their attention towards savings accounts. As a result, moving your savings online can result in annual yields over 2%.

The opportunity to earn more on savings balances with little effort or risk has posed a threat to traditional deposit-holding banks. But should credit card issuers also be concerned with the rise of online bank accounts? Due to many added features and the overall “platformification” of these products, the answer is yes.

In addition to providing a revolving line of credit, credit cards have grown popular due to ease of use, near-universal acceptance, and added features like insurance, travel benefits and monetary rewards. Credit cards have also been criticized for being an unnecessary tool for accumulating debt. According to Mintel research on consumer payment preferences, six in ten 18-34 year old consumers prefer a debit card over a credit card. Similar preference for debit (and cash) over credit cards is visible in black and Hispanic communities, with only 32% and 46%, respectively, preferring to use a credit card for typical purchases.
Six in ten 18-34 year old consumers prefer a debit card over a credit card.

Enter online savings account plus debit card

Online products offer customers a card that can be used for purchases, often with similar fraud protection and earnings opportunities traditionally seen only on credit card products. High-APY savings accounts, allow additional earnings potential for those with money stashed away. In some cases, a lending facility easily embedded into the environment, offering credit as needed.

T-Mobile customers can earn up to 4.0% APY on savings with T-Mobile MONEY, with additional features such as zero liability protection, 30-day grace periods on overdrafts and the ability to temporarily disable your debit card.

Varo offers a “one-stop” solution with a Visa debit card, paychecks up to two days early, high-interest savings, financial management tools and pre-screened personal loans exclusive to customers.

Newcomer Empower has inched even further into the credit card rewards space by offering up to 2% cashback on all debit purchases, coupled with up to 4.3% APY on savings balances and an AI assistant. Acorns recently introduced its Spend product, a checking account with a debit card that helps you invest by rounding up everyday purchases and depositing them into an investment account. Customers can also earn up to a 10% bonus when using their card to shop at participating retailers.

Essentially, this combination of rewards debit cards, high-interest savings, and small amounts of available credit may prove more attractive to many consumers, while still offering some of the prime benefits and everyday usage capabilities of a traditional credit card.

What we think

Since many of these online banks unsurprisingly utilize digital channels to market their products, credit card issuers should follow suit and be sure to pursue an omni-channel approach that includes both digital and social media campaigns. Traditional issuers would also be smart to leverage their history, as many consumers have more trust in longstanding institutions than with less established newcomers.

In addition, to combat similarities in rewards and payments structures, card issuers must promote some of the core, less-flashy benefits of a credit card, such as enhanced fraud protection, instant availability of credit, and improvements to credit scores. While cashback debit cards and high-yield savings accounts may be lucrative in the near-term, the benefits of building credit through responsible use of a credit card could make a much greater contribution to sustained financial health.

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