Square’s master plan to disrupt the banking industry takes shape
Square‘s (NYSE: SQ) recently announced the $ 29 billion acquisition of After payment sparked investor enthusiasm for the fintech ecosystem Square is building. Square’s merchant offering continues to grow, the consumer-centric Cash app expands both its user base and capabilities, and the newly acquired Afterpay will bring a Buy Now, Pay Later (BNPL) to mixed. Initially, the new service can fit into Square’s merchant offerings, but I think that’s just the beginning of Square’s vision.
The ultimate goal is to replace the entire banking system within Square products. Banking, lending, investing, cryptocurrency and merchant solutions are already part of Square’s package. Afterpay strengthens this position and could help complement the lending side of the ecosystem.
Better than a regular bank
Square’s digital products have slowly started to replace traditional banking services. Cash App can accept direct deposits of paychecks, and the Cash App Card is a debit card for accessing deposits. It’s the start of a relationship with clients that I think will increasingly include BNPL’s lending options to traditional lending. And Square can make the lending process a lot easier than a traditional bank.
Consider how loans work in traditional banks:
- With a traditional loan for a home, vehicle, or personal loan, consumers apply through the bank, providing verification of income and the asset they wish to purchase.
- An underwriter reviews the statements and approves or denies the request, tying an interest rate to the loan based on the risk of the loan.
- The terms are generally standard with an upfront charge and a repayment over several years.
Bank credit cards have fewer income or credit checks, but much higher fees. The money from the transaction usually falls on the trader.
- For credit cards, the customer applies for the card and a bank offers credit based on credit score and other factors such as income.
- Customers have the option of using cards at no charge and are often offered benefits, but if balances are maintained the interest rate charged may be 20% or more.
- The cost of using a credit card is normally the responsibility of the merchant who sells the goods. Credit card fees vary, but a fee of 2.4% of the cost of a transaction plus about $ 0.30 per transaction is pretty standard. These charges go to the payment processor, like Visa Where MasterCard, and the bank offering the card.
To take a look at what Square is doing with its merchant service, Consumer Cash App, and Afterpay in the middle of the two, we need to take a holistic view of how this might change the traditional credit, transaction, and lending structure that I have. described above.
Square already offers payment services and other tools to merchants, charging the 2.4% + 0.30 cents I described above. It also has a Cash app, which is actually a bank account for users who can use it for direct deposit of paychecks and to pay for goods and services with the Cash App card. Square wants to develop both the merchant side and the client side of the business. But what binds them together?
The answer could be Afterpay and its BNPL business model. The Cash app can integrate with Afterpay and be used as a payment method. And Square could help businesses determine who is worthy of loaning money and who is not. It’s actually a new form of credit card, all within the Square ecosystem. Think about it:
- Square may already know your income from your direct deposit and can assess your ability to pay for goods.
- Square understands your spending habits and even your assets with Cash App and the Cash Card.
- Square box at once determine how much he will lend you at any time with the funds available almost immediately.
- Since this is the merchant payment solution, Square could change lower fees for highly skilled customers or merchants, or even to make more use of the Square ecosystem.
Afterpay could be the third foot of the stool in Square’s business. He has merchants in the Square app, customers in the Cash app, and now he has credit service between them. BNPL may be the starting point for Afterpay, but given the loans that Square already offers to businesses with Square Capital, we might consider this to be a new credit / loan product as the he ecosystem is developing. Ultimately, Square could be the ecosystem we use to buy everything from dinner in a food truck to a used car on credit.
The disturbance is already here
All these projections are not theoretical, even if they are not yet constructed. Square Capital will provide capital to businesses for a number of business needs and base the loan amount and terms on the amount of processing the business processes through Square. The offer is indeed always exceptional for a business using Square.
Customers could get similar terms from Square based on income, brokerage balances in Cash App, or even bitcoins held in Cash App. Owning the entire ecosystem will allow Square to see a customer’s digital financial situation and offer them loans or BNPL at any time. If done effectively, it could result in lower fees than traditional banks or credit cards and lower interest rates on outstanding loans for customers. And Square could make more money on its transaction fees than it does by processing credit cards today.
On the credit side of the market, Square could offer the instant return of a credit card with the ability to underwrite a traditional loan. Square is simply replacing the traditional banking model with its own integrated set of digital products.
Square’s banking vision takes shape
As Square continues to add functionality, it gets closer and closer to disrupting banking as we know it. The business could integrate services traditionally owned by powerful financial institutions that charge high fees for transactions (credit cards), overdraft fees (banks) and short-term loans (BNPL, credit cards, and loans on salary). If successful, it could be a transformative fintech stock and a great long-term investment.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.