Should Bank of America (NYSE: BAC ) be worried about payments industry darling Square moving into the business of actually offering loans to merchants? After a simple review, the short answer is no.
The dive into lending
Square, which is best known for its payment solutions that enable businesses to swipe customers' credit cards on smartphones and tablets, announced on Wednesday that it was ready to provide cash advances to merchants who use the service.
The company summed it up neatly in a press release by saying Square Capital is "a program that helps businesses grow by giving them quick access to funds in a way that's easy to understand."
As shown below, Square was the clear favorite when consultancy Accenture asked nearly 4,000 people which nonbank company they would bank with if the option were available. So it's easy to believe this could be a real threat to Bank of America and the other banks.
But a dive into the details reveals it likely isn't much of a concern.
The details of the deal
Bank of America is a good point of comparison because it is a massive lender and also has huge operations in the payments industry where Square finds itself. Bank of America Merchant Services -- a joint venture between Bank of America and First Data -- processed a nearly $625 billion in payments last year. Square, on the other hand, processed $20 billion.
B of A also offers its Clover Station touchscreen tablet that allows cards to be swiped, and it has its own mobile payment solution. And with more than $160 billion in loans outstanding in its consumer and small business banking unit, it knows a thing or two about loans.
So Square and Bank of America clearly overlap in some spaces. But there are specific differences when it comes to loans.
The lack of a formal loan application offered by the new Square Capital is lauded by some, but as Wired reports, "Businesses can't apply for these advances, but if they need it, Square may offer one out of the blue." While the thought of an unprompted loan is nice, a small business depending on Square has to hope it is offered a loan when one is needed. It's tough to believe any business seeking growth would depend on a loan it can't even ask for.
But let's say the loan offer comes through. Square uses an example of someone who gets a $10,000 loan. Square Capital charges 10%, for a total of $11,000 to ultimately pay back. While it isn't an apples-to-apples comparison, banks are required by the Small Business Association to only charge prime (3.25%) plus no more than 2.25% on loans, for a total of 5.5%. This means a small business could pay nearly double the maximum allowed amount on certain loans if they're placed with Square.
A loan with Square doesn't have a monthly payment. Instead, the company simply takes 10% of the business's card sales each day until (in this scenario) it collects $11,000. While it may be nice to think -- as Square itself noted -- "you pay more when business is strong and less if things slow down," it also means Square is the first to commandeer the money the business makes. And the same simply isn't true of a bank.
These policies will work for some small businesses, and many will likely love the thought of dealing with Square instead of a bank. But the thing is, this solution will only benefit those on the fringe, and Bank of America and the other major banks will remain the principal sources of banking and processing for countless companies across the U.S.
The Square solution is cool, and it has has grabbed headlines, but it won't be a threat to any big bank anytime soon.
Big banking's little $20.8 trillion secret
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