A recent report from The Wall Street Journal revealed that the cohort of large banks that owns the company that operates Zelle are considering allowing consumers to use the peer-to-peer payment option for retail purchases. The option would enable banks to bypass Visa (V -1.05%) and Mastercard's (MA -0.85%) payment rails, which take a fee on every transaction that passes through their networks.

If implemented, this would certainly come as a challenge to Visa and Mastercard. Let's take a look.

The pandemic has been great for Zelle

Zelle is an instant payments service that allows consumers to transmit funds to one another through text or email in just minutes. It was created by a private company called Early Warning Services that is owned by most of the largest U.S. banks, including JPMorgan ChaseBank of America, Wells Fargo, TruistCapital One, U.S. Bancorp, and PNC. Zelle is also now used in thousands of other small banks and credit unions, covering roughly 100 million people. If a financial institution doesn't offer Zelle, a consumer can download the app and link their bank account to it.

Person holding phone and card, sitting at a table outside.

Image source: Getty Images.

Zelle is actually quite innovative because the U.S. doesn't operate on a real-time payments system, meaning funds typically take one to three business days to actually land in a bank account after a transfer. Zelle completes transfers in minutes.

But I think it's fair to say that Zelle hasn't exactly caught on in the world of peer-to-peer payments like other popular payment apps such as Venmo. After all, as The Wall Street Journal wrote in 2018, you don't hear too many people telling their friends to "Zelle me." However, during the pandemic, Zelle picked up steam as the adoption of digital payments surged.

This image below shows that digital usage is up across Bank of America. For Zelle transactions specifically at the bank, quarterly transactions, total volume, and users climbed significantly in each quarter of 2021. Zelle said there were collectively 1.8 billion payment transactions worth $490 billion sent through the network in 2021, up 49% and 59%, respectively, on a year-over-year basis. This popularity has led big banks to wonder if Zelle could catch on in the retail payments space for regular purchases.

Bank of America digital usage statistics.

Image source: Bank of America Q4 2021 investor presentation.

In doing this, banks would essentially be removing plastic from the transaction. When you buy something using a debit or credit card, Visa and Mastercard essentially authorize that transaction with the issuing and acquiring bank before delivering the funds from one party to the next. For providing this service, they take a small fee on every transaction and have a lot of power over how they govern this network. But with Zelle, funds would be directly transferred from the consumer to the merchant and therefore wouldn't have to pass through Visa and Mastercard's tolls.

Visa and Mastercard aren't the only ones that would lose fees. The large banks themselves also get a piece of the action for their role in the payment process that includes Visa and Mastercard. However, by removing the two, the large banks would now be in a position to make their own rules and set their own fees over the network, and also potentially take a bigger piece of the pie for themselves.

Would it work? 

I'm a bit skeptical right now whether this plan would work, as it's very unclear that Zelle could supplant credit and debit cards. Plastic has ingrained itself in the consumer payments ecosystem, although perhaps as digital payments grow in popularity, consumers will get sick of carrying their cards around and constantly inputting the numbers online.

This also certainly wouldn't be the first attempt by competitors to try and cut out Visa and Mastercard. Several years ago, when PayPal had been working more heavily to evade Visa and Mastercard's tolls, the two payment giants essentially declared war and eventually reached an agreement with PayPal. Visa and Mastercard are so big that they tend to overcome any threats to their business by partnering with their competitors or building competing solutions.

Interestingly, though, The Wall Street Journal reported that the large banks that run Zelle are divided on the issue. One proponent of promoting Zelle, according to the Journal, is Wells Fargo. Wells Fargo's Chief Executive Officer Charlie Scharf previously ran Visa and actually declared war on PayPal several years ago.

If anyone knows this industry, it's Scharf, which is why I found it interesting that he was in favor of extending Zelle. Perhaps he thinks that seven of the largest banks in the U.S. could successfully compete with Visa and Mastercard.