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Is Amazon Becoming a Bank?

Posted by | Fuld & Company

UPDATE: Wells Fargo and Amazon ended their partnership on 08/31/2016 with minimal comment.The partnership fell under criticism from consumer advocates and organizations promoting affordable education.

Last month, entered the student loan business in a partnership with Wells Fargo, offering lower rates for student loans to Amazon customers who subscribe to the online retailer’s Prime Student service.  Wells Fargo will cut half a percentage point from its interest rate on student loans to Amazon Prime Student members, who also get benefits such as free two-day shipping and access to movies, TV shows, and online photo storage.

Does this deal signal what many have felt is the inevitable entry of technology companies into the financial services industry, or is it a convenient and mutually beneficial partnership between two companies with common interests?

A tempting market

As a parent of a certain age, with one kid in college and another just one year away, news about financing tuition costs immediately captures my attention.  And, the private student loan industry has been on quite the roller coaster ride recently.  Fueled by investor appetite for asset-backed securities, the financial institution private student loan market grew from less than $5 billion in 2001 to over $20 billion in 2008, before contracting to less than $6 billion in 2011, according to the Consumer Financial Protection Bureau.  Today, the market stands at about $7 billion, according to the Consumer Bankers Association, a trade association that represents financial institutions that provide retail lending products and services.

Private student loans represent about 7.5% of the value of all outstanding student loans, and the vast majority of student loans are distributed by the US Department of Education under the Stafford and PLUS programs.  Private student loans typically have interest rates about twice as high as government student loans.

Still, a $7 billion private student loan market will attract some serious competition.  As it turns out, this is a highly concentrated and highly competitive industry.  70% of all private student loans are originated by just six financial services institutions.  Private student loans are attractive to lenders as they come with higher than average interest rates and sometimes steep origination fees.

Long term strategy through customer loyalty

Given these competitive dynamics, the Amazon–Wells Fargo partnership makes perfect sense for both parties. For Wells Fargo, this is a distribution deal, pure and simple, for an important part of its lending business.  Wells Fargo, one of the largest private student lenders, had $12.2 billion in student loans outstanding at the end of 2015, up from $11.9 billion in 2014, according to its annual report.  Although Amazon does not publicize how many Prime Student members it has, analysts have speculated that the number is well over one million; with its deal with Amazon, Wells Fargo now has exclusive access to this cohort.

For Amazon, the deal brings an important service to an important customer segment.  If Amazon can build loyalty with consumers in their late teens and early 20s, chances are good that they will be customers for life.  Presumably, a large majority of Student Prime members will become Prime members upon graduation, paying more for their annual Amazon Prime membership and ordering all sorts of products from the online retailer.

But, this deal is not an indicator of the full-on entry of technology companies into the financial services industry.  For years now, fears have been pervasive that the “GAFA” companies – Google, Apple, Facebook, and Amazon – will enter and disrupt the financial services industry, leveraging their massive amounts of personal data on hundreds of millions of consumers.

Assessing intelligence indicators in context

To be sure, from a strategic standpoint, it does seem inevitable that these companies would make a play for financial services.  Each has a massive reach – more than 1 billion users for Facebook and Google, 800 million iTunes accounts, and more than 250 million Amazon customers – and is increasingly at the center of our digital lives.

For the most part, these forays into financial services have been disappointing, especially for companies that are used to dominating their core markets.  The question, therefore, remains: how strategically important is financial services to the GAFA companies?  My take – not very.In reality, technology giants have already entered the industry, but with disappointing results to date.  Apple launched Apple Pay in 2014, and Google introduced Google Wallet in 2011.  Facebook launched Messenger Payments at the beginning of this year, and Amazon Lending was launched in 2012 to offer loans to Amazon’s small and medium enterprise clients.

It’s easy to look at a single development – in this case, the launch of Amazon Prime Student – as a signal of something much larger.  But, one-off developments have to be considered in the larger strategic context.  Is Amazon setting itself up to become a personal loan originator?  Almost certainly not.  But, is it looking for more ways to engender loyalty to a customer segment it has deemed of high value?  Absolutely.

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