PayPal's building its move into physical stores brick by brick, and its processing partnership with TSYS is one of its largest moves to date, threatening to grab payments business away from card-issuing banks.

"The payments market is changing fast, we have a lot of new players coming on board with new technology and new products. PayPal is another company that is serious about changing its business model to expand the consumer base that they can reach," says Victoria Strayer, senior director of enterprise TSYS, which on August 26 agreed to process PayPal payments made through Discover merchants.

The agreement builds on PayPal's massive agreement with Discover, which is gradually making PayPal an option at the point of sale for all Discover merchants.

As PayPal increases payments options for merchants, card-issuing banks will have to work harder to keep their share of point of sale payments volume — a move that may require copying PayPal's aggressive stance.

"This would be a wake-up call for banks to deliver their own mobile wallets," says Richard Crone, a payments consultant. "TSYS and Discover have put PayPal to that last inch before the physical point of sale, which is the biggest part of the payments market."

That's good news for companies such as Paydiant, which just entered into a partnership with Discover's Pulse debit and ATM network to enable financial institutions to provide mobile wallets on a white label basis. 

"The more traction that PayPal gets in driving consumers to use it as an instrument of payments rather than a bank instrument, the more incentive there will be for banks to create a user experience to lock consumers in, and mobile payments will be a big part of that for banks," says Jed Rice, senior vice president of business and corporate development for Paydiant, which also includes PayPal in its mobile wallet.

PayPal has been increasing in-store acceptance for more than a year. In addition to the Discover partnership and its own direct deals with merchants, PayPal works with Mercury Payment Systems to bring in-store payments to small and medium sized businesses; and with Alliance Data to connect digital PayPal payments to retail cards.

"As PayPal's physical world transactions increase, I believe that we will start to see bank partners becoming interested in becoming 'issuers' of PayPal similar to Visa and MasterCard," says Phil Philliou, a payments consultant. "A lot depends on the success of PayPal in the physical world. If PayPal executes well in the physical world, we will see PayPal transform into a true rival of Visa and MasterCard.

However, many large processors and merchants are not on board with PayPal's move into stores.

"While PayPal's partnership with Discover is significant, it is important to note that merchants and their acquirers must sign on before acceptance is granted. First Data, the top merchant processor, has openly stated it will not support PayPal, cutting the company off from some four million merchant locations," says Jordan McKee, an analyst at Yankee Group. "On the merchant side, Walmart has also announced it will not be supporting PayPal. Clearly PayPal still has its work cut out for it."

PayPal and Walmart did not respond to requests for comment by deadline.

"We do not currently support these transactions," says Elizabeth Grice, a First Data spokeswoman, in an email.

"We're continually working with our network partners to evaluate the value of enabling new payment functionality for our merchant and financial institution customers and their customers," she says. "Ultimately our decision will be guided by what's in the best interest of our customers—financial institutions and merchants."

TSYS joins some of the biggest names in merchant acquiring and processing that have signed onto PayPal in-store program. Others include Vantiv, WorldPay, Global Payments, First American Payments and Heartland Payment Systems, says Joby Orlowsky, vice president of strategic initiatives at Discover, in an email.

"These acquirers are leading the way in providing innovative solutions to their merchants, competitive advantage, convenience and choice," Orlowsky says. "We're very pleased that TSYS has joined the program, not just because they are a key acquiring player in the industry, but also because they are the platform that will enable many other acquirers to participate as well."

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