Due to their increased usage and highly focused target marketing efforts on the part of card issuers, there’s lots of buzz in the press regarding pre-paid cards. For the most part, these cards are not new products, but numerous branding strategies and features make them look new. A brief look at the history of prepaid cards demonstrates this point:
Currently the most successful applications of prepaid cards are:
The open loop card resulted in increased consumer acceptance. Propelled largely by payroll cards and government benefit cards, the volume of prepaid cards and their stored monetary value is skyrocketing. Equally important, the ability to reload the prepaid card makes the card reusable and possibly lowers operating costs.
In the past couple of weeks, Visa USA and MasterCard Worldwide announced their first merchant partners for their prepaid card reloading networks. Discover started selling its reloadable prepaid cards in CVS pharmacies in January of this year. Capital One is also entering the reloadable prepaid debit card market.
The Unbanked Panacea?
Bankers have long believed this product to be an excellent alternative to cash and checks. It is currently viewed by many as having the potential to influence the payment behaviors of the unbanked – estimated to include over 80 million people in this country. The unbanked have no banking relationships due to a lack of 1) trust in our industry, 2) adequate credit history or 3) proper documentation required to open bank accounts.
Eighty million people!
Card companies are clearly positioning themselves to be the payment hub for the unbanked market with one thought in mind – fees. It is estimated that the unbanked spend more than $1.5 billion per year in check-cashing fees. Card issuers believe that this market segment will be willing to pay a variety of fees for the convenience and mobility that prepaid cards can provide – enough to change their historic behavior of carrying cash and using money orders to pay their bills. Here’s a quick hit list of the different flavors of fees that are being levied on prepaid cards today:
Of course, not all of these fees are applied together. In cases where there are monthly fees, there may not be an annual fee or ATM / POS transaction fees. Payroll only cards usually do not have any consumer fees as the employer typically covers those costs.
An interesting example of a bank targeting the unbanked is First Bank & Trust in Brookings, SD. It is introducing a prepaid card that also can also be used for small, short term loans – up to $1,000 that needs to be repaid within three months (as opposed to payday loans, which must be repaid in two weeks or extended for additional fees). The bank will report repayment information to the three major credit bureaus, thus allowing the consumer to create a credit history. This is in response to regulators’ encouragement to banks to provide alternatives to consumers using payday loan companies and other alternative lenders. First Bank & Trust is marketing the cards through roughly 200 check cashing stores in the east coast.
Another example is H&R Block, which is offering its Emerald prepaid card (MasterCard branded). The Emerald Card lets customers store refund anticipation loans. H&R Block Bank, chartered in May 2006, has opened nearly 2 million accounts linked to the prepaid card. Its strategy is to apply cross-sell tactics, and harvest savings and investment products. Not a bad way to leverage the old IRS 1040.
With these types of competitors hitting the market, many GonzoBankers are asking, “Could this product be the next fee income opportunity for us? Could this be the next courtesy pay program or the next debit card?
Reality Check on the Prepaid Paradise
While prepaid cards and strategies for the unbanked represent exciting innovations, GonzoBankers should inject a healthy doze of skepticism into their product development activities in the prepaid arena. Before jumping in head first, bankers should dig into three common but not necessarily accurate perceptions about the prepaid market:
Perception #1: “This is going to be a great source of revenue for our bank.”
Reality #1: While prepaid can provide banks with fees, float on balances and breakage from unused portions of the cards, the real question is VOLUME. The question banks must answer is, ”Can we realistically sell enough of these cards to offset the operating expenses and generate profit?” Even if the margins are great, a multi-billion bank selling several hundred pre-paid cards a month will never move the revenue needle. Before introducing prepaid programs, banks should develop clear pro forma projections that test the reality of volumes – where will this volume come from and how will our program be differentiated from competitors?
Perception #2: “The unbanked will want to establish a relationship if we provide the convenience of new payment alternatives.”
Reality #2: Banks have been trying for too long to penetrate this end of the market to be optimistic. The facts are that the unbanked continue to rely heavily on alternative financial service providers because of familiarity, convenience (in my neighborhood and late night hours) and trust with regard to money transfer operators. One key impediment to prepaid growth could be that a large portion of the unbanked consciously wants to stay off the radar of banks and other intimidating institutions. We need our marketing folks to dig deep into market research and consumer behavior to challenge whether the unbanked will adopt prepaid products.
Perception #3: “We can introduce this product easily – all we have to do is contact our current card issuer and we’re in business.”
Reality #3: Prepaid is yet another area fraught with compliance responsibilities. Although the Fed last August removed some regulatory uncertainties regarding FDIC insurance (yes – balances are covered) and Reg. E (yes – it applies, without the requirement for periodic paper statements), there are still numerous hurdles to conquer. Issues regarding AML, escheatment of unused balances, fees for inactivity and Know Your Customer are still fuzzy and inconsistent at the state and federal levels. Any cost analysis and risk assessment of introducing prepaid should recognize that ongoing compliance challenges and resource requirements will be a cold hard reality.
We’ve seen it before and I’m sure we’ll see it again. Even though you are in compliance, you can still get in trouble.
Bank of America was just hammered for making a new secured credit card (a hair away from a prepaid card product) available to customers that may be illegal immigrants. Critics claimed that the bank could be supporting terrorists and drug traffickers. The hoopla is that B of A is allowing prospects to use the Mexican government issued Matricula Consular card or an Individual Taxpayer Identification Card (ITIN) issued by the IRS in lieu of a Social Security card. Critics of illegal immigration are not happy, and Ken Lewis now has to deal with the negative press.
Not a good place to be. The bank didn’t do anything illegal and by no means is it the only bank using those forms of identification. The risk to your bank’s reputation is very tough to control, and when damaged, it’s even harder to regain.
The moral of the story is this: “Prepaid” isn’t a fad for banks to aimlessly pursue. Instead, it’s a term used to describe a variety of different payment businesses that will be dominated in the future by focused and savvy competitors. Meaningful revenue will only come to banks that pursue the opportunity creatively while staying vigilant about the volume challenges, consumer acceptance challenges and compliance challenges that are sure to be part of the journey.
Faced with tremendous competitive pressure, financial institutions are being forced to continually seek ways to maximize the value they provide to their customers while also striving to maintain operating efficiencies.
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