How Banks, Spurred by Regulation, Are Eyeing Prepaid Products

Banks are likely to become much more active as issuers of reloadable prepaid cards in response to new regulations that are making traditional bank accounts more expensive for consumers, according to a new report from Javelin Strategy & Research. “There’s an opportunity for banks to use prepaid as an account-replacement tool, not just as a payment product,” Beth Robertson, managing director at Pleasanton, Calif.-based Javelin and an author of the report, tells Digital Transactions News.

Recent regulation includes a change to Regulation E that has wiped out much of the overdraft income banks earned on debit cards and pending rules from the Federal Reserve that will severely restrict debit card interchange income. The change to Reg E, which took effect last year, requires banks to allow customers to opt-in for so-called overdraft protection before fees can be levied. The Fed interchange rules, released in December in response to the Durbin Amendment to the Dodd-Frank Act, would cap fees at 12 cents, down from an average of 44 cents. The rules were originally expected to take effect in July, but bills pending in Congress would delay rulemaking for anywhere from one to two years to allow further study of the issue.

Nonetheless, banks have reacted by either slapping new fees and restrictions on checking accounts or contemplating doing so. That’s making these traditional accounts too expensive for some customers, creating a ready market for prepaid products, Javelin’s new report says.  Further impetus for bank involvement in prepaid comes from the Durbin Amendment, which exempts reloadable prepaid products from interchange regulation. “There’s a lot of banks actively looking into prepaid and whether becoming an issuer makes sense for them,” says Robertson.

She says this new involvement in the prepaid market is a departure for banks, which have historically shied away, preferring at most to act as BIN sponsors for third-party managers. “Banks felt that with their credit and debit card portfolios they were satisfying the needs of their cardholders, and they were able to make the revenue they needed,” she notes.

Javelin says two market segments in particular are good fits for prepaid products, the underbanked and so-called Gen Y customers. The underbanked population, long ignored by banks but actively courted by non-bank prepaid players, has swelled to some 53 million people as a result of the economic downturn and the higher expense brought on by new account fees, according to Javelin’s report. Many of these people cannot pass credit checks even if they can afford the account costs, the report points out. For these consumers, a prepaid product can serve not just as a payment vehicle but as an account substitute, Robertson says. “You don’t necessarily perform that same [credit] evaluation for a prepaid card,” she says.

Javelin’s research also shows that underbanked consumers perform on average 11.7 prepaid transactions each month, nearly double the 6.7 transactions performed by all consumers. And the average prepaid ticket for the underbanked is higher, at $67.79 versus $55.84.

Gen Y consumers, those people born between 1979 and 1999, are prime candidates for prepaid products as well, according to the report. Some 16% of consumers in this segment own a general-purpose prepaid or payroll card, compared with 11% of all consumers, the research shows.

Pricing could be tricky for banks venturing into direct issuance of prepaid products, which are often criticized by consumer groups as laden with high or unnecessary fees. Javelin found monthly account fees for consumer prepaid cards ranging from 99 cents to $9.95. So-called entry-level bank accounts, by contrast, charge $8 to $10 per month. Fees can be waived in both cases in view of activity. For customers who don’t qualify for a traditional demand-deposit account, Robertson says, banks will have to levy “a competitive price point” to avoid attrition and possible regulatory scrutiny. Already, there has been recent federal legislation proposed to cap prepaid card fees and set up greater oversight and protections for prepaid accounts.

Pricing “is something that will have to be monitored,” says Robertson. “It’s in banks’ interest to keep fees under control.”