Prepaid debit cards growing in popularity

The emergence of new types of consumers and the acceptance of prepaid financial services post-recession are driving banks to enter the lucrative prepaid debit card industry, a business traditionally dominated by alternative financial services companies such as Green Dot Corp. and Western Union Co.

Prepaid cards typically work like a Visa- or MasterCard-issued debit card but don't draw from a bank account. The card has whatever balance the holder puts on it. Unlike a gift card or a rebate card issued by a retailer, the prepaid credit card can be reloaded at any time.

General-use prepaid cards, a recent outgrowth of the store-specific gift card industry, have gained popularity in recent years, so much so that the amount loaded onto prepaid cards is expected to top $81.8 billion this year, according to the Mercator Research Group.

Tim Sloane, director of Mercator Research Group, said card use will jump to $116.9 billion next year and to $167.2 billion in 2014. He said consumer demand is driving growth in the prepaid market because "they like the control it gives them over budgeting and spending."

Those numbers have attracted the attention of such mainstream brands as J.P. Morgan Chase & Co., U.S. Bancorp, and Wells Fargo & Co as they look for new revenue sources to offset a recently implemented federal law restricting fees on other consumer loan products.

The Durbin Amendment, part of the Wall Street Reform and Consumer Protection Act of 2010, took effect in October. It reduced the interchange fees banks can charge merchants when a consumer swipes a debit card.

The Federal Reserve settled on a maximum fee of 21 cents plus 0.05 percent of the transaction amount, which worked out to about 24 cents on the average debit purchase. The previous fee was 44 cents per swipe.

The rules included an exemption for many types of prepaid cards. Those products can still earn the higher fees from merchants.

But fee income isn't the only force driving traditional banks into the prepaid card industry.

American Express Co., which has traditionally pitched credit cards to affluent customers, now pushes prepaid cards as a way to broaden its customer base. The company recently struck deals with Target Corp., Office Depot Inc. and Barnes & Noble Inc. to offer its prepaid cards in stores.

PayPal recently introduced its own prepaid card that can be linked to a consumer's online account.

"It's very much seen as a growth product," said Greg McBride, senior financial analyst with Bankrate.com. "A lot of banks are getting into the prepaid because of that growth potential."

Consumers are increasingly embracing prepaid cards as they realize the plastic is useful for transactions beyond basic ATM withdrawals and point-of-sale purchasing. Some are able to avoid establishing traditional bank checking and saving accounts while still having access to banking services such as online bill pay and debit card purchases. Some prepaid card issuers also allow customers to reload through regular paycheck direct-deposit.

A study conducted by Javelin Strategy & Research found 13 percent of adults in the U.S. used prepaid financial services last year, up from 11 percent in 2010.

While prepaid use increases, the same study found declining use of bank accounts and traditional credit cards. According to Javelin, 88 percent of consumers maintained checking accounts in 2011, down from 92 percent in 2010.

Sixty-seven percent of consumers, meanwhile, had credit cards last year, down from 74 percent in 2010.

PRODUCTS FOR THE GREAT UNBANKED

Traditionally, banks concentrated on offering credit cards, while "alternative lenders" such as Green Dot and NetSpend offer products to lower-income consumers who usually are unbanked or underbanked.

But that business model is changing rapidly in the post-recession economy.

J.P. Morgan Chase and Wells Fargo are just two traditional banks now marketing their cards to individuals whose assets and credit scores have been hit hard by sinking home values or other financial challenges.

"Our main customer for the Chase Liquid card is a consumer who wants a checking account, but can't get one," said Gary Kishner, vice president of media relations at Chase in Los Angeles. "It's a graduation product. A way to show they are responsible before moving on to a traditional checking product."

Bank-issued prepaid cards give those consumers a way to pay their bills at a lower cost than services offered by check-cashing stores, payday lenders and some big-box retailers.

The Federal Deposit Insurance Corp. defines unbanked consumers as those without access to mainstream financial products such as bank accounts and low-interest loans. The underbanked might have access to a bank account but rely more on costly alternatives.

The FDIC says 9 million adults in the U.S. are classified as unbanked while 21 million are considered underbanked.

McBride said demand for prepaid cards is broader than most consumers and bank executives realize.

"It's a demographic that is not confined to the unbanked or low-income consumer, but there have been notable increases in usage by middle-class and high-income consumers," he said.

McBride said high-end consumers use the cards for budgeting purposes and in some cases as an alternative to giving a traditional credit card to children.

NUMBER OF USERS POISED TO GROW

As more banks and even credit unions launch prepaid cards, analysts say, the prepaid user base will continue to grow and become more diverse.

"We see prepaid moving up from a low-income product," Tal Clark, vice president of Prepaid and Advanced Marketing Solutions at First Data, said Monday at the Prepaid Press Expo at Paris Las Vegas.

Most major banks with branches in Las Vegas already offer prepaid cards. Wells Fargo offers the Stagecoach prepaid card, which costs $2.50 a month, with no activation fee, no ATM balance inquiry fee and one free withdrawal per month. Then it's a $1.50 fee for each additional withdrawal.

U.S. Bank's Convenient Cash Card costs $3 a month, with a $3 card activation fee, no ATM withdrawal fee, and no fee for balance inquiries at U.S. Bank ATMs. The Chase Liquid prepaid card only charges a $4.95 monthly fee.

McBride said bank-issued prepaid cards benefit from large branch and ATM networks and more transparency in their fee structures than those issued by alternative financial services companies. He said greater price transparency ultimately will "weed out a lot of the high-priced cards in the market."

It's also about getting bank prepaid cards in front of a larger audience.

Sloane of Mercator Research said banks will have to sell their cards at retail locations to appeal to more consumers. Sloane doubted Walmart would carry Chase or Bank of America prepaid cards, but large pharmacy chains, electronics stores and other well-known retailers present a real opportunity to reach more consumers.

A Mercator Research Group survey of the availability of prepaid cards sales in Stockton, Calif., found Bank of America's cards were available at three branches, while Green Dot cards were on sale at 14 locations. Sloane said to reach low- to moderate-income consumers, banks need to move beyond the branch.

At Chase, the Liquid card is offered exclusively through 5,500 branches. Kishner said Chase has no plans to offer the cards in other retail locations. He said the bank has received a "positive response" to its Liquid prepaid card since its launch in July.

PARTICIPATION NOT WITHOUT RISK

As a relatively new financial product, prepaid cards are subject to few regulations, and the most common complaint about them has been outrageous fees charged by some providers.

That soon might change as federal regulators look to rein in a fast-growing and popular industry. The Consumer Financial Protection Bureau recently took public comment on how to make fees and terms transparent while also ensuring that consumers' money is safe on the plastic. The agency has not said when it will make public the proposed regulations it is now drafting.

One big difference between prepaid cards and credit cards is consumer protection: the money is not always insured by the Federal Deposit Insurance Corp., which backs bank deposits.

Richard Cordray, director of the CFPB, said the focus of any regulation will be on "safety and transparency" in the prepaid card market.

"We believe that innovation can bring great benefits to consumers and can provide those outside the traditional banking system with access to financial products that meet their needs," Cordray said in a statement.

Among the areas are disclosure and fees. This information is often tucked inside the card's packaging, so consumers aren't always aware of transaction fees, general terms or whether their card is FDIC insured until after they buy it.

The federal agency also wants to know how consumers are protected against unauthorized transactions. There's a limit on how much a credit or debit cardholder ends up owning if a card is used without their permission. Prepaid card issuers might voluntarily extend similar protection, but the CFPB might require all to do so.

Contact reporter Chris Sieroty at csieroty@review journal.com or 702-477-3893.