The Economics and Regulation of Network Branded Prepaid Cards
General-purpose network branded prepaid cards are one of the fastest growing segments of the consumer banking sector. While retail banking operations have shrunk in response to the financial crisis that began in 2008 and the recession and regulatory responses that followed, the market for prepaid cards has grown rapidly, in large part to fill the niche opened up by the retrenchment of the traditional retail banking sector. Moreover, although prepaid cards traditionally catered to low-income consumers, there has been a rapid mainstreaming of prepaid card usage, as reflected by the entry of retail financial stalwarts such as American Express, J.P. Morgan Chase, U.S. Bancorp, and BB&T. Prepaid cards are rapidly being recognized as a mainstream consumer payment system, along with debit and credit cards.
This paper will examine the economics and government regulation of network branded general-purpose reloadable prepaid (GPR) cards. Network branded prepaid cards are those processed by major payment network brands such as Visa, MasterCard, Discover, and American Express, and accepted wherever those network brands are accepted, just like a debit or credit card. As such, network branded prepaid cards offer many of the same benefits as debit and credit cards: nearly ubiquitous acceptance, convenience, and the ability to make electronic payments easily, including online payments. Fundamentally, the products differ only in the time at which the consumer actually pays: as the name suggests, consumers load money onto a prepaid card before using it, whereas debit cards draw money at the time of use, and credit cards allow consumers to pay theirs bill after use. In appearance, prepaid cards are identical to debit and credit cards. Many consumers value this feature, especially lower-income consumers who often feel excluded from the financial mainstream. In essence, prepaid cards provide consumers with the same security, functionality, convenience, and mainstream respectability as those products.
Prepaid cards are especially important for unbanked Americans as a mechanism for electronic payments and as an alternative to traditional bank accounts. Moreover, the number of unbanked consumers has increased in recent years. A 2011 survey by the Federal Deposit Insurance Corporation (FDIC) found that there were approximately 10 million unbanked households in the United States (approximately 8.2 percent of all households), an increase from 9 million unbanked households (7.7 percent of all households) in 2009. Javelin Strategy and Research found that the percentage of consumers without a checking account increased by 50 percent (from 8 percent to 12 percent of the population) from 2010 to 2011. In addition, the FDIC found that approximately 24 million households (20.1 percent of U.S. households) were underbanked in 2011, an increase from 21 million households (17.9 percent) in 2009. Rates of unbanked or underbanked households are especially high among non-Asian minorities, lower- income households, younger households, and unemployed households.
The growth in the number of unbanked and underbanked consumers reflects in part the retrenchment of the retail banking industry in the wake of the financial crisis. But it is also the unintended consequence of several regulatory initiatives that have increased the cost of bank accounts to consumers and reduced access to debit and credit cards. Price controls on debit card interchange fees enacted as part of the Dodd-Frank Financial Reform legislation and new regulatory limits on overdraft protection have dramatically cut into banks’ bottom lines leading banks to impose fees and limits on once-free checking accounts. They have also tightened eligibility for free checking through methods such as raising the mandatory minimum balance or tying free checking to usage of other bank products such as mortgages or car loans. According to a fall 2012 Bankrate.com study, only 39 percent of bank accounts were eligible for free checking, down from 45 percent in 2011, and down by almost half from 76 percent in 2009. Similarly, a summer 2012 survey by MoneyRates.com found that the percentage of accounts with free checking had fallen to 35.3 percent, down from 38.8 percent a year earlier, and that in 2012, only 21 percent of the accounts at large banks (those with more than $25 billion in assets) were still free. Meanwhile, Bankrate.com’s 2012 survey found that the average monthly service charge on a non-interest-bearing checking account increased 25 percent from 2011, to $5.48 per month, and that the average minimum balance needed to avoid a monthly service fee rose by 23 percent, to $723.02 (with some accounts requiring an average minimum balance as high as $5,000).
In addition to raising fees, banks have reduced costs by reducing services (such as by closing bank branches and laying off workers) and by shedding unprofitable customers. For example, Bank of America’s CEO has stated that the bank is going to focus on the top 20 percent of most profitable customers and get rid of the unprofitable ones. J.P. Morgan Chase has estimated that new regulations on overdraft programs and price controls on debit card interchange fees have made unprofitable 70 percent of customers with less than $100,000 in deposits, requiring it to raise fees, reduce costs and services, or shed unprofitable customers. At the same time that access to banks has shrunk, credit cards have become less available to many consumers as a result of the Credit CARD Act of 2009, which imposed new rules that directly restricted access to credit cards for consumers under the age of 21 and indirectly restricted access for many lower-income consumers.
Prepaid cards have also become more mainstream for middle-class families. Closed loop prepaid cards, such as gift or reloadable cards that can be used only at a single merchant (such as Target, Starbucks, or Amazon.com) or with a group of related merchants (such as Old Navy, Gap, and Banana Republic), have become a staple of middle-class shopping habits. General-purpose “open loop” prepaid cards are becoming more common as well. For example, some parents now provide their college-bound children with prepaid cards to access funds and make electronic payments without the danger of incurring credit card debt. Parents can conveniently reload the cards online and even monitor their children’s spending and budgeting habits. Prepaid cards also may be useful for caregivers, such a child’s nanny or elderly parent’s home care provider. Rather than providing cash and making them account for it after usage, or providing access to a credit or debit card and creating a risk of misuse, prepaid cards enable the caregiver to access funds with greater security an