Ask the Experts: Taking Stock of the Prepaid Card Market
Like so many banking customers in recent years, the federal government is going paperless. Well, kind of. Federal benefits checks made way to direct deposit and prepaid cards on March 1, underscoring an increasingly digital and plastic-based economy as well as the meteoric rise of a financial product that was largely unknown to most consumers just a few years ago.
Yes, these prepaid cards are different from both gift cards and prepaid calling cards, and while they’re often referred to as such, they aren’t credit cards or traditional debit cards either. Rather, you can think of these re-loadable prepaid cards as a type of new-age checking account. They offer the majority of the same features as would the combination of a checking account and a debit card – including direct deposit, bank transfers, ATM access, online bill pay, check cashing services, and the ability to make purchases directly at the point of sale – just without the physical check book.
A Shifting Payments Landscape
Though prepaid cards were the fastest growing form of electronic payment from 2006 to 2009, with the number of transactions increasing by nearly 20% during that time, they didn’t truly burst onto the mainstream scene until July 2010. That’s when the Durbin Amendment to the Wall Street Reform & Consumer Protection Act took effect, capping debit card swipe fees (what merchants have to pay banks whenever customers use debit cards) and costing the banking industry $8.4 billion in annual revenue as a result. Given the similarities between debit cards and prepaid cards and the fact that the latter’s swipe fees aren’t regulated, banks turned to prepaid cards to try to offset these losses.
We’ve seen a number of increasingly attractive new prepaid card offers hit the market since then as well as an emphasis on celebrity endorsers that belies the investment being made in this space. Since prepaid cards can conceivably do the job of a checking account or a check cashing store at a lower price and projections indicate that by the end of 2013 their popularity will have increased by roughly 200% since 2010, it’s fair to wonder what role they’ll ultimately play in the personal finance landscape once all the dust settles.
In order to get a few other perspectives on the matter (check out WalletHub’s 2012 Prepaid Card Report), we turned to some prominent experts in the fields of banking, finance, and economics. You can check out each expert’s thoughts by clicking on their name below or simply jump to our Takeaways section for a recap of their insights.
The biggest factor is time, but that’s because time is money in this instance. Think about the time involved in processing a check, especially about how long it is between the issuance of the check and the payment to the intended recipient. I’m sure you, like most of us, has used the so-called float to your advantage. It’s a minor advantage to the person signing the check, but it’s a huge disadvantage to the recipients because of the quantity of payments coming via check. Time!
Another factor is the processing procedure. Even with advanced computer-based readers that replace humans (saving the human labor cost but adding the capital cost), it is very laborious process. Retailer receives and processes in-house (step one); deposits the check with local bank (step two); bank records the check, perhaps crediting the depositors account or more likely holding the credit until the check clears (step three); the check goes to a clearing house, historically the Fed but more often now an out-sourcing company (step four); processor needs to scan the check, electronically connect with the issuer’s bank (step five); issuer’s bank needs to verify funds (step six); recipient’s bank needs verification of transaction (step seven); ultimately the checks are returned to issuer’s bank and either included as is or in some form with monthly statement to issuer (step eight). Even if some of this happens electronically, there is still the need for checks to be moved and/or scanned. How many people and/or machines are involved?
How quickly do you anticipate prepaid cards overtaking checking accounts in popularity? Will something fill the void left by checking accounts?
First, checking accounts, i.e. paper checks, will not disappear quickly, maybe not for a long time. In part this is a cultural demographic. We could equate checks, in a way, to land lines. Some people simply are not comfortable giving up their land line and they won’t be with checks. The same factor(s) will apply. Fees will come to reflect the relative cost of checks vs. alternative forms of electronic payment. Historically some of this cost was covered by little or no interest on checking accounts but that will not be the primary means for banks to cover their costs. There will be outright fees applied to the use of checks. This will encourage some to shift to alternative payments faster than they otherwise might, but for some folks they will just absorb the fee in order to have the comfort of hard-copy checks. Ask yourself how often you see customers using checks abroad. I don’t mean Americans trying to use checks; that never has been a means of international payment for customers. I mean the locals. It’s not something that happens.
How do you expect businesses, particularly monthly billers that currently require payment in the form of a check, to adapt to the declining relevance of checking accounts?
They will (have already) adapt very well. Few firms require payment in the form of a check; many have not moved to automatic withdrawal. This is probably because of the nature of their customers and/or the challenge of implementing the system is the scope of operations is not that large. Those that haven’t, will soon make that switch. They will, of course, allow customers to maintain the check-payment system. No retail operation wants to lose customers over this. But, they will adjust the customer charges to encourage automatic withdrawal and discourage checks. Might be a processing fee. More likely it will be a one-time incentive–credit to account, pre-paid cash card, etc.
It is the small retailer who will be squeezed as this process unfolds. That’s what is behind the Durbin Amendment. Look for banks to move more and more to pre-paid cards rather than credit cards. The advantage of credit will not go away. Rather banks will establish credit accounts against which customers draw for the pre-paid card.
Even prior to implementation of the Durbin Amendment, as of 2009 prepaid cards were experiencing broader adoption. According to data in the 2010 Federal Reserve Payments Study, in the U.S. in 2009 there were 6 billion prepaid card transactions, valued at more than $140 billion ($43 billion of which was made on 1.3 billion general purpose prepaid cards). While prepaid cards accounted for a relatively small share of all consumer payments in the U.S. as of 2009, transactions conducted on prepaid cards grew substantially faster than transactions on debit and credit cards. The 2010 Federal Reserve Payments Study reports compound annual growth rates for 2006-2009 of 22.1 percent for prepaid card transactions, 14.9 percent for debit card transactions, and -0.2 percent for credit card transactions. In addition through the U.S. Department of the Treasury’s all-electronic benefit payments initiative, prepaid cards are also replacing the remaining paper checks used to disburse federal government benefits. Consumers will learn more about the features of these cards as they gain more experience using them.
What role do you foresee prepaid cards ultimately assuming? Are they going to completely replace traditional checking accounts, eliminate check cashing stores, or settle into a smaller niche?
It appears that open-loop reloadable prepaid cards still have some years of significant growth ahead. Mercator Advisory Group’s annual market sizing and forecast publications report that more than $148 billion was loaded onto open-loop prepaid cards in 2010 and forecast double-digit compound annual growth rates through 2015.
I don’t think that most consumers understand the differences in the protections that they have on some cards vs. other cards. I think that they kind of look at them as pretty interchangeable and they don’t understand that for some, like your credit card, you have protection that you wouldn’t have with your prepaid card or your gift card. You know, they’re all plastic.
Do you believe that lack of understanding prevents strategic use of these products and ultimately costs people money?
Yeah, I think that it’ll probably cost some people money, at least some people. The biggest concern that I see among the people that I work with, which are mostly low-income people, is that a lot of them don’t have access to credit cards or debit cards because they’re unbanked or they have some issues with mistrust of banks and the like. So the prepaid cards are kind of their only option.
There is no doubt that at this point most people might be reluctant to switch quickly to this medium of exchange, but Americans love convenience and thus it won’t be long before they massively begin using it. Currently, those that have no bank accounts, travelers, students, and certain shoppers may be attracted to this type of cards. But some studies have projected that by the end of this decade it will reach to 1 trillion dollar, which might not be much compared to the size of the banking system, however, it will pick up at much faster rate similar to the electronic bill payments or online purchasing, as long as laws and regulations that protect the consumers keep up with its pace (which usually does not) and there are greater transparency by the financial institutions offering such cards.
Prepaid cards were traditionally used by consumers with weak credit who were unable to qualify for a traditional credit card and did not have a bank account that would support a debit card. The fees associated with these prepaid cards were often quite high, especially when you consider that no credit was being extended to the card holder. It has been suggested that banks have recently been offering prepaid cards to their debit card holders due to the limits placed on debit card fees by the Dodd-Frank Act. Due to the limits on debit card fees, prepaid cards are a more profitable product for the banks.
What can you take away from our experts’ insights? Well, there are a few key points:
- The rise of prepaid cards has been a long time coming: While the relative importance of prepaid cards in the payments landscape has increased significantly due to swipe fee regulation and digitized government benefits, prepaid card usage had already been rising at a faster clip than that of credit cards and traditional debit cards for years.
- Heavy investments in the space speak to the increasing importance of this payment type: If you believe in the notion that money talks, the billions of dollars being poured into the prepaid card industry by institutions both public and private should tell you a lot.
- Initial consumer hesitance will make way to rapidly increased adoption: As prepaid cards become more commonplace, their simple ubiquity and the influence of early adopters will encourage widespread use.
- The industry still has considerable growth in its future: Growing consumer familiarity and increased institutional reliance indicates that the prepaid card boom is just getting started.
Ultimately, the most striking characteristic of a prepaid card is perhaps its versatility. The right one can fill in for or even outperform a traditional checking account, check cashing business, retail loyalty program, government benefits program, and more. Increased competition in this space is also driving down fees and fostering the inclusion of more consumer-friendly services in any given offer. In other words, it’s becoming increasingly likely that a single prepaid card will offer a wide-range of utilities, both in the arena of banking and beyond. As such, prepaid cards highlight the broader trend toward streamlined personal financial management.
The versatility of prepaid cards also extends to the demographics of users. While prepaid cards were once predominantly the domain of the unbanked, they are now serving not only as a gateway into the traditional banking system, but as a useful tool for those already operating within it as well.
However, the various names for and applications of prepaid cards also create significant opportunity for confusion among consumers. While this will likely subside in accordance with market penetration, it’s nonetheless something to watch out for in the years to come.
But what exactly do those years hold for the prepaid card market? The following projections from a 2012 MasterCard report might give you some idea:
- Government benefits disbursed via prepaid card will rise from $47 billion globally in 2010 to $177 billion in 2017.
- The prepaid card industry will grow 22% annually through 2017.
- Prepaid could be an $822 billion global industry by that time.
- Aside from the U.S., Brazil, Mexico, Italy, U.K./Ireland, India, Canada, Russia and KSA/UAE are expected to drive the growth of prepaid cards.
It therefore seems that prepaid cards will quickly grow from being the new kids on the block to a global payments force in the near future. We should all familiarize ourselves with the best ways to use them responsibly in the meantime.
Image: Oleksiy Mark/Shutterstock