Prepaid Cards Move Beyond the 'Underbanked'

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Prepaid bank cards — reloadable debit cards originally designed for consumers without bank accounts — are becoming more mainstream.

As competition for the growing population of 'underbanked' spenders rises, banks keep lowering their fees on prepaid accounts, which is prompting some to rethink their business model.

“These are really small accounts that don’t have a lot of transactions happening compared to middle-income accounts. It's hard to make money; prepaid is not a slam dunk business," said Rachel Schneider, vice president at the Center for Financial Services Innovation.

As a result, prepaid card providers are busy adding card features to attract customers with traditional bank accounts — while still vying for their corner of the underbanked market.

"Prepaid cards have been moving upmarket, to middle income customers. At some point, we’ll all be using prepaid cards. I think in 10 years, they'll be ubiquitous," said Schneider.

Prepaid cards meet a clear demand. Consumers can get a prepaid card with or without a good credit score, or a bank account. And be it shopping online, renting a car, or reserving a hotel room, they can use the card for the many daily activities that cash just won't cover.

But growth in this market seems to paint a bigger picture: Consumers loaded $57 billion onto prepaid cards in 2011, according to Mercator Advisory Group, who projects this amount will hit $167 billion in 2014.

Because there is no danger of being charged overdraft fees (the total amount on the card is all that can be spent, much like cash), some fully banked customers are using prepaid to manage their budgets, or to teach their children to do the same.

"It was an easy way to get my daughter acquainted with using a credit card. I am able to monitor her spending, and there are no overdraft fees. I think it’s really helped her learn how to use a credit card wisely," said one New Jersey mother of two who purchased USAA's prepaid card.

With credit card interest rates typically reaching 18 to 19 percent per annum, any way to avoid credit-card spending may sound appealing.

The popularity of prepaid cards explains the influx of prepaid products from household names such as Capital One , Walmart , and Western Union .

In addition, the two largest prepaid card providers Net Spend and Green Dot have reported a jump from 6.53 million active cards in 2011 to over 7 million this year. Green Dot CEO Steve Streit said this year during a quarterly conference call that "more than half" of their customers are banked.

So while it's still a young industry (both Net Spend and Green Dot went public in 2010), providers are quick to adapt; seeing that in order to grow, they'll need to make prepaid cards useful for the already banked.

Two of the latest newcomers — each announcing launches this month — are doing just that. JPMorgan's "Chase LiquidSM" and Kaiku's Visa prepaid card(Kaiku partners with First California Bank)are able to offer low-fees and still bank on profits because their prepaid products can attract people with traditional — read bigger — bank accounts.

"We saw a gap in our product lineup, so we got into the prepaid space. We did a lot of customer research, and what we're seeing in terms of demand cuts across sectors — its the need to control spending," said Jon Wilk, head of marketing for Chase's consumer bank.

Joel Sherwin, chief operating officer of Kaiku Finance, counts middle income parents among his target market. "Prepaid is no longer the card of 'last resort.' It's about controlling your finances," he said.

Regulators Concerned

On the other hand, regulators say prepaid is not risk-free for consumers. Part of the upside for banks is that, unlike ATM cards or credit cards, there are no limits on fees for prepaid cards.

Transparency on these fees is their biggest gripe. "Prepaid cards have a significant weakness — their consumer protections do not serve users well. The number of different fees they can charge is confusing. It would be better if fees were more standardized across the industry," said Rachel Schneider.

While companies disclose their fees, "their design, content, and location vary so widely that making relevant comparisons is a difficult exercise," says a CSFI report.

For these reasons, the Consumer Financial Protection Bureau is currently developing rules meant to standardize fees and increase transparency in the prepaid market. Federal protections for prepaid cards would be a first for the bureau.