The use of prepaid debit cards is rapidly rising. Despite consumer advocates’ widespread concerns and the less than enthusiastic reception to a string of celebrity endorsements, more than ever, people are using reloadable prepaid debit cards for their financial needs.
Consider the following:
- The amount of money added onto reloadable prepaid debit cards in the U.S. almost tripled from 2008 to 2012, rising to $76.7 billion, with the Mercator Advisory Group predicting that that figure will reach $168.4 billion by 2015.
- Following explosive growth from prepaid pioneers like Green Dot, big financial heavyweights like JPMorgan Chase, Wells Fargo and PNC Bank have rushed into the market.
- Demand for prepaid debit cards has expanded from the predominantly underserved to include the general public, with 59 percent of prepaid card users reporting that they also have a checking account, with increasing numbers buying the cards for their own use, rather than as gifts.
- The market is also growing fast outside the U.S., with some analysts predicting that prepaid cards could be an $822 billion global industry by 2017.
What’s the secret to prepaid cards’ success? For starters, they’ve fulfilled some of customers’ key banking needs better than banks themselves. They initially became popular among lower-income consumers who either couldn’t qualify for a checking account or who closed their accounts due to insufficient funds resulting in high overdraft penalties and other excessive fees. For many, the fees associated with prepaid cards amount to less of a burden than those charged by banks – let alone the high fees associated with alternative financial products like check cashers and bill-paying services. Prepaid cards offer many of the advantages of a traditional debit card, including ATM withdrawals, greater security than cash, and the ability to make purchases online and at vendors that only accept electronic payment. And for many prepaid users, including those who have bank accounts, they provide a budgeting tool that helps them avoid spending money they don’t have.
Other factors have also propelled prepaid’s growth. The federal government has begun distributing benefits payments electronically, requiring recipients to use either a government-issued prepaid card or a qualifying alternative. Meanwhile, cash payment options have become increasingly restricted, in everything from airplane cabins to road tollbooths. And crucially, federal financial reform legislation has capped banks’ debit card swipe fees, eliminating over $8 billion in annual revenue and prompting many to turn to prepaid cards to offset their losses.
Yet in spite of the benefits and the industry’s momentum, prepaid cards aren’t an ideal solution for low-income customers. Until recently, they’ve resided in a regulatory gray area, in which they weren’t required to provide many of the basic protections of bank accounts, such as deposit insurance, clear disclosure of terms and fees, and protection for lost or stolen cards. So, even though the CFPB offered new guidelines on November 13th, the disadvantages to prepaid cards will likely remain. They mimic some functions of a checking account, however they don’t generally provide the related benefits of a banking relationship, like affordable savings tools or the opportunity to build a credit profile and access loans. What basic banking services they do offer generally come with a fee. Without further innovation, prepaid cards may remain a financial inclusion Band-Aid, providing superficial (and often costly) services for lower-income customers without addressing their underlying financial needs.
In response to these drawbacks, some companies have developed prepaid alternatives that address the needs these cards overlook. For instance, the secured credit cards offered by financial service providers ranging from big banks to credit unions fill in some of prepaid’s biggest gaps. By requiring a refundable security deposit as collateral, these cards let banks lend to lower-income customers without risk. The credit offered to these customers is based on their income, ability to pay, and the amount of collateral – their repayment is tracked by the major credit bureaus. This helps customers build their credit score and move toward greater financial access, and the security deposit they put down may be refunded if they eventually qualify for an unsecured credit card. However the collateral doesn’t count toward payments, and it’s not considered savings.
Meed, a new entrant to the field, is taking these approaches a step further. Partnering with financial institutions, the company provides a mobile-based solution that gives consumers a holistic range of banking products, including a checking account with no minimum balance and unlimited international and domestic money transfers at no additional cost. It offers credit through a similar approach to secured credit cards, but rather than simply serving as loan collateral, Meed’s security account also acts as a savings tool, accruing interest while allowing members to borrow up to 75% of the total amount saved. Since members’ repayment activity is reported to credit bureaus, Meed users can build their credit scores through regular account use, potentially facilitating additional banking relationships.
As companies increasingly innovate new products that aim to serve consumers’ needs, new solutions will continue to emerge that deliver the advantages of prepaid without the drawbacks. Though prepaid is currently seen by many customers as the best of a very limited number of options, that is likely to change as these alternatives proliferate.