Prepaid Cards’ Big Bullseye

Can the fast pace of innovation  that has characterized the prepaid card  sector in recent years continue  as lawmakers and regulators  increasingly target the business?

By Linda Punch

After years of skirting the edges of the industry, the prepaid card market finally is getting a toehold in the mainstream of financial services. Over the past two years, Wal-Mart Stores Inc. launched a prepaid payroll card for its employees and two big prepaid card program managers—Green Dot Corp. and NetSpend Holdings Inc.—pulled off successful initial public offerings.

More recently, in December, the U.S. Department of the Treasury issued a final rule mandating that Social Security and other government benefits be paid to beneficiaries electronically, via direct deposits into their bank accounts or loaded onto a prepaid card. An existing prepaid card for Social Security recipients already is a big hit.

And in January, the Treasury Department launched a pilot program that could enable more than half a million low- and moderate-income individuals to receive tax refunds via prepaid cards.

Now major banks are beginning to “pay attention” to the prepaid card market, which thus far has been dominated by smaller financial institutions such as Meta Financial Group Inc.’s MetaBank, says Melissa Koide, policy director for the Center for Financial Services Innovation. CFSI is a Chicago-based non-profit focused on lower income and underbanked consumers and a proponent of prepaid cards.

But even as the prepaid card market is beginning to catch the eye of Wall Street and larger financial institutions, it also is drawing the attention of lawmakers and regulators in Washington, D.C., and state capitals. Swept up by the push from the federal government and consumer groups for regulatory reform of the financial system, prepaid cards are being targeted from multiple angles.

Already, restrictions on prepaid card fees and more disclosure requirements have been included in legislation such as the Credit Card Accountability, Responsibility and Disclosure Act of 2009, or Credit CARD Act.

And new laws and regulations on prepaid cards are in the offing, including a bill from U.S. Sen. Robert Menendez, D-N.J., that would require full disclosure of fees and restrict the types of fees that could be charged. Observers also are closely watching the new Consumer Financial Protection Bureau, which many expect to issue regulations on prepaid cards after it opens for business in July.

Crisis Averted

For many players in the prepaid space, more regulation translates into higher costs and lower fee revenues in a business with slim profit margins. That could inhibit growth in a market just beginning to gain momentum

Nevertheless, many say the outlook for prepaid cards remains bright. “There are more positives than negatives for the market,” says Gwenn Bézard, research director at Boston-based Aite Group LLC. “Ultimately, there are tons of opportunities for prepaid to grow.”

Indeed, a recent Aite report estimates that load volume on prepaid cards and their payroll card cousins will grow to $164 billion by 2014 from $43 billion in 2009 . Prepaid cards will increase to $104 billion in 2014 from $24 billion in 2009, while payroll cards will grow to $60 billion from $19 billion in the same period.

 Aite also expects the combined number of prepaid and payroll card users to reach 12.4 million by 2014, up from 5.1 million in 2009. Prepaid card users will total 7 million by 2014, up from 3.4 million in 2009, while payroll card users will grow to 5.4 million in 2014 from 1.7 million.

In 2009, the largest players in combined prepaid and payroll card volumes were NetSpend ($7.6 billion), H&R Block Inc. ($7 billion), Green Dot ($5.8 billion) and First Data Corp. ($5.5 billion), Aite says.

Yet, the onslaught of new and proposed regulations is raising concerns in a market just beginning to gain its footing among traditional financial services. Restrictions on fees could cut a major source of revenue for prepaid card programs, and the cost of complying with new regulations could reduce profit margins.

Prepaid card issuers and processors already are grappling with fallout from the CARD Act, which mandates changes in disclosures, fee structures, expiration dates, and related areas. Under the rules, more-restrictive state laws take precedence over federal rules.

The Federal Reserve last year issued 104 pages of rules for complying with the CARD Act. They cover general-use prepaid cards, gift certificates, and store gift cards. Provisions include:

? Dormancy, inactivity, or service fees may be assessed only for a card or certificate that has had at least one year of inactivity. There can be no more than one such fee charged per month. The consumer must be given clear and conspicuous disclosures about fees.

? Fees subject to restrictions include monthly maintenance or service fees, balance-inquiry fees, and transaction-based charges such as reload fees, ATM fees, and point-of-sale fees.

? Expiration dates must be a minimum of five years after the date a certificate or card is issued or the date funds are last loaded. The expiration restrictions apply to a consumer’s funds, not to the certificate or card itself.

? Fees are prohibited for replacing an expired certificate or card, or for refunding the remaining balance, if the underlying funds remain valid.

Gift card issuers already averted one crisis resulting from the legislation. The law originally called for an Aug. 22, 2010, deadline for retailers to replace gift cards to make them compliant with the regulations. But Congress later delayed the deadline until Jan. 31 after card companies and retailers said that the original deadline would create a logistical nightmare if they had to replace hundreds of millions of cards before the 2010 holiday-shopping season.

Circumventing Durbin

But other challenges remain. For example, general-purpose, or open-loop, prepaid cards could be subject to more stringent and differing state rules on fees and expiration dates. The success of general-purpose reloadable (GPR) prepaid cards largely stems from their being able to operate with the same rules across all 50 states.

The biggest piece of financial legislation emerging from Congress in 2010—the Dodd-Frank Wall Street Reform and Consumer Protection Act—left the prepaid card market largely untouched, but could lead to more regulation in the future.

The law’s so-called Durbin Amendment, which tells the Federal Reserve Board to draw up regulations by mid-2011 that would regulate debit card interchange, exempted some reloadable prepaid cards. The law also exempts the debit card interchange income of financial institutions with $10 billion or less in assets. Major prepaid card issuers, including MetaBank and The Bancorp Inc., fall below this threshold. The amendment also exempts governmental prepaid cards.

The Dodd-Frank Act with its Durbin Amendment might even have a positive impact on the prepaid market, says Ben Jackson, a senior analyst with Maynard, Mass.-based Mercator Advisory Group Inc. Faced with restrictions on debit card interchange, many banks might begin offering prepaid cards that have no interchange limits in place of low-end checking accounts that generate little or no profit, according to Jackson.

But while the amendment could give non-banks offering GPR prepaid cards an economic edge over regular banks’ debit card programs, it also sets out rules that could negatively impact the prepaid market in the future, Jackson says. Under the Fed’s proposed regulations, banks using a prepaid card program to circumvent the debit card interchange regulations could be required to comply with the new rules.

“That’s going to be one of the things that prepaid card managers may have to be careful of,” he says. “Does it look like a bank that’s just trying to get around Durbin with prepaid cards? If it’s an obvious end-run around those regulations, you’re going to see the regulators step in and crack down.”

Another section of the Dodd-Frank Act stipulates that prepaid card issuers that charge overdraft fees will lose their exemption from interchange regulation, Aite’s Bézard notes. That could prove an issue for players that rely on overdraft revenues.

Menendez’s ‘Road Map’

While the Durbin Amendment and CARD Act have captured most of the headlines over the past two years, there are other bills and proposed regulations that could slow growth in the prepaid market.

In mid-December, Menendez introduced the PrePaid Card Consumer Protection Act of 2010 in the Senate. The bill—cosponsored by Sens. Richard Durbin, an Illinois Democrat and author of the now-famous Dodd-Frank amendment, and Jeff Merkley, D-Ore.—would eliminate some hidden fees, increase fee transparency, and enhance consumer protections. The bill died in the lame duck session of the 111th Congress, but a Menendez spokesperson expects it to be reintroduced in the current session.

The bill would provide for full fee disclosure before the consumer buys the card, including a wallet-sized summary of all fees and a toll-free number for customer service. It also would limit the types of fees that could be charged, banning overdraft fees, balance-inquiry fees, customer-service fees, inactivity fees, account-closure fees, and other types of fees.

The bill also would provide for consumer protections for prepaid cards, such as Regulation E safeguards against loss or theft and Federal Deposit Insurance Corp. coverage to protect consumers’ money if the card sponsor goes bankrupt.

The newly created Consumer Financial Protection Bureau and the FDIC would issue regulations within nine months of enactment. Consumers Union and the Consumer Federation of America support the bill.

Menendez’s proposal would explicitly extend “the same coverage regular debit cards get to prepaid cards to make sure that everyone gets the same types of protection against unauthorized transactions if a card is lost or stolen or if you find a billing error,” says Suzanne Martindale, attorney and associate policy analyst in Consumers Union’s San Francisco office. “That’s something we’ve been wanting to see for a long time.”

Observers say the bill has little chance of passing in the Republican-controlled House of Representatives, but CFSI’s Koide says it “sends a strong signal that cannot be ignored, which is that policymakers at the federal level are paying very close attention to the prepaid card marketplace.”

And Martindale says that even if the bill doesn’t pass, “we’re hoping the Consumer Financial Protection Bureau will look to this bill as a road map of what they need to do.”

Prior to the Menendez bill, the Fed proposed extending Reg E protections to prepaid cards onto which federal payments are loaded, a position that CFSI and Consumers Union support. Regulation E is the Fed’s body of rules for enforcing the Electronic Fund Transfer Act.

FinCen’s ‘Showstopper’

The prepaid card market also is facing proposed regulations from another quarter: the Treasury Department’s Financial Crimes Enforcement Network (FinCen). FinCen in June 2010 proposed new rules that would subject non-bank-owned or operated providers of so-called prepaid access—such as retailers or proprietary reloadable prepaid card networks—to the same Bank Secrecy Act regulations imposed on banks and other depository institutions. Prepaid cards issued by banks already fall under the BSA regulations.

The proposed rules, mandated under the CARD Act, would cover prepaid devices such as plastic cards, mobile phones, electronic serial numbers, key fobs and/or mechanisms that provide access to funds that have been paid for in advance and are retrievable and transferable.

FinCen is addressing concerns that because prepaid cards and similar devices can be easily obtained and are anonymous, they are attractive for money laundering, terrorist financing, and other illegal activities. Under the proposed rules, providers of prepaid access would be required to meet the same registration requirements, suspicious-activity reporting, customer-information recordkeeping, and new transactional record-keeping mandates as banks.

The entity within a prepaid-access-transaction chain with predominant oversight and control would be obliged to monitor and report any meaningful information—information that might suggest illegal activity—to regulators and law enforcement. The proposed rules exempt certain categories of prepaid-access products and services, such as payroll cards, that pose lower risks of being used for money laundering and terrorist financing.

The proposed regulations stem from the belief that “someone can anonymously load as much money as they want onto a prepaid card either in the U.S. or abroad, take it across borders, pull that money down again and not have anyone notice,” Mercator’s Jackson says.

But the prepaid card industry already has load limits, suspicious-activity monitors, and other procedures that enable issuers and processors to detect and halt suspicious transactions. “The industry needs to make sure they’re educating the government,” Jackson says.

Koide of CFSI terms the proposed rules “a showstopper for the industry.” In an Aug. 27 letter to FinCen, she noted that the policy as proposed would require retailers and prepaid card networks to subject anyone with a card carrying a balance of $1,000 or more to identity verification each time funds are added to the card.

“Some retailers would stop offering prepaid cards rather than assume responsibility for training sales clerks and others to collect consumers’ identification information, verify it, and safely store it in a manner that protects against identity theft and ensures privacy,” she wrote.

In addition, prepaid card providers might limit maximum card values to $1,000 or less, reducing the cards’ utility as a financial tool for consumers. The policy also could have a “chilling effect” on consumers who might not be comfortable providing personal information such as address, date of birth, or identification number, such as Social Security, to a store clerk, Koide wrote.

While most of the legislation and regulations affecting prepaid programs are being generated at the federal level, states also are getting into the act. And because the CARD Act gives more stringent state laws precedence over federal law, state regulations could pose a “real problem” for the prepaid card industry, Jackson says.

In New Jersey, for example, gift card accounts are covered by the state’s escheatment law, which mandates that property unclaimed or abandoned for two years be turned over to the state. That means that retailers now have to maintain records on everyone who buys a card, Jackson says.

“There already are retailers who are saying, ‘we’re probably not going to sell gift cards there any more,’” he says.

Despite all the recent laws and rules, no one can say for sure just how the new regulatory environment will affect the business case for prepaid cards in the long term. “If there were enough fee restrictions and enough other kinds of controls that were put on the industry, it could be very hard for a lot of smaller programs to remain viable,” Jackson says.

But the fact that federal and state governments increasingly are using prepaid cards to deliver benefits such as Social Security and unemployment insurance gives GPR prepaid cards a “level of protection,” Jackson adds. “The perception that prepaid cards are used mainly by the unbanked and underserved also offers some level of political protection.”

“Nobody wants to be seen as the official who pushed unbanked people back to high-cost financial-service providers,” he says.

What’s more, increased regulation may give consumers more confidence in prepaid cards, Jackson says. “In some ways, it isn’t all bad,” he says. “It’s opened up opportunities and made the business more transparent to consumers in some cases. That’s a good thing.”

 

Prepaid’s Regulatory Challenges

In Effect

The Credit Card Accountability, Responsibility, and Disclosure Act of 2009: Mandates changes in disclosure, fee structures, card expiration dates, and related areas for some prepaid cards and gift certificates.

Durbin Amendment to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010: Exempts general-purpose reloadable prepaid cards issued by financial institutions with $10 billion or less in assets from stringent debit card interchange regulation. Also exempts government prepaid cards.

Proposed

The PrePaid Card Consumer Protection Act of 2010 introduced in the 111th Congress by U.S. Sen. Robert Menendez, D-N.J.: Would have provided for full disclosure of fees before a consumer buys a card and called for limits on the types of fees that could be charged. Expected to be reintroduced in the 112th Congress.

Financial Crimes Enforcement Network’s prepaid rules: Would subject non-bank-owned or operated providers of prepaid cards to the same Bank Secrecy Act regulations imposed on banks and other depository institutions, including registration requirements, suspicious-activity reporting, customer-information record keeping and transactional record keeping.

Regulation E: Proposed changes would extend Reg E consumer protection to prepaid cards.

Consumer Financial Protection Bureau: The controversial bureau created by the Dodd-Frank Act is expected to consider regulations for prepaid cards when it opens for business in July.

Source: Digital Transactions

 

Visa at the Intersection of Digital Goods And Prepaid

Since it went public in 2008, Visa Inc. has shown itself willing to spend big money to buy its way into critical markets. One such market could be digital goods—chiefly the equipment and accessories gamers eagerly snap up for online shoot ‘em ups. The market is expected to boom, going from $25 billion last year to $280 billion in 2014, according to PriceWaterHouseCoopers and Forrester Research.

With numbers like that in mind, the world’s largest payments network announced in February it is shelling out $190 million in cash to buy PlaySpan Inc., a Santa Clara, Calif.-based processor of digital-goods transactions, particularly so-called in-game payments.

The deal for PlaySpan follows Visa’s $2 billion buyout last year of CyberSource Corp., a major gateway for e-commerce transactions, and catapults Visa into the burgeoning market for digital goods sold online and, increasingly, through mobile payments.

Founded in 2007, PlaySpan specializes in so-called in-app and in-game transactions, which allow gamers and other users to pay for goods while they are using an application rather than having to leave the app to make the purchase. The company operates a payment gateway that it acquired in 2008, but its primary mode of payment is a prepaid card, called the Ultimate Game card, that it sells through more than 50,000 convenience stores and other outlets.

PlaySpan moved into mobile payments in November with the launch of an in-app payment feature that works on Android smart phones. How many software publishers and other companies are using PlaySpan was not announced.

Visa sees PlaySpan as complementing CyberSource and cementing its place in the digital-goods market. “The whole area of in-app purchases or downloadable purchases is a big one for the software industry,” notes Aaron McPherson, practice director for financial services at Boston-based consultancy Financial Insights. At the same time, the use of prepaid cards helps control risk, he adds. “You have a lot more control over chargeback procedures,” he says. “It stays within the network and you have your own rules.”

In addition to the $190 million price tag, Visa will pay “additional consideration for performance milestones,” the company says. The acquisition is expected to close by the end of March, pending regulatory approvals and other ordinary closing conditions.