Banks Overlook Prepayment Card Even as It Surges

As many bankers struggle to maintain profitability in credit cards and set strategies for debit cards, they may be missing out on a new kind of card that could prove a potent competitor.

The challenger is the prepayment card pioneered by the Japanese. The card has become increasingly popular in several countries for use with pay telephones and mass transit.

While bankers generally have not been paying attention, prepayment cards have emerged as the first realistic, automated alternative to coins and currency in small transactions, according to industry analysts.

The credit-card-size device has a preset spending value that is decreased electronically until exhausted. Most pay telephones in French cities, for example, require stored-value cards, rather than coins, for access. The cards can be purchased from newspaper kiosks and post offices and are thrown away when their value is spent.

Some Subways Use Paper

In the United States, subway systems such as those in San Francisco and Washington require riders to purchase prepaid fare cards, but the cards are made of paper rather than the more durable plastic.

According to one study, more than a billion prepayment cards are sold annually and perform $4 billion in transactions around the world, a figure that could rise to more than $20 billion within 10 years.

Volume that high may be seen as a competitive threat to bank-controlled payment systems - or as an opportunity for banks to get into the prepayment game.

Warning for Bankers

Linda K.S. Moore, in an article in a recent anthology, "Electronic Money Flows: The Molding of a New Financial Order" (Kluwer Academic Publishers, Boston), makes a case for bankers to develop a prepayment-card system to increase their share of the payments market.

Ms. Moore, a New York-based researcher, has studied the accelerating demand for cash in recent years and estimated that 300 billion payments in the United States each year are for less than $10 - and most are in cash.

"The fact that cash is used primarily for low-value payments suggests that consumers have a preference for storing value in bank accounts," she wrote.

Since the returns on bankers' investments in payment technologies will reach a limit, and since the industry's aim is to maximize deposits rather than the use of cash, banks may be "better off investing to maximize aggregate deposits through the transaction convenience of prepaid cards," Ms. Moore concluded.

Prepayment cards are basically an electronic updating of the railroad tickets that were purchased as long as a century ago for multiple trips.

With each journey, a conductor would punch a hole in the ticket until it expired.

Many of the present-day prepayment cards utilize smart card technology, with a tiny computer chip imbedded in the plastic and readable by computerized telephones or other point-of-sale devices.

Not only is the technology modern, it also generates a profit to the seller. Invariably, the seller is not a bank.

Nippon Telegraph and Telephone Corp., the first to set up a major prepaid phone-card system in Japan, gets what is, in effect, an interest-free loan from the time a customer pays for a card until it is used.

Phones Are Top Application

According to a study published by Financial Times Management Reports, of 1.1 billion prepaid cards used worldwide in a year, 500 million are for making telephone calls and 200 million are for buying tickets on trains and buses.

The average transaction size is below $10, though uses are spreading to higher-value transactions with utilities as well as stores and restaurants - all areas that bank credit card companies are targeting for future growth as conventional markets become saturated.

Japan, Italy, France, South Korea, and Britain are the largest users of pay-phone cards, while the United States, Japan, and Hong Kong lead in applications for mass transit.

Demand Is on the Rise

Worldwide demand for single-issuer prepayment cards and similar devices that can be used at multiple outlets like gas stations, pay telephones, taxis, or stores, is spreading.

Officials at Danmont, a Danish company planning a universal prepayment card system, said up to 75% of respondents in a survey preferred prepaid cards to coins and bank notes.

Reasons cited included convenience as compared with coins, and elimination of the need to tip as there is no "human interaction."

Impact on Money Supply?

As they replace coins and currency, the multiple-use cards will be the first "capable of having a measurable effect on the coinage and even the money supply of a country," said Peter Harrop, who conducted the Financial Times study on prepayment technology, and whose work influenced Ms. Moore's conclusions on banks' role.

Mr. Harrop warned that the rise of prepaid cards could prove damaging to banks if they stay on the sidelines.

Banks have had to invest heavily in systems and procedures to handle low-value transactions, which can represent 40% of the expenditure of a typical retail bank acting as a supplier and processor of cash.

Additionally, prepaid cards are being set up as low-cost systems that are likely to dominate the small-transaction market in competition with credit cards, which are most efficient in bigger-ticket transactions.

Most bankers mistakenly assume prepayment cards dedicated to a single service provider, like a phone company, are so narrow in application "that they will never pose a significant threat to their business," Mr. Harrop said.

They overlook the cards' technological potential, he said. For example, smart-card devices have vast memory and application capacity that could give home banking systems what they have lacked and what may have hindered their success: the ability to deliver cash.

Reusable prepayment cards could be "recharged" with value at a home banking terminal before shopping, providing an alternative to automated teller machines.

The explosive growth of point-of-sale electronic funds transfer systems in some nations could be eclipsed by wider adoption of a universal prepayment card, which would be available even to people who do not have bank accounts.

Some Retailers Do Well

Already, low-volume cards specific to certain retail chains are proving cost-effective and can reduce lines at the registers, Mr. Harrop said.

The rapid adoption of point-of-sale payment cards in the United States, Britain, and France did not reduce queuing because the need for signatures was not eliminated.

The main impetus for the growth in prepayment cards will continue to come from retail merchants seeking improved profitability, Mr. Harrop contended.

Benefits to Vendors

Prepayment cards address stores' needs because they can cut vandalism - pay telephones, for example, would have no cash to steal - and prompt higher product sales because consumers find the cards easy to use and the equipment is more reliable than coin-operated machinery.

Cards also carry advertising, estimated to be worth more than $100 million a year and often compensating for the cost of issuing the cards.

Some of the largest, fastest-growing consumer goods manufacturers are backing prepayment cards because they are proving to be a more cost-effective promotional device than manual approaches such as tear-off coupon promotions.

Mitsui Jumps In

One bank, at least, is preparing to join the trend toward prepaid.

Mitsui Taiyo Kobe Bank Ltd. this year became the first in Japan to issue such a card, typically for use in restaurants and stores. The cards are loaded with value at bank equipment that debits funds from from a user's checking account.

The Japanese bank, acting as a settler of prepaid card transactions, has reported it finds the information obtained in the process valuable in helping target sales of financial products to individuals.

Mr. Harrop said in Japan alone, prepayment card transactions already exceed $2 billion annually.

If just a few other countries match this growth, "$20 billion a year [worldwide] within 10 years is a reasonable projection."

Jeffrey Kutler contributed to this article.

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