The government's embrace of prepaid debit cards is the latest sign that the product has truly arrived.
Last week the Treasury Department announced that it would phase out paper checks for federal benefit recipients by 2013 and push all payments through direct deposit. Currently, 85% of federal benefit recipients receive their payments electronically. Moving all these recipients to electronic payments is expected to save upward of $300 million in the first five years.
Treasury officials said the prepaid debit card they launched in 2008 enabled them to finally mandate electronic payments, something they have been trying to do for more than a decade.
The agency first attempted to mandate direct deposit of federal benefits in the mid-1990s. The idea led to an outcry from recipients and advocates, in large part because millions of check recipients lacked bank accounts. In many respects, this was the first time the nation became collectively aware of the plight of the unbanked.
Since then, the Treasury's attempts to provide the unbanked with a way to receive direct deposit all met with failure — until now. The Direct Express prepaid debit card has made a measurable dent in reducing the number of Social Security and disability payment recipients receiving paper checks. One million recipients are using the card, and customer surveys show that they are satisfied with it.
Direct Express has been so successful, there is even talk of trying to leverage a similar prepaid product to help unbanked tax filers who lack a mechanism for receiving their refunds via direct deposit. Besides cutting the government's costs, such a move would enable the unbanked to receive their refunds faster, potentially cutting their dependence on high-priced refund-anticipation loans.
More than 7 million people receive government disbursements via prepaid cards, according to a 2009 consumer survey by Mercator Advisory Group. As the use of prepaid cards for government payments grows, the product will almost certainly come under increasing scrutiny, especially in terms of consumer protections. A deeper assessment is appropriate.
The prepaid card industry has benefitted from the judicious approach taken by federal regulators. The FDIC, for instance, issued and reissued draft opinions regarding prepaid cards and deposit insurance over the course of more than three years, tracking the industry's evolution and waiting to finalize the rules until the time was right.
The final opinion, issued in 2008, detailed the conditions under which the FDIC would extend pass-through insurance coverage to prepaid cardholders. The result is that today the biggest prepaid programs in the country have structured their products so that consumers' funds qualify for FDIC coverage.
Similarly, the Federal Reserve took a measured approach when it wrote new rules in 2006 to ensure that payroll cards were covered by Regulation E, which details consumer protections related to electronic fund transfers.
The rule ensured cardholders are protected if their cards are lost or stolen. In addition, the final rule did not require issuers to provide paper statements as long as transaction information is made available by telephone, electronically and in writing at the customers' request. The rule acknowledged that payroll cards are patently different from traditional bank accounts, and that consumers' expectations are different as a result.
Indeed, innovation has thrived in the prepaid card industry, creating the conditions for vigorous competition in the marketplace and leading to a significant decline in prices and improved consumer practices. As card volume grows, even bankers are taking notice and considering whether to add prepaid-like products to their standard suite of checking accounts.
As the product takes center stage, it is time to address the few remaining regulatory holes.
While the FDIC opined that insurance coverage is possible for holders of prepaid cards, it stopped short of mandating coverage. It should do so now. It is also time for the Federal Reserve to extend Regulation E, with flexibility around paper statements, to reloadable prepaid cards.
These changes would serve to codify existing industry best practices. More important, they would boost consumer confidence in prepaid at a time when Americans are increasingly mistrustful of financial products and the institutions that sell them.
Prepaid card providers have leveraged that sentiment, marketing their product as an alternative to a traditional bank account for those who don't want one or can't get one. Prepaid cards do offer a number of advantages over checking accounts, particularly for underbanked consumers with constricted cash flow or poor credit. But as it stands today, consumer protections are not among the advantages.
Consumers shouldn't have to choose between access and safety. Beefing up prepaid card protections will send the message that these cards have truly earned a place in consumers' wallets.
