For bank customers who can't keep big balances, free checking is on its way out. New overdraft rules and the proposed cut in interchange rates have ushered in a new reality in banking.
But an alternative waits in the wings: prepaid debit accounts.
The Durbin amendment's carve-out of prepaid from the new interchange rules essentially provides banks with an indirect subsidy to ensure that financially underserved consumers can continue to access the financial system.
Overdraft fees and interchange income were what helped pay for free checking for all and rewards programs for the elite. Overdrafts made banking spectacularly expensive for a core group of largely low- and moderate-income consumers, and the fees they racked up subsidized everyone else. In the future, everyone will be expected to pay their own way. The fear is that not everyone will be able to afford a $10 or $15 a month checking account, especially one that has fewer bells and whistles and still assesses unexpected overdraft fees.
Prepaid accounts offer banks consumers and banks alike a favorable alternative to checking.
Prepaid poses less risk than a checking account because only good funds can be deposited, thus eliminating check overdrafts. That's why prepaid products can be offered to consumers with no credit history or a poor one, a situation that can be an obstacle to opening a traditional checking account.
While the prepaid cards on the market today are all bank-issued, they are generally sold by retailers and other third parties. That should change.
Banks could sell prepaid products in their lobbies, as yet another offering in their suite of checking products. The interchange exception and reduced risk and cost of prepaid provides banks an opportunity to turn millions of unprofitable checking accounts held by low-balance customers into a break-even or better proposition by embracing prepaid.
In large part, the interchange carve-out was designed to deal with prepaid cards offered by federal and state governments to provide benefits like food stamps and unemployment electronically. Electronic benefits cards are cheaper to provide than paper checks and offer consumers greater convenience and safety. Interchange revenue is the grease that makes the cards economically viable.
The real promise of government disbursement cards is that, by making them reloadable with funds other than government benefits, they could serve as an on-ramp to broader financial services access. That idea is finally being realized with the recent Treasury Department announcement that it will pilot test a prepaid account with tax filers. The account will be loaded initially with a tax refund. Among other things, the program will test what it takes to keep consumers using the card beyond tax season.
Banks have taken notice. While they continue to fight the new interchange rules in part by threatening to dismiss underserved customers, privately they are developing plans for new prepaid accounts that will enable them to offer an alternative to free checking.
These prepaid accounts probably won't be free. But they will offer most of the same features as a traditional checking account at a lower cost.
Prepaid has been getting a bad rap lately in the media, where stories focus on the handful of bad-apple products with outrageous fees and terms. The fact is, the most popular cards in the market offer consumers a fee structure comparable to that of current checking account offerings, if not cheaper. The problem is that prepaid products are not yet subject to the same set of consumer protections as checking accounts. As banks get in the game as direct distributors, it is critical that prepaid and checking gain equal footing.
Regulators are moving in the right direction. The Treasury recently issued an interim final rule requiring that any prepaid product that accepts federal payments provide consumers with FDIC insurance coverage and Regulation E protection, which governs electronic payments.
We should celebrate the fact that more banks are looking at prepaid accounts as a way to take advantage of the interchange carve-out. It is one of the few ways they have to serve the underbanked directly, responsibly and profitably.