A unique merchant-funded cardholder rewards program just got a powerful new marketing channel — and, thanks to regulatory reform, a stronger pitch to make to banks.

Fifth Third Processing Solutions LLC is set to announce Thursday that it has agreed to market edo Interactive Inc.'s Prewards system to issuers and merchants.

The system until recently suffered from the classic chicken-and-egg problem: Banks wouldn't sign up unless there were plenty of participating merchants to provide rewards, and merchants weren't interested because there were few banks on board.

But with debit interchange fees likely to be curtailed under the new reform law, banks are now eager to find other sources of revenue to support rewards programs.

"With less interchange available, the traditional rewards model is too expensive for issuers," said Beth Robertson, the director of payments research at Javelin Strategy and Research in Pleasanton, Calif. For banks, getting merchants to fund cardholder perks "is a way to continue offering consumers rewards … without having the corresponding expense of supporting a traditional rewards program," she said.

Tony Emrick, a senior vice president and director of business development at Fifth Third Processing, called Prewards "pretty timely, given the financial legislation going on out there."

What banks "need to be able to do is continue to make that card valuable," he said. "If your interchange rates are going down, issuer-based rewards are going to be pressured."

Robertson said edo's deal with Fifth Third Processing should give Prewards an important endorsement for banks seeking an unconventional rewards system.

"Fifth Third is a really nice win for them," she said. "Fifth Third is a significant processor."

Prewards works by storing funds provided by merchants in a "purse" that is linked to a debit or credit card from a participating issuer. The merchant takes part to generate more business.

Unlike the standard rewards formula, in which consumers accumulate points to use in the future based on their spending, Prewards functions more like a coupon, offering immediate discounts at specific merchants. These offers are not dependent on the consumer's past spending.

People are notified by e-mail or text message of available rewards offers, such as $5 off purchases made at a drugstore within a specific period, and the funds are deducted automatically from the rewards purse at the point of sale.

When a reward is redeemed, the merchant pays a fee to edo and to the bank that issued the card used for the purchase. This redemption process is invisible to the cashier and, initially, to the consumer, to whom edo immediately sends a text message verifying that the reward was redeemed and that the discount has been applied to the transaction.

Though the discount does not appear on the receipt, it does show up on the user's statement and online.

Jonathan N. Dyke, edo's chief operating officer, said that, though mobile phones are not needed to use Prewards, mobile integration makes the entire system more valuable.

"Mobile drives redemption," he said.

Edo's mobile software can also be integrated with an issuer's existing mobile banking application, or used as the foundation of one for a bank just starting with mobile. "This is a good way to get folks into electronic channels," Dyke said.

Edo is testing a full-featured application for iPhone and Android phone users to get more detailed feedback. The company said several other financial companies have expressed strong interest in offering Prewards, including a "well-known" U.S. bank that plans to use it in its debit rewards this fall.

Edo introduced Prewards in late 2008 through its own prepaid Facecard. Though that card is still available (marketed mainly to teens), edo has stressed that Prewards is now its primary business — Facecard exists largely as a way to demonstrate Prewards.

Before the regulatory reform push, edo had some success getting Prewards noticed, as in a mid-2009 deal with the Miami gift card provider Aentra LLC.

Edo said the Fifth Third Processing deal would help the system take off — even merchants that liked the idea were hesitant to fund rewards until a major financial company signed up on the issuing side, and edo said Fifth Third Processing Solutions, which is owned by Fifth Third Bancorp and Advent International Corp., is a big enough name to sway those merchants.

Ed Braswell, edo's president and chief executive, said that the government crackdown on interchange and on other sources of banks' fee income "put a lot of wind in our sails."