WASHINGTON — The explosive growth of prepaid cards as an alternative to checking accounts has sparked a debate over whether they should be required to have federal deposit insurance.
Federal Deposit Insurance Corp. protection is a gray area in prepaid cards. While the vast majority of cards have indirect FDIC coverage, some — including the recently-announced Bluebird card by Walmart — instead backstop customers themselves.
American Express, which issues the Bluebird card, and others argue their protection is just as secure. Yet some banks and consumer advocates say nothing can replace the FDIC; they argue regulators should strengthen FDIC disclosure rules and perhaps require government insurance outright.
"Prepaid cards could become a viable alternative to checking accounts if there is adequate consumer protection and deposit insurance. Right now those elements are not required," said Susan Weinstock, who directs the Safe Checking in the Electronic Age Project for the Pew Charitable Trusts.
American Express and Walmart announced Bluebird's launch on Oct. 8, letting customers manage certain financial services without opening a bank account. In addition to loading funds on a prepaid card, users have other features such as making electronic payments and taking pictures of checks with a smartphone to deposit them.
But unlike other Walmart products backed by a financial institution, such as the prepaid Walmart MoneyCard, Bluebird does not offer deposit insurance protection.
Although American Express has two FDIC-insured bank charters, the card will be offered through its nonbank travel services subsidiary, which is behind other well-known products such as American Express Travelers Cheques. Under state transmitter rules, it must hold assets in permissible investments equal to 100% of customer funds should something go wrong.
In a video interview with American Banker, two executives involved with Bluebird's launch said the product's protections are appropriate. Dan Schulman, Amex's group president of enterprise growth, said the state transmitter rules have been in effect for decades in the company's most established products. He noted the company is also a registered bank holding company, overseen by the Federal Reserve Board.
"We've been issuing prepaid types of products there for over a hundred years. We are regulated by all 50 states under their money transmitter licenses," he said. "Instead of paying for insurance, … for every dollar a customer has in their account, we have to set aside that amount in assets from American Express. It's a very strict regulatory environment that we work under with these state money transmitter licenses."
Daniel Eckert, Walmart's U.S. vice president for financial services, said the product is a low-cost option, but only one choice in the market.
"We think it's unmatched in the marketplace based on the capabilities, features and benefits for the price. But that's not to say that there aren't other choices in the marketplace that customers are free to choose, and if that works in their needs that's terrific for us, because we are a choice model organization," he said in the video interview.
But regulators and consumer groups have already focused on the deposit insurance issue in prepaid cards, raising questions about the extent to which prepaid cards that are not FDIC insured are fully protected—and whether there should at least be more disclosure of what kind of guarantee is in place.
"Simply put, state money transmitter laws do not provide the same 100% guarantee that consumers' funds will be returned to consumers quickly in the event of a failure down to the penny," Michelle Jun, senior attorney for Consumers Union, said in a July 23 comment letter to the Consumer Financial Protection Bureau.
Ben Jackson, a senior analyst at Mercator Advisory Group, said that the more prepaid card products begin to look like debit and checking accounts, the more likely policymakers will want to regulate them similarly.
"At what point do the regulators say, 'You're offering a bank account; if it looks like a duck and quacks like a duck, then it's a duck,'?" Jackson said.
In May, a CFPB advance notice of proposed rulemaking signaled plans to apply Regulation E protection to prepaid cards, and asked for comment on whether issuers should disclose if their prepaid product uses deposit insurance.
For prepaid products that opt for FDIC insurance, the agency does not insure the accounts directly. Instead, all funds for every customer are held in just one bank account. As long as the card provider keeps detailed records showing that a user's funds do not exceed the $250,000 insurance limit, the FDIC will cover those funds on a "pass-through" basis. But the mechanics and availability of that coverage can be unclear to consumers.
"Some issuers have structured the pooled accounts in such a way that each of the cardholders does have the benefit of FDIC insurance should anything happen to the bank, but others do not. And there is no reliable data on how often this protection is provided, and there's no requirement that issuers provide this protection," CFPB Director Richard Cordray said at a recent field hearing the agency held on the subject. "Because consumers often have no way of knowing how the banks are treating their money, we will consider how best to let consumers know about the risks to the safety of their funds."
But wire transmitters and some observers say applying similar standards to nonbank-issued cards would be unfair, and they insist the state rules for protecting funds are sufficient.
"It's not just a reserve," Judith Rinearson, a partner at Bryan Cave LLP, said of coverage rules for transmitters. "They have to have enough funds available at all times to cover cardholders. It's not like they can just hold a 12% reserve and invest the rest. The money transmitter licensing laws are really there to protect those funds."
Others say FDIC protection is simply a more straightforward approach should a company providing a prepaid card product fail.
"There are significant differences between FDIC insurance and the surety bond and permissible investment/outstanding obligations requirements of state money transmitter statutes," said Chris Daniel, a partner at Paul Hastings. "There is greater clarity with respect to the availability of federal deposit insurance in the case where a bank is placed into receivership with the FDIC versus the availability of funds for customers of a money transmitter when that money transmitter declares bankruptcy."
Weinstock pointed to the increasing prominence of prepaid cards for everyday uses, such as receiving social-security payments. She said as they become more prevalent, users who see some cards carrying deposit insurance may start to assume that all prepaid products have the FDIC seal, when in fact some do not.
In a recent Pew study on prepaid cards, of 52 cards evaluated, three issuers stated outright that they lacked FDIC insurance and 23 disclosed the existence of deposit insurance. Disclosures for the rest were unclear.
"Once prepaid cards are used by more of the population, the lack of FDIC protection becomes more of a concern," Weinstock said.
But Jun said disclosure should only be the first step.
"Apart from the disclosure of FDIC insurance, it is essential that all prepaid card funds are FDIC or [National Credit Union Administration] insured to the individual consumer," she said.
At the CFPB field hearing, some issuers of bank-backed prepaid cards agreed that FDIC protection should be universal.
"Bancorp and other issuers support requiring FDIC insurance protection for [general-purpose reloadable] cards," said Jeremy Kuiper, managing director of the payment solutions group at the Wilmington, Del.-based The Bancorp Bank, a $3.1 billion-asset bank in Wilmington, Del., that is one of the top five issuers of open-loop prepaid cards in the nation.
But in a comment letter responding to the CFPB's notice, an executive for Western Union said stronger rules regarding the type of protection for prepaid cards could create an unlevel playing for nonbanks.
Wire-transmitter laws "protect billions of dollars of money transfer and money orders," and "we do not believe that there should be a requirement that the existence, or lack thereof, of FDIC pass-through insurance associated with a GPR card be disclosed to the consumer," wrote Michael Hafer, senior vice president of Western Union Global Prepaid.
"This type of disclosure implies that cards without FDIC-insurance are inherently less safe than those with it and would give those programs a government-endorsed preference in the marketplace that is not warranted. The playing field should be level between banks and non-banks and consumers should have the choice as to which protection they feel is best for them."
— Sean Sposito contributed to this article.