Durbin's Unintended Consequence for the Underbanked
The Federal Reserve’s recently finalized interchange rules have unexpectedly crimped the prepaid debit card market and will make it even tougher for underserved consumers to gain access to the multifaceted financial products they need to get ahead.
In attempting to keep large banks from abusing the interchange cap exemption for reloadable prepaid cards, the Fed may have inadvertently scuttled one of the most promising opportunities for banks to profitably serve low-balance account holders who are likely to question the value of traditional checking accounts once they are no longer free.
Prepaid cards are essentially checkless checking accounts issued by banks and sold by marketing partners at retail locations and online. They don’t require a credit check, as they allow consumers to spend only the money they have. Past problems with overdrafts are a big reason why consumers get rejected for traditional bank accounts and gravitate to prepaid.
The new interchange caps will reduce the fees that banks earn on debit card purchases to about 24 cents per transaction from a current average of 44 cents. The Dodd-Frank financial reform law exempted general-purpose prepaid cards from the cap, as did the Fed’s proposed rules. The exemption was critical to ensure the economic viability of state and federal programs to disburse benefit payments electronically via prepaid cards.
The fast-growing prepaid card industry relies heavily on interchange revenue — it made up 32% of first-quarter operating revenue at GreenDot and 24% at NetSpend, the two dominant players. Card balances are on average lower than those of checking accounts, and customer service costs are high. Moreover, providers are increasingly adding features like bill payment, international money transfer, interest-bearing savings and convenience checks that put prepaid cards on par with traditional accounts.
Big banks have been closely tracking the prepaid card market, particularly in the wake of new overdraft rules, which led banks to restructure and reprice free checking accounts. When the Durbin amendment became law and banks saw that prepaid would be exempt from the interchange cap, they got serious about the product and began drawing up plans.
That made regulators nervous. So when the Fed announced its final rules in late June, it added a new provision to keep banks with more than $10 billion in assets from gaming the prepaid card exemption.
For banks to claim the exemption, the prepaid cards they issue cannot provide access to funds by check, ACH or wire transfer. That translates into a bare-bones product with little functionality beyond cash withdrawal at the ATM or purchases at the point of sale. It means no electronic bill payments, no courtesy checks, no money transfers.
Prepaid cards could be a boon to low-balance checking account holders who aren’t getting much value out of their (currently) free account and are almost certainly not going to be willing to pay $10 to $15 a month on top of overdraft charges.
The new Regulation E opt-in requirements have reined in debit card overdraft practices, but consumers are still at risk of debit and check overdraft fees that can throw a tight budget off kilter.
Most prepaid products don’t allow overdrafts, and the Fed interchange rules expressly forbid overdrafts on prepaid in order to qualify for the exemption.
Prepaid cards also could offer banks a responsible way to cut the cost of serving low-balance customers without reducing service. Bill payment, for instance, is a critical element of any transaction account.
Electronic bill payment is particularly relevant for consumers
living paycheck to paycheck who don’t have enough cushion to write a check for the electric bill and mail it a week before the due date.
The Fed understands the opportunity that prepaid represents. The day that the Fed voted on the interchange rules, Federal Reserve Governor Sarah Bloom Raskin gave a speech in which she acknowledged prepaid’s value. “There is interest in the use of prepaid cards that offer the payment ability of a debit card, combined with the functions of a checking account, to go along with an optional savings feature, as a new product that provides expanded options for consumers without traditional bank accounts,” she said.
In today’s environment, banks need positive incentives to serve underserved consumers. Even though the Fed lost its consumer protection job last week as the Consumer Financial Protection Bureau opened for business, it still has a critical role to play in creating an enabling environment in which banks can innovate safely on behalf of the underserved. Interpreting the interchange rules presents the Fed with another chance to promote financial inclusion.
Jennifer Tescher is the president and chief executive of the Center for Financial Services Innovation.