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.

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 kind 
of 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 accountholders 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 one of 
the primary reasons 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. 
Why? 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 developments in the prepaid card 
market, particularly in the wake of 
new overdraft rules, which led banks 
to restructure and reprice their 
free checking accounts. When the 
Durbin Amendment became law and 
banks saw that prepaid would be 
exempt from the interchange cap, 
banks got serious about the product 
and began drawing up plans. 
That made the retailers nervous. So 
when the Fed announced its final 
rules late last month, 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 via 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 reigned 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. Ironically, 
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.
"New technology, such as recent 
advancements in mobile financial 
services and the prepaid card 
industry, are spurring financial 
product and service innovation in 
the private sector," she said last 
month during a forum at the New 
America Foundation. "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."
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 Innovatio