Banks' New Money Machine: Prepaid Cards

Gus Artiles used to wait anxiously for the mail carrier on Friday afternoons, hoping his California state disability insurance check would arrive before his bank closed for the day. Now Artiles, 54, doesn't worry about the the mail. By Friday morning, Bank of America (BAC) automatically loads his funds onto a prepaid card, which Artiles uses to buy groceries and gas like a regular debit card. "It's a beautiful thing," he says. "It's more convenient, and you get your money a lot faster."

Artiles is one of almost 2 million people taking part in "one of the largest prepaid programs on the planet," says William M. Sheedy, the head of Visa's (V) Americas group, referring to California's effort to use prepaid cards for unemployment benefits, disability insurance, and paid family leave programs. Such demand from governments as well as employers is helping power the prepaid card market. Last year, people used prepaid cards for $65 billion in transactions, up from $48 billion in 2009, according to the Nilson Report. Sanjay Sakhrani, an analyst at KBW, estimates that would have generated about $1 billion in transaction fees for card issuers. That comes as banks look for ways to replace the $25 billion in projected lost revenue that recent credit and debit card reforms may cost them, according to Boston Consulting Group.

While the prepaid market includes cards sold directly to consumers in drugstores and other retail outlets, large banks see issuing cards for government benefits and employers' payrolls as a growth opportunity. Tim Wall, head of Citibank's (C) prepaid sales, says using cards instead of cutting and mailing checks can trim costs by 75 percent. "We're just at the beginning of many of our government clients moving from paper to a paperless environment," says Margaret A. Scopelianos, a treasury services executive at Bank of America.

Issuing prepaid and debit cards is a high-volume, low-margin business, in which banks collect two types of fees. They get money from the payment networks that charge retailers swipe fees when consumers use the cards to make a purchase. While financial reform capped such fees for debit card transactions, Congress did not limit them for most prepaid cards. That exemption will be a "positive thing" for the prepaid market, says Citi's Wall. As they do with debit cards, banks also may charge users for such things as making multiple ATM withdrawals, using a non-network ATM, or overdrafts.

Because of the project's scale, California was able to negotiate a program that has almost no fees for consumers, something that was "paramount" after learning other states had less favorable deals, said Loree Levy, a spokeswoman for the California Employment Development Dept. JPMorgan Chase's (JPM) prepaid cards for Michigan's unemployment insurance charge $1.50 for each denied transaction, for example, and U.S. Bancorp's cards in Ohio charge $17 for each overdraft.

Consumer advocates have a love-hate relationship with prepaid cards. The cards help the estimated 60 million Americans who, either by choice or circumstance, don't regularly use bank accounts and instead depend on costlier check-cashing services and payday loans. Yet fees add up quickly and are painful for lower-income consumers. Earlier this month, the National Consumer Law Center graded all 40 states that use prepaid cards for unemployment compensation, noting 13 particularly "problematic" state programs that had heavy consumer fees.

Similarly, consumer advocates and the prepaid industry trade organization recently issued a set of 10 "joint principles" for prepaid payroll card fees. The industry says the increased consumer pressure, combined with more competition, means "fees are dropping and becoming more simplified in their structure," says Brian Triplett, Visa's head of prepaid products.

More prepaid programs are on the horizon. The number of workers receiving prepaid payroll cards from their employers will double to 5.4 million by 2014, according to estimates by market research firm Aite Group. And the federal government is embracing the approach. This year the Treasury Dept. ran a pilot program to put tax refunds on prepaid cards. Starting in May, new Social Security recipients must choose between direct deposit or prepaid cards from Comerica Bank (CMA), retiring the paper check entirely.

The bottom line: Prepaid cards may help banks replace some of the estimated $25 billion in revenue they will lose to debit and credit card reforms.

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