Regulation Comes to Prepaid Cards
How do you get by in today's economy without a bank account? Americans who are living paycheck-to-paycheck may choose to avoid banks because of the potential for fees, overdraft charges, and ATM access concerns.
Prepaid cards offer a viable alternative to these consumers, and such cards are growing in popularity. A study by the Pew Charitable Trusts found that 45% of prepaid card users choose prepaid cards to avoid bank overdraft fees and 27% of those who regularly use prepaid cards do not have a bank account at all.
However, due to the limited regulation of these cards, consumers can end up paying more in fees than the bank charges that they were trying to avoid. Further, these cards do not provide consumer protections similar to bank accounts and/or credit cards — but thanks to the Consumer Financial Protection Bureau (CFPB), they will by this time next year.
The CFPB recently issued their final rule on protections for users of prepaid accounts, covering more than just traditional prepaid cards and reloadable cards. These rules also apply to mobile wallets like Venmo and Google Wallet, person-to-person (P2P) payment platforms, tax refund cards, payroll cards, cards for student financial aid, and some government benefit cards. Exclusions include gift cards that are "marketed and labeled" as such, merchant-specific store cards, and loyalty/promotional rewards cards.
Card providers have until October 1, 2017, to make their products compliant — although some worry that the products may disappear instead.
Industry Growth Outpaces Regulation
The prepaid card industry has grown dramatically in recent times. General-purpose reloadable prepaid cards grew from a less-than-$1-billion industry in 2003 to almost $65 billion by 2012. The industry is expected to reach a total loaded-dollar value of $112 billion by 2018.
Meanwhile, the industry's protection and regulation has not kept up with growth. With minimal rules on disclosure, some consumers have been caught by surprise with how much their prepaid cards cost them in the end and how few protections were included. The CFPB action aims to help these consumers, especially those who are not in an economic position to handle the extra expenses.
The new rules that go into effect include free access to account information (or periodic statements as with traditional accounts), $50 liability limits for unauthorized transactions on lost or stolen cards when loss or theft is promptly reported, fee disclosures in easy-to-read standard forms, and credit protections similar to those of traditional credit cards.
Blurring the Lines
Why would prepaid cards need credit protections? Overdraft protection is the reason. From the consumer standpoint, protection against overdrafts on your card is an obvious positive — until you realize that overdraft protection is effectively a line of credit. Since your credit risk is never evaluated in acquiring a prepaid card, the card issuer may assume you are high risk and apply disproportionately high charges to compensate.
CFPB's new rules mandate that prepaid card companies evaluate a consumer's ability to pay debts before offering credit. CFPB also requires a 30-day waiting period after a new account is registered before credit features may be offered to the consumer at all.
If card issuers do extend credit, monthly billing statements are required, late fees may not be charged before 21 days past the due date, and fee and interest charges are subject to limitations. Card issuers will see lower fee income and increased costs. New rules also create a wall between prepaid funds and credit repayment, meaning that a reload of prepaid funds can't be automatically seized and applied to the credit balance.
Card issuers' reactions are predictably negative. However, there are legitimate points to be raised. The president of the Network Branded Prepaid Card Association, Brad Fauss, considers the categories to be too broad. Fauss points out that protections are reasonable for a reloadable card do not make sense for a one-time non-reloadable card offer. Currently, CFPB does not make that distinction.
Fauss adds that the need to underwrite credit will make it "more challenging to offer the product" and limit consumer choices. Card issuers will adjust as needed to both make money and meet regulatory requirements. Ultimately, will prepaid reloadable cards eventually morph into traditional debit cards or secured (prepaid) credit cards? If there's no difference, will there be enough offerings to meet the needs of all consumers?
At this point, nobody can say — but somebody has to service the riskier low-income market and make enough money at it to survive. Otherwise, these marginalized consumers may be forced from the poorly regulated market into a completely unregulated one, aka loan-sharking or the equivalent.
Technical Glitches Remain
One troubling aspect of prepaid cards is not addressed by the new rules: concerns about system failures that effectively cut off access to funds without any action from the consumer. Earlier this year, RushCard ended up paying $19 million to resolve a lawsuit brought by cardholders after computer problems cut people off from their money for several days. In May, Walmart's MoneyCard suffered similar glitches that temporarily restricted people's access to their accounts.
While the rule does not directly address these issues — and in fairness, that would be difficult to do through regulatory means — it does give regulators a few more tools to hold companies accountable for their technical concerns. Assuming that viable alternatives for consumers remain, the market should take care of the rest.
Prepaid cards seem likely to following the path of payday loans and other financial targets of the CFPB: an industry that serves a financial niche but has some predatory tendencies is reined in by regulation. Consumer advocates hail it as a great step; critics argue that it will restrict access to people who need the services the most and drive them into even riskier practices. Usually, both advocates and critics turn out to be partially correct.
The prepaid-card industry may be correct that fee limits and protection mandates could distort the industry or drive it into irrelevance. Prepaid cards are not bank account debit cards or credit cards, and they aren't intended to be. Markets can dictate the proper fees to stay in business as long as there is proper disclosure and reasonable alternatives.
It's hard to argue against the disclosure component of the CFPB rule. We advocate educating consumers about the potential downsides of any financial product in order to make a more informed decision. In turn, as a consumer, you must remember that there's always a reason behind any good deal or inexpensive service. What's in it for the company and how do they stay in business?
There will be tradeoffs to offset service costs and market risks. Find those tradeoffs. If they don't affect you disproportionately — for example, the cash withdrawal fees are high but you rarely withdraw cash — great! You have found the best product for your needs.
The bottom line: look over the fine print of any deal before you take it and understand the potential downsides of taking that deal. For prepaid cards, the CFPB will be effectively making that fine print available to you. It's up to you to use it.
If you want more credit, check out MoneyTips' list of credit card offers.