Everyone into the next shadow banking system

September 19, 2011

By Barbara Kiviat

Consumer advocates have been worrying for a while now that the rapid rise of reloadable prepaid cards will lead to a two-tier financial system. There will be folks with bank accounts, and then there will be folks with prepaid cards.

Prepaid cards, which consumers (or their employers) load with money for debit-card-like spending, may  seem like the perfect solution for the 17 million American adults without a bank account—no carrying around wads of cash, no pesky check-cashing fees—but prepaid cards are hardly little angels. They often come with significant fees, including ones to use ATMs, to put more money on the card, and to close out the account. Plus, they tend not to have handy devices, like account statements, that people with bank accounts rely on.

This has led to calls to more closely regulate the industry.

One of the biggest issues is that, unlike bank accounts, prepaid cards don’t necessarily come with FDIC insurance or the protections of the Electronic Funds Transfer Act. To be clear: many prepaid cards do carry “pass-through” FDIC insurance, and some prepaid cards do fall under Reg E, thus carrying consumer protections like limited liability for lost or stolen cards. But the regulation of prepaid cards is patchwork, much of the compliance is voluntary, and consumers are almost certainly not shopping around based on which cards are covered. In many cases, consumers wouldn’t get to pick which card they use anyway, since their employer or government is the one putting money on the thing.

Typically, when people talk about these facts, the conversation is framed as being about the “unbanked,” the low-income, or those out of the “financial mainstream.”

But maybe it’s time we think a little more broadly about prepaid cards.

Since signing up to guest blog while Felix is on vacation, I’ve started doing things like reading wire stories about what MasterCard executives have to say to investors. This Dow Jones piece provides the following nugget:

MasterCard also is pushing its prepaid card business to spur growth.

Prepaid cards, which traditionally have been offered to low-income or “underbanked” consumers, are also a focus.

Increasingly, interest in prepaid cards “will be driven by banked consumers looking” to divide up and budget their spending, Murphy said.

In other words, prepaid cards are on their way into the financial mainstream.

The MasterCard execs point out a demand-side reason for the expansion: using a series of prepaid cards can be a useful way to set aside different pots of money for different uses. It’s mental accounting come to life. I’ve heard about people doing this—even buying prepaid cards specifically to store them away as savings—but I’m guessing what will have much more of an impact on the size and reach of the prepaid industry is the insane marketing muscle of firms like MasterCard.

Anyway, none of that is necessarily bad. Fifty years ago credit cards were the new kid on the block, and 30 years ago hardly anyone was using an ATM. New financial products can be useful, even life-changing.

But there are real reasons why current mainstream products typically come with substantial consumer protections. If the future is one in which we’re all using prepaid cards, perhaps more than those looking out for the “unbanked” should be paying attention.

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