How prepaid debit is displacing checking accounts

October 8, 2012

Prepaid debit cards just keep on getting better — ever closer, that is, to the holy grail of essentially replicating the free checking account of yore. Checking was never actually free, of course: it was basically a bait-and-switch, where people thought that they were getting free checking but then got hit with huge unexpected fees when they could least afford them.

But when hidden overdraft fees and the like were made illegal, and bank fees started becoming increasingly salient and obvious, the search for a checking-account replacement began. And there are two big ones: credit unions, on the one hand, and prepaid debit cards, on the other.

I’ve been a bit disappointed in the way that credit unions in general have responded to the new world of banking. As far as I can tell, most of them have been subdued and cautious when it comes to trying to poach customers from the big banks. And many of them actually opposed the Dodd-Frank law which did so much to protect consumers and to prevent banks from running up hidden fees.

For instance, Patrick Adams, the CEO of St Louis Community Credit Union, was a vocal opponent of the Durbin Amendment, laying out a parade of horribles that he was sure would come to pass were the amendment to be signed into law:

Here’s another surefire lock of a bet. You will be more frustrated than ever. Your costs at the bank will be up. Your costs at the retailer will be up. You will be confused as to which retailers accept your debit card and which ones don’t. You will have no clue what the minimums and maximums of your debit card activity will be because there will be no consistency among retailers. As a result, you will carry more cash and more checks.

I took his “surefire lock of a bet”, and eventually we agreed to settle it in July 2012, once the new law had been in force for a year. Adams sent me a grudging email in August, saying that although he would “pay the $100 to your credit union in the name of helping a fellow credit union do the good works of our industry”, he had also learned that he “will never again be lured into sharing information with someone I thought was an interested party from a credit union perspective to only have it placed as a topic for a blogger”.

The point here is that in many cases — see also my article about Missouri Credit Union — credit unions look and feel very much like banks, with the similarities far outweighing the differences. And so while credit unions are nearly always a better deal than banks, they’re generally not being nearly as aggressive as I would like in terms of trying to be a much better deal.

Meanwhile, prepaid debit cards have been improving enormously. Once upon a time they were nearly all rip-offs; now, they’ve reached the point at which they can start to be a real checking-account alternative, without the fees and the kind of haterage which almost all of us feel towards our bank at some point.

bluebird-chart_129940301332156543_293x483.pngThe latest card to hit the market is the Bluebird, from American Express and Walmart. The fee schedule, on the left, is very impressive, starting with the first line, a $0 monthly fee. American Express has had no-monthly-fee debit cards in the past, but nothing with the kind of distribution clout offered by Walmart.

On top of that, if you use this card as a checking-account replacement, then ATM withdrawals are free within the reasonably extensive MoneyPass network. In order to qualify for that, you need to sign up for some kind of direct debit, which is easy to set up from most employers, Social Security, and the like. We’ve seen this incentive to use direct debit in the past: Suze Orman’s Approved Card has pretty much the same thing, for instance. But it costs $3 a month — and, crucially, it’s expensive to reload if you try to put money on it through means other than some kind of bank transfer.

The Bluebird card, by contrast, can be reloaded with cash at any Walmart: pay for your groceries and put any money you have left over right onto your card. And the Bluebird card offers something else pretty revolutionary as well — you can even deposit checks into your account, for free, using mobile check deposit.

Being able to deposit money into your account for free is a key feature of checking accounts which prepaid debit cards have historically had a very difficult time replicating. This is one area where banks have a clear advantage over other prepaid debit-card providers. If you have a debit card from Chase or US Bank, for instance, then you can deposit money into your account at any of their branches or ATMs. But the bank cards have their own limitations: Chase doesn’t offer bill-pay, for instance, while US Bank doesn’t offer check deposit.

Interestingly, the loophole which is making all these prepaid cards possible is exactly the same as the loophole which prevents Chase from offering bill-pay. The Durbin Amendment to Dodd-Frank forced interchange fees on debit cards to come down substantially, while carving out an exception for prepaid cards. So Durbin allowed the prepaid industry to keep on growing — but because Chase is a big bank, it’s not allowed to offer bill-pay on its prepaid card, since at that point it would fall foul of the rules about the interchange fees charged by big banks on their checking-account debit cards.

One interesting thing about prepaid cards is that they’re easy to start up — and, by the same token, they’re easy to drop. People tend to use a single card for no more than a few months at a time — in stark contrast to the many years that they use a checking account. Especially if you’re moving from job to job, it’s as easy to just get a new prepaid card, most of the time, as it is to set up direct debit onto your old one.

Which helps explain why Green Dot shares are down almost 20% today. Green Dot used to be the exclusive provider of prepaid cards at Walmart; no longer. And given the choice, it makes very little sense to choose one of Green Dot’s cards over the Bluebird: the only real disadvantage that Bluebird has is that it’s an Amex card, which means that it isn’t accepted in as many places as Visa and Mastercard.

So expect to see Bluebird make some serious inroads with respect to the Green Dot user base — and expect, too, that Bluebird users are going to be less likely to graduate to a checking account than Green Dot users were. While most checking accounts offer a lot of things which you couldn’t get with a Green Dot debit card, that list is much smaller once you’ve got a Bluebird card.

The number of unbanked households in the US is rising — it’s now at 8.6% of all households, up 0.6 percentage points in the past two years alone. As prepaid debit cards become ever cheaper and more attractive alternatives to checking accounts, and as online startups introduce their own checking-account alternatives, that number is only going to increase.

But the economics here are interesting. I’ve spoken to a number of prepaid debit card issuers, including Chase Liquid and Suze Orman, and they all swear that there’s simply no way they can even break even unless they charge a monthly fee. But now Bluebird has joined Simple in giving out cards where pretty much everything is free, there’s no monthly fee, and you even have access to things like mobile check deposit which are still rare in checking accounts.

And what that says to me is that it’s going to be very difficult to compete as a pure prepaid-debit play, going forwards. American Express and Simple don’t need their debit-card arms to be profitable on a month-to-month basis: they’ve got their eyes on bigger prizes. That’s good for consumers, but it’s likely to mean that the universe of prepaid offerings is going to shrink. If you can’t offer something for free, or very close to free, then increasingly you might as well just not bother.


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