Why prepaid debit needs deregulation

By Felix Salmon
October 11, 2012
John Kiernan wrote up an excellent list of the pros and cons of the new Walmart/Amex Bluebird debit card. And one of the cons took me by surprise:

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On Tuesday, CardHub’s John Kiernan wrote up an excellent list of the pros and cons of the new Walmart/Amex Bluebird debit card. And one of the cons took me by surprise:

No Automatic Loading of Federal Benefits: Recipients of federal benefits such as Social Security, a federal pension, or VA benefits won’t be able to have them automatically deposited into their Bluebird Prepaid Card accounts.

The whole point of prepaid debit cards in general, and of the Bluebird card in particular, is to help bring checking-like financial services to the unbanked and underbanked. In turn, the main source of income for many of the unbanked and underbanked is federal benefits. It just doesn’t make sense to put out a prepaid debit card and then to say that it can’t be used with federal benefits. So what’s going on?

The answer, it turns out, is something called 31 CFR 210.5 (b)(5)(i): “Where a Federal payment is to be deposited to an account accessed by the recipient through a prepaid card”, says the statute, the account has to be at an insured institution, and it has to have FDIC insurance.

The government is OK paying out benefits onto prepaid debit cards, be they its own card, Direct Express — which has 3.6 million users — or someone else’s, like the new Liquid card from Chase. But if the money’s going onto a prepaid card, that card account has to be FDIC insured. Direct Express, like Bluebird, has no monthly fee, which is great, but it also isn’t reloadable by the consumer: only the government can add new money to it. I should just Venn this, maybe?

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I’ve put Simple in the middle, there, because it’s the only solution which covers all the bases — it has no monthly fee, it’s FDIC-insured, and it’s reloadable by the consumer. But good luck getting a Simple account: the waiting list is long, and for the time being you need to have an iPhone. What’s more, people who get federal benefits aren’t exactly a huge proportion of Simple’s young, tech-savvy customer base.

I should note here that all of the options in this diagram are attractive on their own terms; it’s also no coincidence that three of them — Bluebird, Simple, and Liquid — are very new products. The world of prepaid debit cards is evolving very quickly, and if you have an old card, there’s almost certainly a newer card out there which is better. Bluebird and Liquid both go to great lengths to solve the biggest problem with most debit cards, which is that it can be very hard and expensive to reload them when you come into some money: Liquid can be reloaded at any Chase branch or ATM, and Bluebird at any Walmart, for free.

What I worry about, at least a bit, is the way in which Bluebird is being left out in the cold when it comes to the direct deposit of federal benefits. It’s a worthy competitor to Liquid and Direct Express, and it should be allowed to compete on a level playing field. Bluebird, of course, can compete on price. And Liquid can compete on the fact that it’s offering a full-on relationship at Chase, complete with teller access, as well as on the fact that its Mastercard is accepted at more places than Bluebird’s American Express. Certainly if you compare Bluebird to Direct Express, Bluebird looks like a significantly better option, assuming you’re OK with not being accepted at a few Mastercard-but-not-Amex places.

But instead of that kind of vibrant competition, Bluebird is not being allowed onto this particular playing field at all.

Is it reasonable for the federal government to effectively prevent the recipients of federal benefits from getting those benefits deposited directly onto their Bluebird cards? I suspect it probably isn’t. American Express is a trusted vendor: the money on your Bluebird card is just as safe as the money in your American Express travelers checks — and that money has been perfectly safe since they were first introduced in 1891. What’s more, under current money-transmitter regulations, Amex keeps all the money on Bluebird cards in highly liquid form, ringfenced so that it can’t be used for anything else. There are perfectly reasonable reasons not to get a Bluebird card, but lack of FDIC insurance really isn’t one of them.

But that isn’t to say that Amex is some kind of victim, here. After all, American Express owns a very large bank, called American Express Bank, where all deposits are FDIC-insured. If they wanted to, they could have made American Express Bank the issuer of the Bluebird card, rather than American Express Travel Related Services Company. But if they’d done that, there would have been at least two substantial downsides for them.

Firstly, they would have had to start paying into the FDIC insurance fund. Amex won’t reveal how much it pays for FDIC insurance, but that’s certainly an expense which Liquid has to pay and Bluebird doesn’t. More importantly, because American Express Bank has more than $10 billion in assets, it’s covered by the Durbin Amendment, which allows prepaid debit cards to charge premium interchange fees — but only so long as the physical card itself is used in every transaction. As a result, Liquid can’t offer things like online bill-pay, which Bluebird does offer.

Big banks, then, are at a significant disadvantage when it comes to the prepaid space: while companies like American Express Travel Related Services Company can offer cards with bill-pay, because they’re not banks, and while companies like Simple can offer cards with bill-pay, because they have less than $10 billion in assets, companies like Chase cannot offer cards with bill-pay, because they’re both banks and big.

I very rarely favor financial deregulation these days, but this is one area where I do. The more competition there is in the prepaid space, the better prepaid cards become for consumers: that’s clear. And in order to encourage competition, it makes sense to lose two different regulations. The first is 31 CFR 210.5 (b)(5)(i): the federal government should be able to pay benefits onto any approved debit card, whether it’s FDIC-insured or not. I don’t have a simple criterion for which cards should get approval, but in general, if there’s basically zero counterparty risk on the part of the cardholder, then the card should be OK. After all, for years the government was happy mailing out paper checks using the US Post Office, and that was much less reliable as a payment mechanism than a direct deposit onto a Bluebird card.

And secondly I think that big banks, including Chase, should be allowed to offer prepaid cards on the same basis that small banks like Simple can. Ban the practice of charging overdraft fees on prepaid debit cards — which none of these cards offer in the first place — and say that if you’re offering a prepaid card rather than a fully-fledged checking account, then you can still charge the higher prepaid interchange rates.

I’ll admit that the distinction between a prepaid card, on the one hand, and a checking account, on the other, can be a difficult one to discern; Simple, for instance, has elements of both. But if you can write checks on an account, then it’s clearly a checking account; and similarly, if you can transfer money easily from one account to a different one at the same institution, then that looks very much like a bank account as well. More generally, there aren’t all that many banks with assets over $10 billion: there are few enough, in fact, that regulators ought to be able to have a quiet word with them and say listen, we’re doing you a favor here, so don’t try any silly business about reclassifying vast numbers of checking accounts as prepaid debit cards en masse. If someone with a bank account would prefer a prepaid card instead, they’re going to have to close their bank account and open up a debit-card account.

With those two changes in place, a third change would become possible: the federal government could start giving benefits recipients a real choice when it comes to debit-card direct deposit. At the moment, while it’s theoretically possible for people to get their federal benefits directly deposited onto their debit card, in practice it’s vanishingly rare, because the government pushes the Direct Express card quite hard, and says very little about alternative options. But if a number of cards like Bluebird and Simple offer all of the benefits of Direct Express and many more on top, then it seems churlish of the government to steer millions of Americans away from those cards and towards Direct Express instead.

Still, first things first: in terms of sequencing, the sensible place to start here is 31 CFR 210.5 (b)(5)(i). Right now, the federal government is basically making a public pronouncement that the Bluebird card isn’t safe, that it doesn’t trust American Express to look after cardholders’ money, and that people receiving federal benefits shouldn’t have those benefits paid onto the Bluebird card. I see no good reason for those pronouncements to be made, and to weight the scales so strongly in favor of FDIC-insured card issuers. Anybody who wants FDIC insurance, of course, can have it. But if you don’t want it, I don’t see why the government should try so hard to force you to have it anyway.

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