Community Banks Consider Offering Prepaid Cards

As prepaid cards grow in popularity, more community banks are eager to snag a piece of the action.

Most banks are dealing with stagnant fee income, tepid loan demand and low interest rates, but smaller institutions have been hit especially hard because of their heavy reliance on spread income. So, many community bankers are evaluating prepaid cards' ability to boost revenue, reach new customers and build stronger ties to existing ones.

"There are a lot of banks that are interested in prepaid cards," says Ben Jackson, senior analyst in the prepaid advisory service at Mercator Advisory Group. "Banks are trying to figure out if this business makes sense for them."

General-purpose prepaid card payments are the fastest growing noncash payment type, rising at a 33.5% annual rate from 2009 to 2012, according to last year's Federal Reserve Payments Study.

The prepaid card industry has "changed dramatically over the last year," says Kirsten Trusko, president and executive director of the Network Branded Prepaid Card Association. Product awareness has spread, technology has improved and prepaid card fees have declined, industry observers say. As a result, prepaid cards have become more appealing to consumers, including those who have checking accounts.

"Prepaid has expanded beyond just the underbanked or the unbanked," says Jim Collas, president and chief executive at OnBudget, which offers a prepaid card and related mobile app with budgeting capabilities.

"There's a lot of research out that there shows continuous growth in the prepaid market," Collas adds. "We think that growth is weighted toward bank consumers as they accept fees more and more and banks start to roll out more programs for prepaid."

Early on, the prepaid card business "got painted with a negative connotation" as some cards charged extraordinary fees, says Phil Valvardi, general manager of prepaid solutions at Fiserv. For instance, the Kardashian Kard, promoted by the sisters of reality television fame, was pulled just weeks after its 2010 launch after critics claimed its fees were predatory.

The prepaid card industry has changed since then. Other players have entered the market, which has led to a "compression of fees and costs," Trusko says. A 2013 study from Bretton Woods found that the average cost of a general-purpose reloadable prepaid card, with or without direct deposit, was cheaper than the average cost of a checking account. (A big cost driver for checking accounts is overdraft fees.)

Prepaid cards with high fees still exist. When a prepaid card costs more than another product, consumers may decide to use the more-expensive prepaid card because it is more convenient or offers more value for the money, Jackson says.

"There's a really weird paternalism in the critiques of prepaid," Jackson adds. "It would be a mistake to assume these customers don't know what they're doing or don't know how to make good financial decisions. Instead, what banks should understand is that people will choose a higher-cost option because it is more effective for them."

Smaller banks, as a result, are showing interest in the product. In addition, prepaid cards could offset declining revenue from the average checking account, Jackson says. Others view prepaid cards as a defensive play to keep customers from going to nonbank competitors, Valvardi says. 

Others view prepaid as an way to deepen ties to corporate and government accounts, Trusko says. For example, a bank could launch a prepaid card by promoting it to small businesses as a payroll solution. Such businesses could encourage employees who lack bank accounts to get their paychecks directly deposited onto a prepaid card.

Lead Bank in Garden City, Mo., recently launched a prepaid card to target small-business clients, says Kelli Buckner, head of the $108 million-asset bank's prepaid card program. Companies in areas like construction or trucking may find that loading paychecks onto a prepaid card provides convenience and helps employees get paid faster.

Lead Bank charges a fee for the card, along with a $3 monthly maintenance fee. A reloading fee is waived if the customer has a paycheck directly deposited onto the card.

Lead Bank views prepaid cards as a tool to recruit and retain small-business customers. The bank has renewed its focus on small businesses by launching other services, including a small-market M&A advisory platform.

"We're looking to expand how we serve our business clients," Buckner says. "We don't see this as an income driver.... It really is about expanding our relationships with small businesses. We are committed to providing all of the alternatives possible to these businesses."

As interested as community banks are in prepaid cards, many are reluctant to dive in, says Matt Schulz, a senior industry analyst at CreditCards.com. Challenges exist, especially for smaller banks. For instance, a community bank needs to gain scale to justify the investment.

"Everyone is a little nervous because the profit margins are pretty low," Schulz says. "When someone gets a prepaid card and doesn't use it for long, the lifetime value of the customers of that card makes it difficult."

Large players already exist, which could make it difficult for a smaller bank to sell prepaid cards, Schulz says. It can also be challenging to cross-sell other products and service to a prepaid card customer.

Bankers are also being more cautious about regulatory and compliance issues tied to new products, including prepaid cards. Regulators are encouraging banks to enhance monitoring of third-party vendors, and such pressure would also apply to any bank that outsources a prepaid program, Jackson says. The Consumer Financial Protection Bureau is planning to issue more guidance around prepaid cards later this year, creating some uncertainty for banks, Jackson adds.

Lead Bank hasn't run into any regulatory issues so far, Buckner says. "We've been busy getting the word out and explaining the benefits and making sure our marketing efforts have been effective," she adds.