Why Surging Prepaid Cards for Unbanked Is a Positive

WASHINGTON — A recent Federal Deposit Insurance Corp. report about the unbanked is shedding light on the potential for prepaid cards to be a gateway product for entering the banking system.

The FDIC survey said prepaid card use among the unbanked skyrocketed last year, stoking concerns that some consumers are still being steered into high-cost alternatives to bank accounts. But some experts on unbanked issues see a silver lining. They note certain prepaid products used by the underserved are actually provided by banks, mirror features of traditional accounts and could therefore be a bridge to more sustainable banking relationships.

"Banks have made more of an effort to reach out to people," said Ben Jackson, who directs the prepaid advisory service for Mercator Advisory Group. "Either they are creating products that mimic the traditional unbanked products or they are using those products to get people in the door and then moving those people into bank accounts."

The survey, which the FDIC conducts every two years with the U.S. Census Bureau, found that 22.3% of unbanked households last year said they had used a prepaid card in the previous 12 months compared to just 5.3% of fully banked households. (Overall, the unbanked dropped half a percentage point between 2011 and 2013 to 7.7% of U.S. households, with the decrease largely attributed to improving employment numbers.)

In 2013, over 27% of unbanked households reported having ever used prepaid cards, which was higher than both the 17.8% reported in 2011, and 12.2% in 2009. Of those households that had used a prepaid card over the previous year, 79.4% reported relying on the cards for services traditionally facilitated by banks, such as everyday purchases, paying bills and receiving payments. That is compared with 37.6% of fully banked households.

"The bad news is people are spending their money to manage their money," said Jonathan Mintz, president of the Cities for Financial Empowerment Fund, which works with municipalities to help the underserved access mainstream financial services. "There are more and more cards. Some of the very worst of them … have luckily gone away but for the most part I think it still really bad news."

But the flip side of that, he said, is banks are trying to compete for prepaid business with products that may be more beneficial to consumers.

"Increasingly there are card based products coming from financial institutions that are trying to learn from the success of these prepaid cards," Mintz said. "They are going after them with prepaid products that appear to mirror some of the bad prepaid cards out there but do it in a better way."

Some observers say a targeted effort by banks to create alternative products geared towards people on the fringes of the financial system has the potential to improve banking access.

Jennifer Tescher, president of the Center for Financial Services Innovation, said prepaid cards have evolved dramatically and can provide a lot of the same services that a traditional demand deposit account does.

"Prepaid is an incredibly powerful access tool," she said, adding, "There is a lot of potential to use prepaid as an onramp to more significant engagement."

Last year, a blue-ribbon FDIC panel that looks at unbanked issues heard from banks about their specific prepaid card products. For example, a presentation from a JPMorgan Chase banker said 69% of the institution's Chase Liquid card users had no prior customer relationship with the bank before signing up for the card. Of those users, 48% fell into categories of either never having had a bank account, not currently being banked or having limited access to the banking system.

However, according to the FDIC's definition of being banked, having a prepaid card issued by a bank would not qualify someone as being banked unless they had a checking or savings account that was associated with the card.

"We are in a moment when we might want to question that logic," Tescher said of the FDIC's definition of being banked. She argued that prepaid cards are increasing in functionality and can even be a replacement or substitute to a traditional bank account.

Still, an FDIC spokesman noted that just 4.2% of unbanked respondents on the survey said they had obtained a prepaid card from a bank branch.

"Holding a prepaid card alone would not be sufficient to classify an individual as banked," the spokesman said. "To be counted as banked in our report, households need to hold either a checking or savings account … with an insured depository institution."

But Nessa Feddis, a senior vice president at the American Bankers Association, said defining someone as unbanked enters a gray area when the consumer is using a bank product.

The FDIC seems "to [consider] prepaid cards as a step child, but it is a good choice for someone who finds managing an account challenging and wants a simple solution, or for someone who is young and doesn't feel the need for a full service checking account," Feddis said. "And yet, [regulators] seem to think that is inadequate."

The ABA has also designed a prepaid product for its smaller members to provide, which is designed in part to get more people in the banking system. "We would consider it a bank account," Feddis said.

Lisa Servon, a professor of urban policy at The New School, said some lower-income consumers who use a prepaid card have made an informed decision after doing their homework on other financial services avenues that are available to them.

"The thing I try to be most careful about is assuming people don't know what they are doing, because what I found is most often is people do" know, said Servon, who has done research on payday lending and consumers living on the fringes of the financial system. "They have looked at their options and made the best choice. It's just a choice that often seems counterintuitive to those of us who have not been in that kind of financial situation."