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Banking the Unbanked--Government-Sponsored Prepaid Cards?

posted by Adam Levitin

Blogging about the RushCard has me thinking.  Prepaid debit is filling a market need for financial services (payments and safe-keeping) for the unbanked.  But prepaid debit products are often as predatory in their pricing as check-cashing outlets.  So two questions.  

First, why isn't this market working better?  That is, why isn't competition pushing out the bad products and lowering prices?  This can't be a credit-rationing or red-lining story, as there's no credit (and almost no risk) involved with a prepaid product.  

And second, is this market isn't working, what role for government?  There are lots of ways to respond to market failures, and a lot depends on identifying the nature of the market failure.  But one option, when the private market isn't working, is to spur it along with public competition.  To this end, it's worth considering the possibility of government-sponsored prepaid debit cards as a means of providing low-cost basic financial services access (payments and safe-keeping) to the unbanked (who are generally low-to-moderate income (LTMI) consumers.  

Payment systems are the infrastructure backbone of commerce; we should want to ensure that all Americans have basic commercial access; it's no stranger to think of the government subsidizing payments than for the government to subsidize rural housing or rural broadband.  I think there's a case that since the private market is not providing low-cost access to basic financial services for LTMI consumers that government competition in that market is a reasonable policy response.  A low-intensity form of postal banking through prepaid cards could be a way to bank the unbanked.   

The government already transfers a variety of welfare benefits to consumers using prepaid debit--SNAP benefits (foodstamps), Social Security, state benefit programs, etc. But these programs are just using prepaid cards as a means of transferring funds to consumers.  They could be leveraged to achieve a broader goal of providing LTMI consumers with no-or-low-cost access to basic financial services like payments and safe-keeping of funds.  For this to work, entitlement programs would have to be combined with a reloadable, prepaid government-sponsored debit card.  

There would be a thicket of operational issues to work through for such a program, including the expense (I suspect that float income alone might be sufficient to fund a large-scale program with economies of scale) and then there is a conceptual question of whether we want a "public option" of this sort?  Do we think there is value in public-private competition? 

Comments

Who says the market isn't working in prepaid? Two years ago, the competition in the prepaid market was pretty thin, and products like the "First Vinyard card" or the "BuyRight" card were available, and charged really outrageous fees like $39 "activation" fees, and $2.50 transaction fees.

In the past 2 years there have been great, aggressive pricing reductions by cards like the Walmart Money Card, etc. Activation fees are typically waived by the better issuers, and many cards have no monthly fees.

At www.getdebit.com, we are compiling a database of all of the cards available (the full database is not available on the site yet). There are over 50 programs we have identified, and at least a dozen have fees MUCH less than a typical "starter" checking account.

Perhaps the US Postal Service could get into this business. Great distribution and convenient for load/re-load. Could even leverage their carriers as a walking salesforce for top-up, etc. Desperate need to add to product line-up and boost revenue. And in-store could offer all the same services as Wal-Mart money center (money order, bill pay, money transfer, prepaid). In other countries, postal services use financial services to drive additional revenues since there are lower mail volumes.

Prepaid cards are far from being predatory. The literate consumer can use these cards and spend less than $10 per month in fees. A small price to pay for access to the MC/Visa network, and the avoidance of the mainstream banking system.

The problem with these cards arises from the bulk of their customers not having the most basic understanding of how the cards function. Read the many complaints around the web, and the misconceptions jump right off the page. The cards are pretty simple, money in-money out. If the consumer has trouble understanding that, than there's few other financial transactions they're going to be able to understand either. Prepaid cards or otherwise.

There will likely be an increasing portion of the middle class using these cards. Many are fed up with the mainstream banks, and their constant gouging and invasion of privacy.

Another benefit of these cards is their relative anonymity. While no doubt, law enforcement with appropriate resources, could trace these cards in short order in a criminal matter, civil creditors enjoy no such luxury. Prepaid cards leave no trace on credit reports or other public databases. There is no brick and mortar location. The author mentioned in the previous "Rush Card" article, about the relationship between the card issuer and the bank. Now, if a judgment creditor is fortunate enough to locate a prepaid card of a debtor, how is he to proceed in garnishing the funds held in that account? With so many consumers having debt issues, the prepaid card is an element of judgment proofing and informal bankruptcy that should not be overlooked. There's more to these cards than meets the eye.

The entry of low margin firms like Walmart into the prepaid space has done a lot of good, but there are still plenty of prepaid products around with really bad terms.

Brent's correct that a savvy consumer can use prepaid with relatively few fees. But prepaid is not marketed primarily at the judgment-avoiding consumer; it's marketed at the unbanked consumer, who tends not to be so savvy. The benefits it has for those seeking to avoid judgments or law enforcement (can you say money laundering) are incidental. I think the cards are more anonymous than Brent suggests. I can go into a Walmart, buy a prepaid Visa in cash, and although my transactions on that particular card can be connected, they cannot be connected with me unless something else about the transaction identifies me (I give my name or a traceable IP address or a security camera films me).

As far as judgment proofing goes, I'm not sure that prepaid is foolproof. Brent's comment makes me think that a standard part of collection discovery should be inquiring if the defendant has prepaid cards and, if so, getting a turnover order.

Having just completed a survey of prepaid card users at my organization, I agree that this product has a lot of potential. However, it’s not a cure-all for unbanked issues. While the market has become more competitive, it is still opaque and hard to shop between cards. Also, cards are becoming increasingly complex, countering the simplicity that originally made them attractive. Finally, if the government got into the business of providing these cards, there would need to be a serious conversation about graduation. Prepaid debit cards are interesting as a pre-banked strategy, but without a mechanism of transferring people into mainstream systems it would only serve to further their isolation.

I think we must differentiate between gift cards and debit cards. Walmart sells them both. One is embossed with your name, one isn't. The Rush Card and those similar being discussed, are debit cards. They function like checking accounts, without the checks. In other words, you pay your bills with MC/Visa instead of checks.

The judgment proofing aspect does not arise from secrecy, nor illegality. It arises from the difficulty in locating and garnishing out-of-state bank accounts. Essentially, debit cards are out-of-state bank accounts. Without the trail of bread crumbs.

The reference to money laundering is inappropriate. Unless you think a military pension needs to be laundered. The debit card exist to prevent surprise attacks on exempt funds, which judgment creditors do routinely on local bank accounts. As for a debtor's exam, the funds on the card are traceable to an exempt source. The author's imagination is running way too freely as it pertains to my previous post.

Brent's point about distinguishing between personalized and nonpersonalized debit product is fair; part of the problem with discussing this topic is that the terminology has not completely coalesced. So to be clear, what is often called a gift card (meaning a prepaid debit card that is not personally identifiable to a specific authorized user--basically a bearer card) opens up money laundering possibilities; a personalized debit card of any sort does not. I think the technical distinction is whether there is an "account"; if there's an account, then know your customer rules apply, which frustrates money laundering. (Given the definition of account in the USA Patriot Act, I'm surprised that know your customer rules aren't applied to general purpose gift cards).

I'm not following the judgment proofing point, however. I get that it is a lot harder for creditors to locate and garnish a prepaid debit account. But if the funds are exempt because of their source, then what's the benefit of a prepaid card? To commingle exempt and nonexempt funds without losing the exemption? Just to avoid the hassle of a wrongful garnishment? Or something else?

It's something else. Ever hear of a company named ChexSystems? Once in their database, it's next to impossible to get any type of an account with a mainstream bank.

"I suspect that float income alone might be sufficient to fund a large-scale program with economies of scale"

Using float income to cover the costs of such a program would present a challenge. The deposit balances from governments right now are being utilized to cover existing expenses for bank services with very little if any left over. The value of balances/float to any financial institution is based on market rates and given that they are rock bottom now, an alternate source would be needed to fund the card program.

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