Prepaid and Credit: not as incompatible as you think

For Consumers, One Product = One Service

I learned from my days in the Consumer Electronics industry that most hybrid or combination products don’t make sense. For example, while well over 90% of people who have a TV also have a DVD or Blu-Ray player, nobody would buy a combination TV set + DVD/BR. Even when TVs used to be big and fat and had room for a built-in VCR, TVs with built-in VCRs stayed unsold on store shelves.

This is because consumers associate one device with one function: watching TV is not the same as watching movies, even if  the same screen is being used technically.

Granted, today’s smartphones look like the Swiss-army knives of consumer electronics, but they are really a whole new category of personal companions built around a new type of interaction not inherited from prior devices: the touch screen.

Swiss Army Knife CardPlastic or Plastic? The Seeds of Confusion

Consumer confusion is a terrible thing in more than one way: it can even hurt people. This is exactly the point that the Consumer Financial Protection Bureau is making when writing up 100’s of pages of proposed rule making about credit being extended out of prepaid cards through overdraft facilities. A credit card looks exactly the same as a prepaid card: a very standardized rectangle of plastic. The only difference between the two is that the prepaid card has the word “debit” printed on its front. And just to increase the confusion, why “debit” when it should really say “prepaid”? And why offer prepaid cardholders the option to run a transaction through the credit rails anyways??

On the one hand, a prepaid card with no overdraft capabilities is a very safe product: nothing wrong can happen to the cardholder except the embarrassment of being declined for insufficient funds. On the other hand, a credit card can drive cardholders into more debt than they can afford and can damage their credit score. Unfortunately, everything about prepaid versus credit cards, from the physical device to the choice of credit versus debit network is prone to creating confusion in the mind of cardholders.

Prepaid Cards and Credit  Complement Each Other

Remarkably, prepaid cards and credit can be made to work together in a very powerful way and without confusing consumers: by either using prepaid cards as a precursor to credit or by using prepaid cards as a channel for credit disbursement and loan management.

Prepaid  As Precursor To CreditPrepaid as Precursor to Short Term Credit

Prepaid cards can be a stepping stone towards short term credit, in particular for people with no or thin credit files.

Under-banked people as well a Millenials and recent immigrants use prepaid cards as substitutes for checking accounts. A paper checkbook being the only thing missing from the best prepaid card accounts, when compared with regular checking accounts, people can deposit their salaries and tax refunds, pay bills, pay in shops and even set money aside in the built-in saving purses of prepaid cards.

For such users, prepaid card usage history can be leveraged in much the same way as checking account usage history to evaluate how much money people have access to, and how responsible they are in its management. Prepaid card usage can either be used in the underwriting process of granting a loan, or can be used to pre-qualify people with the best chances of success with certain types of loans.

For example, prepaid cardholders who have been able to set aside $300 in the savings purse of their prepaid card, and have organized the regular direct deposit of their salary in the card have significant chances of being approved for a secured credit card, if they agree to turn the $300 they had saved into the required security deposit for the credit card. Prepaid cardholders with recurrent direct deposits but without a savings “pocket” may be eligible for an unsecured loan of the kind provided by LendUp.

The loan product that prepaid cardholders may qualify for is completely separate from the prepaid card and does not need to be issued by the same financial institution.

The US Treasury is devoting a part of its recent Financial Innovations fund to researching how prepaid cardholders and safely by offered access to secured credit cards and what type of financial guidance will help them be more successful once they have been approved for a secured credit card. The project participants are Banking Up, the Consumer Federation of America, Payments Law and the Marketing and Consumer Policy Office of the George Washington University School of Business.

Prepaid As Disbursement for CreditPrepaid as Disbursement and Budgeting Channel for Short Term Credit

In the opposite direction, someone having been granted a short term loan could choose to receive the proceeds of the loan into either an existing or a new prepaid card, mostly for the purpose of separating the loan money from the rest of their finances and facilitate the management of the loan for its intended purpose.

People who open a savings account at the same time as a checking account are provably more responsible with their money than bank customers who don’t.

Oportun has disbursed $1.3B to more than 485,000 customers and is offering a prepaid card to their repeat customers as a way to help them better manage their loan money.

Even borrowers who are already banked benefit from being offered the option of receiving their loan into a separate prepaid card as it helps them keep their resolutions to use the money for specific goals.

Credit with Upstream or Downstream Prepaid

The industry has attempted so far to build prepaid with credit products by adding overdraft or other very short term lending options to prepaid cards. This has all the trappings of a two-in-one product that will confuse many customers.

Instead, the market should deploy credit with prepaid products, where a prepaid card is used either as a precursor to credit or as a vehicle for receiving the loan money. This will increase both the number of people who are eligible for good and safe short term credit, and the odds that they will be successful with the resulting loan.

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Prepaid is the new checking… Now what’s next?

Prepaid As Checking is a FoundationI think the prepaid card industry has reached a maturity plateau in terms of features, access, and acceptance. Products like H&R Block’s Emerald, American Express Bluebird, T-Mobile’s Mobile Money and our own UPside card are pretty good alternatives to checking accounts.

While you don’t get a paper checkbook with those cards, you can pay your bills electronically, and at least the Bluebird and the UPside cards offer paper checks on demand.

You can also deposit paper checks directly into the cards through mobile photo deposit powered by companies like FIS and Ingo Money or services like WalMart’s Rapid Reload.

Don’t get me wrong: prepaid cards still have a lot of growth potential. A majority of people who could benefit from them still don’t use them, mostly because they are not aware of their availability, or because they confuse them with one-time use gift cards. So, the industry has some work to do marketing the cards to the right people through the right channels. For example, under-banked employees who work for small and medium businesses generally do not have access to dedicated payroll cards; so the new generation of “prepaid as checking” has an important market to address among the 110M Americans who work for the 2M businesses of less than 1,000 employees.

Prepaid cards have the ability to upgrade most consumers out of the “cash only” economy by offering them a way to manage their deposits and payments electronically (and with paper checks for as long as paper checks will survive). So far so good.

What should the industry do now to bring consumers one or several more levels up in the world of banking?

Beyond prepaid: Savings and CreditAmong the several services that people need beyond deposits and payments, are at least 2 obvious ones:

  • Savings: the ability to set money aside for later
  • Credit: the ability to borrow some money

Neither of those two services are easy to deploy, in particular among those who need them most: low to moderate income (LMI) consumers.

Savings

Allowing people to set money aside for later is in fact technically easy: several prepaid cards already provide savings “purses” or sub-accounts. Others offer a separate but easy to open savings account.

What is difficult is to motivate people to save, especially when they live paycheck to paycheck and don’t have much to save at all. Current interest rates are so low that the interest accumulated at the end of the year is just a few dollars or even less for most people.

Research is being conducted by the likes of Doorways to Dreams to “gamify” savings: this consists of combining the act of savings with some fun, challenging and rewarding activities other than just accrued interest. Financial fitness games, sweepstakes, contests… are all options being explored. SaveUp is a good example of savings gamification.

Credit

Credit is even more difficult: prepaid cards cannot help build up credit files and credit scores because they are just a deposit instrument.

Very short term loans from payday lenders and pawn shops are easily accessible to prepaid cardholders with no credit history, but they are costly and don’t usually build credit scores.

Alternative (to FICO) credit scoring services that rely on “Big Data” tend to have a market ignition problem, because they are of little use to creditors if few borrowers use them, and of little use to borrowers if few creditors consult them. While the law requires creditors to consider all available credit scores, the market reality is that the FICO score is still indispensable for the vast majority of consumers, while the recent interest in Big Data based scoring has not yielded practical scalable products yet.

Un(der)banked people eagerly seek credit cards because they do build up mainstream credit files and scores by reporting to the top 3 Credit Bureaus. However, the standard qualification criteria for mainstream credit cards are ill-suited because they rely on the very same credit scoring system they contribute to.

Here is how we think access to credit can be provided to prepaid cardholders:

  • use the savings that users of certain prepaid cards have been able to set aside as the security deposit  for a secured credit card
  • use the history of prepaid card transactions as input data for the underwriting decision, to evaluate the creditworthiness of the cardholder

Secured credit cards are not very widespread but they require little of no prior credit history and they do report to the 3 main credit bureaus.

Eligible people would end up with two cards in their wallet:

  • The prepaid card available as a ‘safe to spend’ instrument for everyday purchases.
  • The secured credit card to be used very carefully as its bill will come at the end of every month. When handled within the intended rules, the card starts contributing to the user’s FICO score.

In summary, the prepaid card industry has the opportunity to “graduate” its customers into savings and credit services, by using prepaid cards as a foundation. This is a bright and promising future.

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Pursuing Quality Innovation in the Prepaid Card Industry

Compass Advisory Note on Prepaid Quality Innovation

The Center for Financial Services Innovation has just published its Compass Advisory Note about pursuing quality in prepaid cards. It features NetSpend and Banking Up as early adopters of the Compass Guide to Prepaid.

The Compass principles have helped Banking Up prioritize its pipeline of technical and operational developments: we have brought to the front of the line those developments that would have the most immediate impact along the Compass Principles.

We looked at our pipeline of future product development items and identified those that would have an immediate impact on improving consumer trust. At the time, we were:

  • Building a new mobile app,
  • Reconfiguring our live Customer Support service,
  • Trying to optimize our online customer acquisition,
  • and we wanted to improve our online self-help system.

We took each of the above topics and looked at how we could deploy them in the way that was the most consistent with the Compass Principles.
For example, we started by simply including in our mobile app a button that would immediately display all the fees in a box formatted as suggested by the Compass Principles.
We switched vendors for our Customer Identification Process and chose a solution that minimized the need to escalate to faxing or scanning paper documents, because many applicants don’t have easy access to faxes or scanners.

Some of the things we planned to do have proven more challenging than others. For example, we had under-estimated the amount of effort needed to improve the education & guidance intended to help customers understand the product and optimize its use or minimize the fees.
We have planned to create an interactive contextual help system to replace our FAQs and to produce a number of simple “how to” videos. We still have not deployed those items because they require a lot more content production work than we had anticipated.

Overall, our advice to those who want to use CFSI’s Compass Principles in Prepaid would be to consider this first and foremost as a “consumer trust building” initiative.
Ask yourself what changes you can make to your product and operations that will result in consumers trusting you and your service more than they would otherwise. Whatever the size of our organization, this is a simple criteria to apply, and potential detractors inside your organization will have a hard time fighting this because no one can be seen siding against increasing consumer trust.

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In New York Times, Prepaid Fee Story Misses The Mark

Fees?In yesterday’s New York Times story Paid via Card, Workers Feel Sting of Fees, reporters Jessica-Sliver-Greenberg and Stephanie Clifford raise an important question but fail to answer it: are a significant number of employers forcing hourly workers to use expensive payroll cards?

The three key conditions here are “significant number,” “forcing” and “expensive”. If these conditions are true, this clearly is a front-page size problem. But I can’t find a single concrete example in the story of an employer that forces employees to use expensive payroll cards as an only option.

Instead, the story smears by implication all payroll prepaid cards by naming a couple of outlier fees. And it implicates major retailers like Taco Bell, Walgreens and Wal-Mart up high, only to emphasize later in the story that these companies offer their employees payroll cards as one choice out of several, not as an only option. The story also fails to examine whether these companies’ payroll cards have expensive fees for common uses. I am familiar with the Wal-Mart prepaid card programs. They are known in the industry as some of the most cost-effective accounts available to consumers.

The problem with a story like this is it sows mistrust without adding relevant information for the people who are most impacted: the underbanked.

What would be more helpful? For one, show an actual fee table for a card like the JP Morgan Chase payroll card so readers can see if it is expensive for the way they bank. Then compare those fees side by side with a more affordable prepaid program, a checking account and the cost of relying on check-cashing stores and money order services. Base everything on someone whose annual income is below $25,000 and whose average monthly account balance is below $500.

Also, explore alternatives. For instance, ATM fees are complicated because there are multiple networks involved in different ATMs. It’s unclear whether the charges are from the payroll card program or the ATM network. But most prepaid cards let consumers get cash back for free at the grocery store. People like Krystal McLemore in the Times story who like to get smaller amounts of cash out more frequently can avoid fees altogether by skipping the ATM and using the free cash back features.

For broader context, mention that groups like the Center for Financial Services Innovation (CFSI) have published a set of principles – the Compass Principles – and that consumers and employers may want look at and prioritize card programs that subscribe to these principles.

And perhaps point to the Consumer Financial Protection Bureau’s Project Catalyst program, which has a major initiative to research how the underbanked use features on the more advanced prepaid programs to do things like avoid high-interest payday loans.

 

I wouldn’t expect New York Times journalists to be experts in the payments industry or underbanked consumers. But if the story is about how employers are forcing employees to use expensive payroll cards, I would expect good reporting to uncover specific examples and additional reporting to provide high-quality data and context to put the problem in perspective. Finding a few people to say they’re upset and citing the general growth of prepaid cards as a proof of the problem’s scope just places all payroll programs under the same umbrella and paints them with a black brush.

The lack of specific examples, quality data and thoughtful context turns this into a “he said she said story” that no doubt gets people excited and drives clicks but that is more likely to confuse than help the impacted audience.

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Prepaid is The New Checking (with help from your cellphone)

Did you notice? After years of being two separate product lines, prepaid card accounts and checking accounts are merging into a single new offering:

  • American Express calls Bluebird “The Checking & Debit Alternative by American Express”
  • Simple‘s tag line is “Worry-Free Alternative to Traditional Banking”
  • GoBank‘s pitches itself as “A New Kind of Checking Account”
  • … and of course, at Plastyc, we have had UPside and iBankUP providing “The Power of a Bank Account in a Phone” for a few years now

All the above products are built from a prepaid card foundation, with multiple add-ons to expand their usefulness, not the least of which is a mobile application that turns customers’ smartphones into mobile checkbooks.

The convergence comes after a number of changes in best practices, regulations and innovations for prepaid cards:

  • FDIC “pass-through” insurance applies to individual prepaid card accounts
  • Prepaid cards are routable via ACH allows direct deposits and bank transfers
  • Cards able to receive federal funds have Reg E consumer protection
  • On-demand paper checks enable payments to anyone
  • New services like Walmart’s Rapid Reload™ allow cashing checks directly into cards at low costs
  • Mobile Remote Deposit Capture allows depositing of paper checks 24×7

This results is an all-around equivalence between checking accounts and prepaid card accounts, from a consumer stand-point.

Phone + Prepaid Card Equals Checkbook

Even major market players like H&R Block are deploying prepaid-based financial services that provide a full-blown replacement for a checking account: look at the Emerald Card, which is now available with optional access to a line of credit product called Emerald Advance and a Savings accounts

How should banks react to this new market reality? I believe they should think hard about introducing “prepaid as the new checking” if they want to serve more customers at a lower cost.

Below is a set of slides that I am presenting to Financial Institutions during a webinar hosted on January 31 2013 by Andera, to explain how to leverage prepaid cards to deliver checking account services to everyone:

 

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