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Law and Order in the Wild West: Parsing Prepaid Regulation and Recommendations

March 16, 2012
Personal Finance
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This has been a busy week for prepaid debit: the Senate Banking Subcommittee held a hearing on the prepaid market, and the Center for Financial Services Innovation released a model disclosure box aimed at promoting transparency. The Prepaid Card Consumer Protection Act, introduced by Senator Bob Menendez (D-NJ), winds its way through the Senate; the Consumer Financial Protection Bureau turns its gaze on this new product.

But what should disclosure mean for these products that occupy a nebulous position between throwaway purchase and primary financial product? Can the industry be trusted to regulate itself, or should Congress and the Bureau take an active role? Answering these questions correctly will bring security and stability to millions of Americans; answering wrongly will simply encourage exploitation.

A netherworld between banking and gift cards

Prepaid debit cards have thus far been less regulated than other financial products – consumers are often not shown the full cardholder agreement until they’ve already purchased the card. Although many un- and underbanked consumers treat prepaid cards as their main financial product, prepaid cards are sold alongside gift cards at grocery stores, without the careful consideration given to credit or debit cards. Yet for many who can’t or don’t want to use mainstream financial services, prepaid cards substitute for checking and savings accounts alike.

Susan Weinstock of the Pew Charitable Trusts, who spearheaded the organization’s model checking account disclosure project, noted that people choose prepaid cards because they fear incurring overdraft fees, because they want anonymity, and because they use the cards as a budgeting tool. Prepaid users are dissatisfied with banks’ hidden fees, confusing overdraft policies, and other unpleasant surprises. “People want to know all the fees upfront,” she said. But do prepaid cards possess the positive qualities they’re attributed, and are they a viable alternative to traditional banking?

The problem with prepaid

In our opinion, there are a few key issues that prevent prepaid debit cards from fulfilling their promise as a resource for the unbanked.

  1. Disclosure. The cardholder agreement is often tucked into the card’s packaging, accessible only after purchase. Some cards disclose all their fees on the package, while others disclose a small subset and still more disclose nothing at all.
  2. Insurance. Unlike debit cards, prepaid cards need not be FDIC-insured.
  3. Usage. Most prepaid cards are subject to spending and card value limits, but some are more cumbersome than others. One card allows the user to load only $2,500 a month – a small amount for a key financial product.
  4. Fees. While some issuers have simple, transparent pricing, others charge customer service, inactivity, account closure, and myriad other fees.
  5. Citizenship requirements. Most cards require some sort of identification, such as a Social Security number or passport. Some require proof of US citizenship. These requirements are not always disclosed upfront.
  6. Overdraft. The primary reason cited for using prepaid is the inability to overdraw on the card. Yet this is not always the case: some cards allow, and charge for, overdrafts in a manner similar to checking accounts.

How well do the Center for Financial Services Innovation and Menendez’s Prepaid Card Consumer Protection Act address these concerns?

Center for Financial Services Innovation: box and beyond

Earlier this week, the CFSI addressed the first issue: disclosure. They presented a model disclosure box designed to fit on a card’s package that highlights 14 relevant fees, acknowledging that to disclose all the fees would sacrifice much-needed clarity.

However, they stopped short of suggesting that the number of types or fees be restricted. “Prepaid cards would be more homogeneous, perhaps failing to meet the needs of certain underbanked consumers,” they argued. But that position undermines the disclosure’s effectiveness: if an issuer can charge any fee, or as many fees, as it likes, it can evade disclosure requirements by levying new charges. The CFSI disclosure box, for example, lists the activation fee but not the account closure fee. An issuer looking to get around the requirements could simply rename the account opening fee as an account closure fee, earning the same revenue but avoiding listing the fee. The proposed disclosure box would also exclude usage limits, registration requirements and overdraft policies, leaving the consumer vulnerable to unpleasant surprises.

But the CFSI recommended more than just a disclosure box. At a Senate hearing, president and CEO Jennifer Tescher advocated mandating FDIC insurance, adoption of a disclosure box, and the protections of Regulation E (such as allowing consumers to request paper statements).

The CFSI views prepaid cards as an important financial tool bridging the gap between mainstream banking and cumbersome, unsecured cash. They argue that while the cards are as important as checking accounts, they are fundamentally different products and should be regulated as such. They favor a lighter regulatory touch on the grounds that prepaid cards have much to offer consumers, and that while a small number of issuers may have high or hidden fees, the majority conduct themselves with integrity.

PCCPA: This is not the card I ordered

Senator Bob Menendez takes a less rosy view of the industry. His bill, the Prepaid Card Consumer Protection Act, would impose more restrictions than the CFSI suggested:

  1. Disclosure. The bill would require clear, conspicuous disclosure of all fees, along with a dollar figure estimating the cost to the consumer to allow for easy comparison.
  2. Insurance. All cards would have to be FDIC-insured.
  3. Fees. Menendez would limit the number and type of fees an issuer could charge, prohibiting per-transaction, inactivity, and account closure fees, among others.
  4. Overdraft. The bill prohibits accounts with “a credit feature,” which includes overdraft service, unless the issuer provided it free of charge.

An aide to Senator Menendez argued that prepaid cards deserve the same protections extended to credit and debit cards by the 2009 CARD Act. People would buy prepaid cards thinking them to be generic gift cards, then realize, “This is not the gift card that you’d buy for your kids as a present.” He noted that, ironically, gift cards are better regulated than prepaid cards.

Menendez makes fundamentally different assumptions about the prepaid market than does the CFSI. The CFSI assumes integrity among issuers, discernment among consumers, and imperfect communication between the two; Menendez assumes that many issuers are not making a good-faith effort to fully inform consumers, and that consumers need greater clarity than simple disclosure would provide.

Under this worldview, a consumer could not reasonably be presented with a CFSI-style disclosure box and still know that he’d incur an account closure fee. By limiting the number and type of fees an issuer can charge, Menendez insures that all information can be presented on the card’s package.

We tend to agree with the bill’s recommendations, for a number of reasons:

  1. Clear disclosure is a given, as there is little argument against empowering consumers to make more informed decisions. FDIC insurance should also be required, as prepaid cards often serve as substitute checking accounts.
  2. Enumerating permitted fees ensures that issuers will not evade disclosure regulations by charging new, unregulated fees. While we don’t doubt that many prepaid issuers act with integrity, there have been numerous examples of fee-ridden, blatantly profit-seeking cards.
  3. Prohibiting overdrafts addresses one of the largest inconsistencies in the industry. An FDIC study noted that a plurality of those who left the mainstream financial system did so because of overdraft charges, and a major draw of prepaid cards is the perceived inability to incur those fees. Still, some cards such as the NetSpend Premier allow and charge fees for overdrafts.

We do believe that clear disclosure of registration requirements is necessary, especially given that immigrants and those less likely to have SSNs are disproportionately unbanked. This issue has not been addressed either by the CFSI or by Senator Menendez, but Menendez’s bill would commission a study on prepaid usage and demographics. We hope that such a study will further illuminate the needs of this underserved community.

Overall, we are pleased about the direction towards closer regulation and greater clarity in the prepaid market, and commend Green Dot, Plastyc and Ready Credit for piloting the CFSI’s disclosure box. We’d studied Green Dot in the course of our own research, and would like to note in particular their best-practice disclosures and fees charged. Still, for every Green Dot, there’s a Kardashian Kard, and prepaid debit is still a regulatory Wild West.