Once upon a time, if you didn’t have a traditional bank account, you were out of luck if you wanted to withdraw cash from an ATM, buy something online or put your paycheck somewhere safe, but the increasing prevalence and variety of prepaid debit card products may represent a new way for the previously unbanked to more fully participate in today’s economy.

The Federal Reserve Bank of Boston recently took up the question of whether unbanked consumers were using general purpose reloadable prepaid cards (GPR) in place of traditional bank checking accounts.

“Since the Survey of Consumer Payment Choice started in 2008, we have seen an increase in the ownership of prepaid cards and we wanted to understand more about how consumers use them,” said Claire Greene, a payments analyst in the Consumer Payments Research Center at the Federal Reserve Bank of Boston and one of the study’s authors. “Some of these cards are marketed as a checking account alternative and we were interested to see if consumer behavior aligned with that.”
Drawing on some of the Boston Fed’s previous research, including the 2012 Study of Consumer Payment Choice, the study’s authors zeroed in on the 4.8 percent of U.S. consumers who do not have a traditional checking account, but do use a prepaid debit card.

It’s not necessarily that a larger proportion of U.S. consumers are substituting a GPR prepaid card for a traditional checking account, Greene said, but in some cases, the segment of the population that has a prepaid card, but not a traditional checking account, does use that card for bank-like services in greater numbers than banked U.S. consumers would.

Direct deposit may be the easiest illustration of this point: Among unbanked consumers who have a prepaid card, about 30 percent receive a direct deposit onto that card, compared with only about 9 percent of banked consumers who also have a GPR card.

Greene also said that prepaid card users made overall fewer transactions in a given month than consumers who owned a traditional checking account.

While Greene did not want to speculate as to why those consumers make fewer overall payments, the study did show that low-income consumers are more likely to use a prepaid debit card, with 49 percent of people with a household income under $25,000 owning a prepaid card compared with 18 percent of people whose household income fell between $75,000 and $99,000.

Dislike And Distrust
Though the Fed’s researchers do not focus on why consumers use prepaid debit cards, it’s hard not to draw a link between household income level and prevalence of prepaid card usage. One only has to look to Wal-Mart’s Bluebird prepaid card, which is marketed as an alternative to a bank account.
“It’s clearly a market response to this segment of the population that, for any number of reasons, does not have a traditional relationship with a bank,” said Michael Goodman, executive director of the public policy center at the UMass Dartmouth. “I think Wal-Mart in particular is operating at a scale where whatever cost they’re incurring to manage these products is almost certainly offset by whatever additional sales they might be able to yield as a result of providing them with this service.”
The unbanked may be unbanked for any number of reasons. Nearly 40 percent of unbanked consumers surveyed by the Fed in 2012 answered simply “I don’t like dealing with banks.” The unbanked may be immigrants who do not trust the U.S. banking system because of bad past experiences with banks in their home country, or they may simply be living too close to the edge to afford a single overdraft fee.

Goodman found when he surveyed the unbanked in the city of New Bedford a number of years ago that many low-income individuals who avoid traditional banking relationships are motivated by a desire for simplicity and predictability.

The increasing prevalence of prepaid debit card products has also drawn scrutiny from the Consumer Financial Protection Bureau, which is particularly concerned about whether companies offering these products are properly disclosing fees to consumers.

But a quick look at the bureau’s new consumer complaints database seems to suggest that perhaps prepaid cards offer just that simplicity that many unbanked customers want. Complaints about prepaid cards made up just 796 out of 411,976 total complaints. By comparison, the bureau logged 2,678 complaints about payday loans; 47,463 complaints about bank accounts or service and 150,851 complaints about mortgages.

Of course, that small fraction of complaints could also be due to the fact that a fairly small percentage of unbanked U.S. consumers (4.8 percent) even use these products to begin with. Or one might argue that these products appeal to a segment of the population that may be less attuned to the bureau’s activities.

Perhaps Greene put it best when she said, “Certainly, looking into what people are doing always raises more questions about what people are doing.” 

Wal-Mart’s Alternative To Banking

Perhaps the best thing the banking industry could have done for Wal-Mart was deny it a bank charter.

For nearly a decade before the financial crisis, the big-box retailer had pursued a bank charter, but it withdrew its application in 2007 amid criticism from lawmakers, industry lobbyists and consumer advocates. When the Federal Deposit Insurance Corp. (FDIC) announced it was going to delay its review of industrial loan corporations early in 2007, Wal-Mart withdrew its application.
The retail giant today offers its customers the Bluebird card in conjunction with American Express, and it explicitly markets that financial product as an alternative to banking. (Go ahead: Google it.)
Yet, the funds that Wal-Mart’s customers deposit into their Bluebird accounts are protected by FDIC insurance because of something called pass-through insurance.

Sean Mahoney, a partner at K&L Gates in Boston, explained that the origins of pass-through insurance are fairly innocuous. One of the most common examples in which it would be used is when a lawyer is acting as a trustee and depositing cash into a bank account on behalf of several different clients.

“If I have my own cash in my own account, that’s insured up to $250,000,” he said. “If I’m holding client funds and as long as it’s clear that I’m the trustee, then each client can be insured up to $250,000 and I maintain records of which funds are held by each client.”

That’s essentially how Wal-Mart can offer its customers a non-bank bank account with the protection of FDIC insurance. The Bluebird account is administered by American Express, which deposits those customers’ funds into accounts it maintains at Wells Fargo Bank and American Express Centurion Bank. The custodian keeps track of which funds belong to which customer, and if either of those banks should fail, the customers’ money is insured up to $250,000 (including, of course, whatever other funds that customer may have on deposit at that bank separately from their Bluebird account).

“I think when [the FDIC] issued the most recent opinion [in 2008], they were clearly aware of the development in the industry, but it’s ballooned in the past five or six years,” Mahoney said. “In retrospect it seems like something to be expected, but I don’t think anyone expected the growth there’s been.”