“Just because consumers may not be able to afford or qualify for a bank account, or just because they do not want to be a part of the brick-and-mortar banking system, this does not mean they deserve to be treated as second-class citizens. Like anyone else, they deserve to have a safe place to store their money and a practical means of carrying out financial transactions,” CFPB Chairman Richard Cordray noted during a field hearing in November 2014. “Consumers deserve that from us. As Helen Keller once noted, ‘Alone we can do so little; together we can do so much.’ We agree wholeheartedly.”
These remarks were made in the context of proposed CFPB rule changes that would reclassify a segment of prepaid cards – specifically those that offer overdraft protection – as a credit product instead of a banking product for the purposes of regulatory oversight. You’d have to read the nearly 900-page document released earlier this year to get to that punchline.
There’s a lot of good stuff on those 900 pages – things that legitimately protect consumers by making disclosures more transparent.
But the big bomb that was dropped within those 900 pages centers on a particular feature offered by some prepaid products – calling into question just what a prepaid product really is.
That feature: overdraft protection.
That product definition: a prepaid product that offers it is really a subprime credit product.
Now prepaid card issuers have positioned prepaid cards as alternative financial products since Day 1 – describing them as substitutes for bank accounts. In fact, most of the prepaid products are described in marketing materials as “prepaid debit cards” to make the analogy even more clear.
And like debit products tied to bank accounts, the funding source for prepaid debit cards is provided in one of a couple of ways – by a consumer in the form of cash that they deposit (or “load”) onto those cards, from other people in the form of money transfers that are sent to these accounts, or from employers in the form of wages deposited on those cards.
In terms of pure functionality then, prepaid debit products then take on the personality of any other debit product. Monies deposited to that card are available to the owner of that account just like they are available to a consumer with a debit card attached to a checking account. And the card is used just like any other plastic debit card – in a store or online to buy things and to pay bills. In fact, the original intention of the prepaid card product was to give the prepaid cardholder the chance to be included, financially, in commerce and payments by providing a convenient, safe and affordable way to store and access their money.
A few prepaid card issuers, those who have the ability to see the funding history of their customers, have added another feature – allowing prepaid debit customers to “overdraw” their account, in much the same way as a bank will allow a checking account customer to overdraw theirs. These overdrafts are typically two to three days in length and range between $50 and $90.
And that’s the crux of the issue at hand today.
The CFPB argues that this overdraft protection is really a loan in disguise, and that consumers who overdraw simply don’t understand that they are setting themselves up to pay overdraft fees on their next payday.
Now, only 7 of 325 cards reviewed by the CFPB even offered overdraft protection at all, according to Bloomberg – but many of those cards that did are issued by prepaid issuer, NetSpend. I recently spoke with NetSpend CEO Chuck Harris about the forthcoming rule change and his concerns about what comes next for consumers who want or need an alternative to traditional banking products and who have come to rely on NetSpend’s prepaid debit products that offer overdraft protection.
"We want sensible disclosures, we fully embrace transparency disclosure and we want consumers to fully understand our products,” Harris noted when I asked him about the merits of the specific recommendations made by the CPFB, further stating that most of what is outlined is “non-controversial."
He went even further, telling me that he had “no objections” because none of the proposed requirements were anything new to the company’s existing policy.
Where he is, however, greatly concerned is the move to regulate prepaid cards that extend overdraft protection under Regulation Z – which governs credit products – as opposed to its current regulatory home under Regulation E – which governs deposit accounts. Moving down the regulatory alphabet, would require that prepaid issuers treat each overdraft as a credit decision, verifying that the “borrower” is capable of paying back the overdraft – before extending it.
"There is a section of our customers that we fear we won’t be able to serve because of the extensive credit application process. We are concerned with the impact this rule will have on our consumers,” Harris told me.
What is confusing to prepaid card issuers like NetSpend is the discrepancy between how the CFPB looks at checking account overdraft protection and how they propose to treat prepaid overdraft protection. Most deposit accounts offer overdraft protection which consumers now have to opt into. When there is an overdraft, consumers pay, on average, $35 dollars an instance. Harris told me that for NetSpend customers, an overdraft is $15 an instance but only if customers don’t repay it in 24 hours. In addition, there is no fee if the customer overdrafts their account by $10 or less. According to NetSpend’s internal figures, opt-in cardholders don’t pay fees for approximately 60 percent of overdraft transactions. Additionally, 12 percent of customers never pay a fee for overdraft.
"This [potential rule change] is a real issue for our consumers,” Harris told me. “These are people who had bad experiences with a bank- and for that reason, we didn’t build a product that looks just like a bank product. It’s the antithesis of that."
Harris also believes that this proposed regulation misses the big reason that consumers “overdraw” in the first place: to address the issue of income irregularity.
"If a customer of ours makes $36,000 a year, they generally don’t make that in 12, $3,000 a month increments,” Harris explained. “Our customers have overtime, they often do seasonal work, they do jobs on the side – and we see that almost 50 percent of our customer base has income swings of around $500 a month. When you think about that – in terms of those kind of income swings, we have discovered that there is a real need for $50-$80 smoothed out from time to time to cover groceries, gas or a car repair – just ordinary stuff in life."
That is the type of overdraft Harris says they overwhelmingly see – more than 60 percent of overdrafts are free, including those paid within the 24-hour window.
Harris is also quick to point out that there are also situations where a prepaid product should be considered credit – but that all or nothing approach just doesn’t seem rational.
"Sure, at some dollar amount it should become credit. If we’re extending $1,000 or two or three thousand bucks and for weeks or months at a time, yes that should clearly come with the traditional regulatory structure of a credit product. But if we’re going to let a consumer overdraw their account for a few days for $50 or 60 bucks, does that really rise to the level of a full blown credit product?"
Harris told me that he doesn’t think so – and further, says that NetSpend’s customers don’t think so either.
Neither do I.
And hardship that Harris thinks essentially undercuts Cordray’s stated goal – to make sure the underbanked (and unbanked) are not treated as “second-class citizens.”
"We bristle under the notion that our customers are somehow not as good as a customer at a bank who can be offered overdraft in a deposit account. For 10 years we have been trying to give these folks a responsible alternative, because they deserve it, and now we’re being relegated to a second tier product. That doesn’t sit well with us."
What also doesn’t sit well is how much this one issue has overshadowed the “goodness” of the prepaid product for consumers who need – and want – a financial services alternative.
"Here’s how we think about it. Overdraft is only one of many features on our card and it is consuming all the air in the room for obvious reasons. But what is getting lost here is that we’ve actually built our product for the consumer – and their hills and valleys. So, sure we provide overdraft protection for a couple of days for those few who need it. But we also pay consumers 5 percent on money they save – go and try find a savings account that is paying 5 percent right now."
The 5 percent Harris is referring to is the rate the NetSpend savings account pays out to customers who store savings with the company. Harris looks at this as just another tool in NetSpend’s toolbox for income smoothing that is imperiled by the potential rule change.
Reflecting on the potential future of prepaid, a future that is buried beneath the nearly 900 pages of rules that the CFPB would like to impose on prepaid issuers, Harris believes that he has more common ground with the CFPB than he has disagreement. He also thinks that regulation of prepaid products is a good and entirely sensible goal.
"When you think about the growth rates, it’s not just a gift card anymore, some of us are providing a unique financial alternative to a bank account, and when you do anything at that sort of size or scale it’s going to attract the attention of regulators. And frankly we embrace that, I think the idea of having a regulator for our industry is a great idea – the initial response we had to the CFPB was ‘fantastic’ – it legitimizes our industry, we have a regulator now."
But should the reclassification of prepaid from a regulatory oversight perspective move from Reg E to Reg Z, the implications to the business and the uptick in cost will change the economics of the any prepaid card that enables overdrafts.
“It’s going to make it challenging to continue to provide in its current form,” Harris told me.
And that challenge seems like one that it will have to pass on to consumers in the form of higher fees, more friction, or simply not provide at all.
Leaving a potentially growing segment of consumers without any sound options if they are unable or unwilling to work through a traditional bank for debit product.
Which, if you believe the current stats coming out of the Federal Reserve, could disadvantage a lot of consumers. According to the Federal Reserve, 30 percent of Americans – many of whom use prepaid products as banking alternatives — have irregular incomes due to work scheduling, joblessness and seasonal work. As the “on demand” sharing economy continues to grow – that number might rationally be expected to go up – as could the income irregularity that goes hand in glove with it.
However, a lack of good options doesn’t mitigate need – and it does beg the question: Where will consumers go when they need an extra $50 for one or two days?
Cordray rallied the crowd at his field hearing announcing the potential rule change, by quoting from Helen Keller, the 20th century deaf/blind humanitarian whose life has inspired so many.
As we contemplate the future of prepaid, given some of what is being proposed, and the impact to consumers who seem to both understand and benefit from the overdraft services provided them, another quote of Keller’s comes to mind.
“The only thing worse than being blind is having sight but no vision.”