Portals and Rails

February 01, 2010

New prepaid card functionality: Card-to-card funds transfer

Innovators now have developed a new prepaid card feature that facilitates a seamless transfer of funds from one card to another, providing a more efficient person-to-person (P2P) payment process that includes remittances. Prepaid cards, also known as stored value cards, are another alternative to paper-based P2P payments and have been a boon to underbanked consumers, allowing them to participate in the electronic economy.

The question is, will this enhanced convenience help drive the adoption of prepaid payment card products?

Prepaid cards were first introduced in 1994 by retailers as proprietary gift cards that could be used only at the stores of the issuing merchant. These are referred to as "closed system" cards and include the popular "loyalty" cards typically issued by one or a group of merchants. Other early uses of stored value cards in the United States included prepaid telephone calling cards, mass transit cards, public benefits payments, and even child support payments. In contrast, "open system" cards are typically issued by a bank under branding of the major card networks and functional wherever they are accepted.

Popularity growing but still lagging traditional debit and credit
Today pre-paid cards are increasing in popularity, but a recently released survey conducted by the Boston Fed shows most consumers still prefer credit or debit cards over prepaid cards.

ENLARGE

However, changes in fee and interest programs among banks issuing credit cards may change consumer preferences. As card legislation limits the interest and fees that card companies can impose on borrowers, many banks have started to implement across-the-board increases in interest charges and eliminating loyalty programs for borrowers with higher credit quality.

State of adoption
Prepaid card users can now transfer funds from one card to another through the Internet or by phone. MetaBank is a major U.S. issuer of prepaid open-loop products licensed through the major card networks. Many of these products are marketed to underbanked communities. Also, many of these products may be used for cross-border remittances in addition to domestic person-to-person transfers. Prepaid card products in other markets throughout the world are offering this feature as well. For example, this service is offered in India free of charge to bank customers of DBC (Development Credit Bank Ltd.). Visa Europe offers cards with this feature, allowing recipients to receive funds in all major currencies directly to their Visa card using the global Visa network. If the recipient does not have a Visa card, he or she can collect the cash from a nominated bank branch. In all, Visa Europe’s money transfer operates as card-to-card, card-to-card via email, and card-to-cash.

Convenience as a driver
In a final analysis, technology is driving the development of myriad alternatives in the P2P space, as with other retail payments. How prepaid instruments evolve, in whatever physical form they take — be it a plastic card, a fob, or a cell phone — will ultimately depend on consumer preference. Expanding the functionality of the prepaid instrument for money transfer could be a driver of a new type of prepaid product.

By Ana Cavazos-Wright, payments risk analyst, and Cindy Merritt, assistant director in the Retail Payments Risk Forum at the Atlanta Fed

February 1, 2010 in Card-to-Card, Credit, Debit, P2P, Prepaid | Permalink

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December 14, 2009

Consumer preference for opt-in guides Fed rule on overdraft protection

A recent report by the Center for Responsible Lending found that more than 50 million Americans overdrew their checking account at least once over a 12-month period, with 27 million accountholders incurring five or more overdrafts of nonsufficient funds (NSF) fees. The costs to consumers for overdrafts are significant, with many instances of fees exceeding the amount withdrawn. ATM and one-time debit card transactions have been a key driver behind the growth in the volume and cost of overdraft fees. Point-of-sale/debit overdraft transactions accounted for 41 percent of surveyed institutions' NSF transactions, according to an FDIC study. These POS/debit NSF transactions had a median dollar value of $20, while the median overdraft charge assessed by banks was $27.

ENLARGE

To address high overdraft costs, last month the Federal Reserve Board issued a final rule amending Regulation E, which will provide greater consumer protection by limiting the fees financial institutions can charge consumers for paying overdrafts on ATM and most debit card transactions.

The new rule essentially eliminates a common practice by financial institutions of automatically enrolling consumers in overdraft services. In fact, the aforementioned FDIC study found that 75 percent of banks automatically enrolled customers in automated overdraft programs. Starting on July 1, 2010, financial institutions will have to provide a notice explaining its overdraft service and fees for ATM and one-time debit card transactions before the consumer can accept it. The rule includes a model form that institutions may use to satisfy the notice requirement.

Public comments and consumer testing help inform final revisions
The Board's final revisions to Regulation E were informed by comments received on its January 2009 Regulation E proposal and results of consumer testing. The Board received more than 20,700 comment letters (including 16,000 form letters) on its January 2009 proposal, the majority of which were submitted by individual consumers. In addition, the Board engaged a consultant to conduct consumer testing on a model disclosure notice that would effectively communicate information to consumers about how their overdrafts would be handled by the bank, what fees they could be potentially charged, and what choices they had related to overdrafts.

Consumer advocates, members of Congress, federal and state regulators, and the overwhelming majority of individual consumers who commented favored the opt-in provision because they felt that the harm to consumers from overdraft fees outweighed the benefits from permitting the payment of ATM and debit card overdrafts. In contrast, the majority of industry commenters contended that the opt-out approach was better because it provided consumers with the benefits of overdraft services with fewer disruptions to the consumer and bank operations.

In the end the Board determined that an opt-in approach to permitting overdrafts was the best decision for consumers. This decision was based partly on the Board's consumer testing, which indicated that consumers prefer to have transactions declined than incur fees for overdrafts.

Certain types of transactions not covered by the rule
Other types of transactions are not covered by the rule, including withdrawal by check, ACH, and recurring debit. The Board determined that with respect to checks, the payment of overdrafts may be preferable to having the check returned for NSF and paying the return fees charged by the bank and merchant. In addition, participants in the Board’s consumer testing generally indicated that they were more likely to pay important bills using checks, ACH, and recurring debits. Debit cards were primarily used on a one-time basis for discretionary purchases.

Opting in is not requirement for other services
Consumers who do not accept an institution's overdraft service cannot be treated differently than those who opt in. For example, institutions are prohibited from declining payment of overdrafts of other types of transactions (e.g., checks and ACH) because the consumer did not opt in to that institution's overdraft service for ATM and one-time debit card transactions. The institutions are also required to provide those customers with the same account terms, conditions, and features that they provide to consumers who do elect to take the service.

Overdraft fee income for banks and credit unions rose 35 percent in the last two years. Although not a panacea, the Board's overdraft rules provide greater protection for consumers in navigating their personal finances. Ultimately, an informed consumer is the best consumer protection.

By Jennifer Grier, senior payments risk analyst at the Atlanta Fed

December 14, 2009 in Banks and Banking, Debit, Overdrafts | Permalink

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November 09, 2009

Will interchange provide the driver for disruptive payments innovation?

Many start-up payment providers have emerged recently with an eye on competing with traditional credit and debit card networks by undercutting interchange fees. Will the ongoing public debate concerning interchange fees help drive their success?

The use of both debit and credit cards has been rising rapidly in the United States in recent years as an electronic alternative to paper checks and cash. However, recent credit card legislation as well as an ongoing debate concerning interchange fees could influence the direction of that growth.

In simplified terms, interchange fees represent the costs paid by merchants to their banks for processing card transactions. The card-issuing bank may also use revenue earned from interchange fees to fund loyalty rewards to attract customers. Recently merchants have contended that the interchange costs they pay for card transactions have become excessively high. Given the universal acceptance of the major card networks, merchants contend they have few meaningful alternatives for consumers to transact payments, especially at the point of sale. On the other hand, card companies indicate that interchange fees are fair compensation for providing a valuable service to merchants.

So how do card issuers earn revenue on cards? This example shows a breakdown of issuer revenue in 2004. In this example, interchange represents 18 percent of the card issuer’s total revenue.

Various trends and policy debates regarding interchange fees and card revenue sources appear to be a factor in the development of innovative point of sale payment methods that seek to compete directly against card networks.

Growth in card use has increased payment processing costs for merchants
The Federal Reserve Board published a staff research paper in May 2009 titled Interchange Fees and Payment Card Networks: Economics, Industry Developments, and Policy Issues. This report considers the economics underlying interchange fees and the background for understanding the interchange fee debate. Merchants argue that recent increases in fee rates, along with transaction volume growth, have increased their card acceptance costs substantially.

According to this report, an argument in favor of interchange fees is that they support the universal acceptance of cards through the strength and efficiency of the card networks. The standard fee, set by the card networks, is established in a way that balances merchant costs with the economic benefits merchants realize through the value of the network. Further, consumer adoption is driven partly by consumer protections associated with the use of cards. Overall, merchants who accept cards may realize increased sales, particularly for large value transactions relying upon credit.

Another factor: The impact of credit card legislation
Recently passed credit card legislation limits or prohibits certain fee and interest charges imposed on credit cards. As a result, some expect card issuers to limit or even to eliminate loyalty reward programs and raise interest rates and fees for more creditworthy card holders. While it remains to be seen, these kinds of effects could alter the economics of card networks, potentially opening up avenues for new competition.

Will these developments create opportunities for innovators of payment alternatives at the point of sale?
Companies such as Revolution Money and Tempo, among others, are working to establish independent point-of-sale payment systems from the established card networks with alternative transaction pricing models. Both companies are offering cards (Revolution issues credit and Tempo “decoupled” ACH debit) that compete partly by bypassing the interchange fees of the major card networks. In addition, successful online payments providers like Paypal and others are reportedly looking to compete at the merchant locale as well. In all these examples, competitors will face the classic "network effect" problem in that success requires adoption by both consumers and merchants. The success of these business models at the point of sale remains to be seen and may depend on those very merchants that complain about the current interchange system.

By Cindy Merritt, assistant director of the Retail Payments Risk Forum

November 9, 2009 in Credit, Debit, Interchange, Payments | Permalink

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