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October 01, 2009

Report Looks at Prepaid Cards as Potential Source of Income for CDFIs
    by Robert Kropp

The National Community Investment Fund finds that by providing prepaid card services in underserved communities, CDFIs can help bring consumers without banking relationships into the mainstream economy. -- Community investment has long been a central part of the investment strategies for many socially responsible investors, who see in the double bottom line of financial return and social good a reflection of their mission. Such investments by both individual and institutional investors, whose involvement can range from simply using a community development bank or credit union for their banking to investing in specialized mutual funds and venture capital, can help gain access to financial services by members of underserved communities.

For a variety of reasons, many members of such underserved communities have no traditional banking relationship, and instead find themselves at the mercy of such services as check-cashing operations that often charge high fees for those services. In an effort to further the development of an alternative, one which in some cases can serve as a bridge to a traditional banking relationship, the National Community Investment Fund (NCIF) has produced a report entitled Demystifying Prepaid Cards: An Opportunity for the Community Development Banking Institution Sector. The report examines the potential benefits, both to the unbanked and underbanked members of an underserved community as well as to Community Development Financial Institutions (CDFIs), of the development of prepaid card programs.

According to Ellen Seidman, the Executive Vice President for National Policy and Partnership Development at Shorebank and chair of the Center for Financial Services Innovation (CFSI), "Prepaid cards are where debit cards were before banks decided that they could make a lot of money by charging overdraft fees on debit cards. With few exceptions you can't overdraft a prepaid card."

Observing that "The United States has 18.5 million households that have no banking relationship," the NCIF report found that "consumers who pay to cash a check and then pay for money orders for each of their bills could end up spending almost $100 a month just to pay their monthly bills." If fees for the use of prepaid cards can be set at an affordable level, then it becomes increasingly likely that those consumers would be willing to use them. The opportunity for CDFIs lies in providing a prepaid card option in the communities they serve, thereby deriving income from the fees associated with the use of prepaid cards.

According to CFSI, prepaid cards "function like electronic bank accounts without checks; consumers load funds on the card and can spend only what they load, limiting the risk of overdraft while providing immediate liquidity." Prepaid cards that are branded with the Visa or Mastercard logo can be used place of credit cards, allowing underserved consumers and consumers with bad credit to engage in transactions without the risk of incurring additional debt.

It is estimated that approximately 100 million prepaid cards have been issued since the 1990s, and there are about 200,000 locations where cards can be bought or reloaded. The annual market for prepaid cards is estimated to be in excess of $50 billion, according to NCIF.

Ronald Mann, a Professor of Law at Columbia University and an expert on electronic commerce, told, "The benefit of branded prepaid cards is social, in that it allows cardholders to engage in the mainstream economy. It extends card use without borrowing to the underserved community."

The NCIF report is based on three hypotheses; that banks can use prepaid cards to generate income, deepen relationships with customers, and eventually turn people who do not have bank accounts into accountholders. Saurabh Narain, Chief Fund Advisor at NCIF, told, "The mission of CDFIs is to serve their communities, but their products have to be profitable."

In order to help develop pilot programs in the use of prepaid cards in underserved communities, NCIF provided grants to Central Bank of Kansas City, Mo., and University National Bank of St. Paul, Minn. Both institutions are CDFIs. While both were unable to gain profits from the programs during their pilot phases, both stated to NCIF their determination to continue offering prepaid cards.

Seidman of CFSI said, "Neither pilot project turned out quite the way they wanted. But these were tiny banks who were early adopters, which made it very challenging." Among other factors, fees paid to third-party processors exceeded the fees charged by the banks to cardholders and other stakeholders, such as employers that contract with banks to provide employees with payroll cards.

Narain of NCIF said, "The costs of the two pilots were an investment. Both institutions involved in the project want to go ahead with the program. I see the program as a significant success." Narain also observed that while the economic crisis has delayed the entry into the field of prepaid cards by many CDFIs, there is a growing interest in the adoption of prepaid card programs.

Regarding NCIF's hypothesis that prepaid card consumers can gravitate over time to become more traditional accountholders, the jury seems to be out at present. Seidman pointed out that using a prepaid card "Is not an account relationship with a bank. Such benefits as the ability to get good credit probably aren't going to happen, although as nonprofits get involved there is more potential. Prepaid cards can become a pathway to becoming an account holder."

Mann said, "The reason that a lot of people don't have bank accounts is because the cost isn't feasible. For them, prepaid cards make it less likely that they will establish a traditional bank account."

And Narain observed, "The migration to a traditional banking relationship requires time to occur, and such a migration should not seen as an end in itself. A responsible prepaid card product can serve as an alternative to that banking relationship."

The report includes a toolkit for CDFIs that are interested in developing their own prepaid card programs. According to the toolkit, institutions must clearly identify their business objectives, and price their offerings accordingly. In developing their products, institutions must assess the potential markets for those products. And it is important for the institutions to determine the infrastructure for their products. Whether a bank decides to be its own issuer, or outsource to a third party, will have a considerable impact on both startup and ongoing costs.

The report concludes with the observation that the prepaid card "product offers significant promise to CDFI banks and other depository institutions in bringing underserved people into responsible financial service providers."

"Prepaid cards have the potential to become a profitable product line for CDFI Banks for serving the needs of both unbanked consumers and commercial clients," the report states, but "Banks need to achieve scale in terms of number of active cards to get significant profitability."

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