For last month’s 2010 Predictions, we talked to dozens of industry leaders and experts to get their perspective on what to expect in 2010. One of the predictions about prepaid debit cards was so intriguing we decided to talk to the prognosticator himself, Alan Mattei of the Novantas consultancy. He speculated on the impact of recent credit card legislation on the sale of prepaid debit cards. Specifically, he sees a significant opportunity, if prepaid card providers act quickly.

GR: I was intrigued with a prediction you made regarding the impact of changing bank regulations on prepaid debit cards. What are these regulations that are going to have this impact?
AM: Well, the first and perhaps the most significant are the regulations that have come into place that we refer to as UDAP, Unfair and Deceptive Acts or Practices, which is around the credit card industry, and the limitations that have been put on the card company.

GR: What is the impact?
AM: Basically, the impact that those regulations are having on the credit card companies is that they have taken away some of the practices that have been, in the past, very profitable for the banks. As an example, they were free to reprice [customers] at any time and now there’s a limitation that in the first six months of the relationship, they can’t reprice.
So you would come in at what would appear to be a low teaser rate and you would keep your zero percent for X months, but the go-to rate may have looked attractive at 11.9 or something. Then you find yourself, a month or two into the relationship, with a repricing up to 18.9. Basically, as they gathered more data about you, they made a reassessment on your risk and they were free to adjust for that risk.

GR: And, before this new legislation, banks could do this repricing at will?
AM: Before, I could spread these great offers around, knowing that, yes, some were high-risk and some were low-risk, but for the high-risk ones, I’ve already got a fairly significant interest rate on those accounts and they have balances, so I’m going to earn back the interest money off of those folks and that will help subsidize the other ones that don’t earn as much or the ones that go back. So that was a good game plan.

GR: So they start turning down the number of people they offer credit cards to as a result, and that’s what opens up this opportunity for these prepaid debit cards, right?
AM: In the end, they’re going to have to tighten all these things down and raise rates. They’re going to have to reduce their tolerance for risk, which means they’re going to have to narrow the population that they’re going to accept, and they’re going to lower the credit limits on people if they feel that there’s any kind of risk at all.

GR: All of this because of the new legislation?
AM: Because of this legislation, if I can’t turn up your rates, because I find out that you’re riskier than I thought, one of the ways to mitigate that is to just not give you as much credit. All of this is going to have the effect of tightening down the amount of credit card loans, if you will, that are going out to people. And those loans that are going out are going to be at higher rates. So it would seem to me that consumers are going to start looking towards debit cards, saying, “Maybe I should be using my debit card instead of my credit card, because my credit card rates are high and it’s uncertain financial times, so I’m going to try to pare back the amount of money and debt I have outstanding.”

GR: So, this seems to me that this would be an opportunity for prepaid debit cards, right?
AM: The convenience of having a credit card and being able to use it for purchases, online and other environments where having a card is . . . let’s face it; it’s very difficult to get through modern-day life without a credit card of some sort. A lot of people have shifted. The prudent thing to do was to shift to a debit card, because now you’re cash-only, right?

GR: Right.
AM: I haven’t seen the data yet for the last six months, but I would expect a shift from credit card purchases over to debit card purchases, but then you run into the third rail of checking, which is overdraft. Let’s say I made three purchases today at the store and I find on my bill or my statement at the end of the month that I’ve got three $35.00 charges, because I was two cents over on overdraft.

GR: Overdrafts on credit cards are a source of revenue to banks, right?
AM: Yes. And, of course, there are a lot of people that incur overdrafts and there are a lot of people, your really good customers, who don’t. So what you’re doing is subsidizing. Why do we have free checking? It’s coming from somewhere, right? Typically, what you’re doing in credit card or in checking, both are the same, is you have a group of customers, who, on a regular basis, incur penalty fees, interest -- all those bad things from a consumer point of view, good things for a profitability point of view. And those people are subsidizing rewards programs, free checking accounts, low-rate interest credit cards. . .

GR: <laughs> I’m laughing because what you’re doing is your subsidizing your good customers with your bad customers.
AM: Yes.

GR: Obviously, in a macro sense, you are going to create more opportunities for prepaid debit cards. Why wouldn’t the banks then be proactively selling the prepaid debit card? It seems to me to be the natural thing for them to do.
AM: It would seem to me a natural thing for them to do. It’s a very good question to which I don’t have the golden answer. I think that there are a couple of things that might prevent it. There’s one set of issues on the consumer side, and then there’s a set of issues on the bank side.
On the bank side, large banks, especially, are built in “silos.” Credit cards run almost as a separate company from the retail bank, which runs almost as a separate company from the investment bank and commercial banks. So there has always been, or has been at least, in the last five to seven years, developing attention between credit cards and debit cards. As an example, if I promote debit cards, I’m bleeding away money from my credit card side of the bank.
If I promote my credit cards, I’m bleeding money away from the debit card. So there’s this tension back and forth, and I guess the question really comes down to, “Which one is more profitable?” Is it more profitable to have you use your credit card 15 times a month and pay it off at the end of the month, or is it more profitable for me to use my debit card 15 times a month? Based on transaction fees, merchant fees, and all the other things that go along -- rewards programs and overdraft charges that are incurred, and the risk on the credit card side, you have to work that whole equation and make a determination which one is going to be advantageous, and then try to promote the one that’s going to be best for the bank.
Now when you throw prepaid into that mix, where does it land in terms of profitability and where does it land within the silos? It’s obviously a retail bank product.

GR: Obviously, so it has to run inde-
pendently?
AM: Right, it’s very difficult for the silos to cross-subsidize each other. In the credit card company, should I be promoting the debit card? What’s the advantage? I incur all the costs for the promotion.

GR: If you were a company that produced or offered prepaid debit cards, wouldn’t this seem to be a great market for you to go into?
AM: If it was as profitable or more profitable than the existing set of products that I have, yes. I suspect that it is.

GR: Yes, and I suspect that it is more profitable, too.
AM: I suspect it actually is quite profitable, because if you think about it, you’re taking people’s money and holding it until they use it.

GR: And I don’t think prepaid debit cards have the same dynamic that you talked about earlier, where you have one set of customers where it’s very profitable and another that it’s not. I think prepaid debit cards stand a little bit more on their own, card by card.
AM: I would agree. Other than the amount on the card, a $1,000.00 card versus a $200.00 card, I think you can pretty much draw a line in the profitability based on the amount, because what’s the risk associated with it?

GR: None.
AM: Right. In both checking and credit card, risk is such a big factor.

GR: And not only that, but debit card companies encourage people, “Buy our debit card. Make all your small payments.” Why? Because every time that merchant – each transaction, they get a transaction fee on. Besides the discount, they get a transaction fee. So they’re perfectly happy for this guy to make $1,000 or $1.00 purchases.
AM: Yes, absolutely, because that’s really the driver of revenue on the debit side. Well, now that the overdraft thing is going away, because that was a driver of revenue prior. Now you don’t have that on prepaid, but you don’t have the risk either. Yet, you still get the transaction fees. So I would think that there’s an opportunity from the institutional side that this product, not only from a profitability perspective and risk perspective, it’s a good moment to try to push that.

GR: And somebody is going to realize that market, some way.
AM: I think right now in the USA, these prepaid debit cards are not a product that has taken hold with the population. We see them in gift cards and they’ve proliferated wildly over the last few years, and people are comfortable with the gift cards. We’re seeing higher denominations in them. I see them everywhere, drugstores, the corner stores, the prepaid phone cards, the prepaid -

GR: Gas stations.
AM: Everywhere. They’re everywhere. So definitely, there’s been a surge in prepaid cards, but they’re still kind of quarantined off into this niche called “gift cards.” We’re not seeing, as we have in Europe, them becoming general usage cards, where you actually have one in your wallet, not because somebody gave it to you, but because you proactively filled it with some money and you’ve used this on a daily basis.

GR: But isn’t that really a consumer education or awareness issue? That if somebody really steps up and does advertising on TV or in malls or whatever they do, isn’t that a consumer awareness issue that they could overcome over a period of time if they were willing to make the investment to do it?
AM: I think so. I do. I think you might not have had success 10 years ago, but I think that today, there is an opportunity there and given the economic climate, there are ways you could position this as being the smart thing to do.

GR: But where we started was the banks are going to force a lot of people off credit cards. So, they may not have a choice.
AM: Definitely, with this squeezing of unsecured credit, the tightening down of credit lines and the reduction of risk, people are going to have to, if they want to continue that kind of convenience, they’re going to move to debit card, but then there are issues with that as well. So prepaid, logically, has an opportunity right now to be beneficial, both to the institution, because of the reduction of risk, and to the consumer. It seems like the time is right.

Alan Mattei is Managing Director, Novantas. Visit Novantas online at www.novantas.com.