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Is prepaid the iTunes of banking?

By Claes Bell, CFA · Bankrate.com
Tuesday, May 29, 2012
Posted: 4 pm ET

Based strictly on bang for the buck, prepaid debit cards should be a fringe product. After all, when it comes to price, it's hard to compete with free, and many banks and credit unions nationwide are still offering free checking. The vast majority of prepaid debit cards, on the other hand, charge fees for many of the basic financial services banks provide at no additional cost as part of the overall checking account package.

But according to a new report by Market Rates Insight, large swaths of the American public who can and do have a conventional checking account seem open to using prepaid debit cards. From the press release:

The latest consumer research from Market Rates Insight shows that 47.1 percent of existing bank customers and credit union members are likely to use prepaid reloadable cards if offered by their financial institution. Moreover, these consumers indicated willingness to pay an average of $4.21 per month for the use of the prepaid card.

The Integrated Study on Service Fees just completed also shows a misconception about the demographics of consumers likely to use prepaid cards. The notion that mostly low-wage earners use prepaid cards might have been true in the past, but it is about to change. The study's findings show that among consumers who are likely to use prepaid cards, 36.7 percent earn between $35,000 and $65,000 per year; 22.1 percent earn between $66,000 and $100,000 a year; and 14.8 percent earn over $100,000 per year.

Another misconception is that prepaid cards are the preferred payment method of very young consumers, who may not have a credit card or banking relations. Again, this might have been the case in the past, but is not the case moving forward. The study found that 42.3 percent of consumers likely to use prepaid cards are baby boomers ranging in age between 47 and 66 years old.

Clearly, something besides price is at work here. The authors of the Market Rates Insight report have their own theory on why people are willing to pay $4.21 per month to use a prepaid debit card, but are often unwilling to pay monthly fees for a checking account:

Traditionally, consumers viewed banking services, such as a free checking account, as part of the service to which they are entitled because they provide the financial institution with funding in the form of deposits, which in turn the financial institution uses to earn interest income on lending. Hence, consumers view traditional financial services as "grandfathered," and they are resistant to new or increased fees on these services. However, consumers feel differently about lifestyle financial services. They view these services as enhancements to their lifestyle, and so they are willing to pay for the convenience and efficiency these services provide.

I agree with the idea that consumers have grown to expect checking accounts to be free (although I'd say it has more to do with the fact that banks trained customers to expect that over the past decade or so). Prepaid debit cards don't seem to run into that expectation as much, in part because they are a relatively new product.

But I think there's another dynamic at work here, similar to the one that made Apple the world's largest music distributor. Apple realized that the technology was in place to sell people individual songs, rather than forcing them to buy an entire album, and had the negotiating acumen to get the record companies to sign on. Customers went on to spend billions on music per year, 99 cents at a time.

General purpose reloadable cards -- the kind of prepaid debit cards most often used to replace a traditional checking account -- are the iTunes of banking. Right now, many checking accounts being offered by the big national banks have customers paying a monthly fee stretching out into infinity, plus whatever penalty and service fees come up, and they can sometimes come up big. On the other hand, GPR cards -- like iTunes -- allow users pay for their products $1 or $2 at a time rather than "buying the whole album" of a banking relationship. Even if they end up spending more overall, GPR users may feel the pain of those payments less thanks to their small size.

Sure, nearly all of those customers could probably find a debit card issued along with a free checking account and get those services for free, and many people are doing so. But I think a number of customers disenchanted with the large national banks will try using prepaid debit instead precisely because of the "iTunes factor."

What do you think? Is prepaid debit the iTunes of banking? Why do you think people who could get free checking are willing to pay for prepaid debit instead?

Follow me on Twitter: @ClaesBell.

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1 Comment
Brian Sexton
June 05, 2012 at 4:50 am

How about security? Exposing a pre-paid debit card with a low balance to a Web site or a strange public terminal may risk that card's present and future balances to fraud instead of those of one's main checking or savings accounts. Also, if attempted debits in excess of associated balances are simply rejected rather than paid, owners of pre-paid debit cards may limit fraudulent debit amounts and avoid overdraft fees entirely.