This is a reprint of my editorial in this week's American Banker.
"Startup's Demise Shows Regulatory Perils in Unbanked Market" (Nov. 13), about TandemMoney's end, should spark a discussion of the most contentious issue in the prepaid market: The idea of
putting credit on the general purpose reloadable prepaid card.
I will start the conversation. Credit is not for prepaid.
Everyone in prepaid has an opinion about credit. In the evolving market for GPR cards, the abstract concept of innovation is almost always an opaque front for short-term credit. Are we forgetting that subprime lending was also touted as an innovation? Besides, the best innovation of late is not credit. It is remote deposit.
TandemMoney's slogan was "you have to be a saver to be a borrower." In the context of what passes for innovation in prepaid, where the unsaid slogan seems to be "even if you are not a saver, we'd like to let you be a borrower," this was intended to be a step in the right direction, albeit a somewhat misguided one.
TandemMoney's story encapsulates three provocative questions:
First, should credit be available through prepaid?
People ask why credit is problematic, but that is a simplification. There are very many – perhaps too many – ways to get credit. Here is the answer: If you want credit, get a credit card. If you cannot qualify for one, then you probably should not have credit. No barrier prevents someone from having both a prepaid card and a credit card. But prepaid cards should remain a safe harbor from credit.
There is disagreement even within the industry on this issue. Even if margins on credit products are high, the risks are real. The long-term value proposition presented by credit remains unproven.
Credit means more customer churn and fewer accounts with direct deposit. Green Dot's CEO, Steve Streit, says that many of his customers "live with a constant financial emergency." He told me that he would never put credit on his cards because it would shrink his customer base. Given that context, it is more likely that they will borrow again and again, eventually falling into a cycle of debt which they cannot overcome. At some point in time, the account is closed and the issuer is granted a judgment of questionable value.
When that happens, both customer and company lose. The most profitable customers in prepaid are the ones who use direct deposit. (According to a study by the Federal Reserve Bank of Philadelphia, a retail card with direct deposit brings 12.8 times more revenue than do those without it.) This is the reason analysts insist that publicly-traded prepaid firms report their direct deposit metrics.
It is only the direct-deposit accounts that get credit. So, credit ends up destroying the most profitable relationships. It smothers an account that could otherwise generate fee and interchange revenue – and with the structure of prepaid credit, that can only occur with those accounts which receive payments via direct deposit.
Second, what further possibilities might develop from Tandem's idea to use two banks?
The TandemMoney card utilized two banks: one for credit and savings and another for spending and receiving direct deposits. Trent Sorbe, TandemMoney's former president, referred to the credit as an "integrated loan product." In a key difference from MetaBank's discontinued iAdvance, a direct deposit was not used to offset a negative balance on the card itself. The loan was instead paid for with an ACH transfer to a credit line held at the other bank.
Treasury Department rules prohibit direct deposit of federal payments (such as Social Security or veterans benefits) onto cards with credit lines that are automatically repaid from the deposit. We can't predict how the model might have been mimicked, or what regulators would have thought about it, but it is easy to see how payday lenders would try to use it to evade the Treasury rule. In fact, we can only contemplate how it might have opened the door for new iterations of payday lending altogether.
Third, can a behavioral model be used as an incentive for savings?
The traditional incentive – paying interest on deposits – does not work on prepaid. Even when issuers pay 5%, it makes little difference. One prepaid executive told me that even 30% might not work. The sums are too small. According to the CEO of a major program manager, most customers with savings accounts have balances of less than $100.
Tandem's aspiration to make cardholders into savers was laudable. Nonetheless, Tandem's approach – to offer credit as a means of incenting savings – is a bit like a hospital encouraging people to get sick so they can be healed. Common sense says the better approach is to be healthy, either financially or physically, by being safe and sound in the first place.
Reinvestment Partners, the nonprofit advocacy organization that employs me, has been consistent about the problems posed by credit on prepaid. This is what I said at the Consumer Financial Protection Bureau's field hearing in May. It was the first principle of my paper "8 Principles for the Reform of the Prepaid Debit Card." In March 2010, I wrote to Treasury and to the Office of Thrift Supervision about the dangers of MetaBank's iAdvance.
The CFPB is writing rules on GPR cards. Certainly, the role of credit will be a part of what the regulator addresses.
I hope the Bureau will acknowledge that credit is a poor substitute to savings for surviving a financial shock. The oft-heard defense of credit inevitably touches upon those shocks (the sudden car repair is a popular scenario) but it may be a need that has to be resolved in a better way.