How Prepaid Debit Cards can Impact your Banking Investments
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Just when major financial institutions like American Express (NYSE: AXP) thought they’d found a viable source to generate more revenues, the federal government is beginning an effort that threatens to throw a monkey wrench into the scheme. It’s the prepaid, or reloadable, card industry, which developed a nasty reputation for preying on the most vulnerable consumers. However, that reputation is changing as more people than ever are now using the cards, creating a ripe opportunity for issuing banks to make money.
From the infamous Dodd-Frank Act sprang the Consumer Financial Protection Bureau. Last week, it took its first steps toward putting certain regulations in place for prepaid debit card issuers in the name of making sure that consumers don’t get ripped off. The industry had become notoriously known as one filled with unscrupulous companies that preyed on people with poor or no credit. These companies were lambasted for their exorbitant fees, but still the number of people seeking their cards has soared.
It is estimated that more than seven million people are using prepaid cards to make purchases. By 2014, it is expected that the total dollar value of funds loaded onto prepaid cards would have grown at an average annual rate of 42%. In 2007, the amount was $12.5 billion. In 2011, it was $57.2 billion. Considering these numbers, it should be no wonder that financial institutions are getting into this business.
The prepaid market is expected to continue to grow as more so-called unbankable or underbanked consumers choose the convenient and latest form of plastic to cover their spending needs. There are about 80 million of these consumers in the U.S. and about 26% of them are considered unbankable because they cannot qualify for traditional deposit accounts at banks. They may not have the means to qualify, but they have plenty of money to spend – to the tune of $1 trillion in payments and income.
American Express was one of the first mainstream credit card issuers to offer prepaid debit cards. It offers a variety of cards to suit consumer needs. In fact, just last week it announced a prepaid card partnership with Zynga (NASDAQ: ZNGA), which is widely known for its Farmville game. Users of the prepaid card can accumulate credits to use on the games offered by Zynga when they make purchases using the card.
I think that this partnership will be a boon for American Express when it comes to younger people, like college students. This demographic has been all but locked out of the credit card industry due to the federal Credit Card Act. It provides that people under the age of 21 have a co-signer in order to get a credit card. This has led to an increase in the number of young people getting prepaid cards.
Their prepaid debit cards are different from those that are being targeted by the feds because they don’t have the egregious fees. For example, there are no usage fees, annually or monthly. There are no fees to speak to customer service representatives or transaction fees to use the card.
In 2010, President Obama signed into law the Dodd-Frank Act, which was supposed to help in transforming the banking industry. It came on the heels of the 2008 economic meltdown, where big banks like Lehman Brothers and Bear Stearns failed. Some of the regulations led to a decline in revenues for financial institutions like those mentioned above. Implement the provisions of Dodd-Frank and other financial reforms may cost the financial services industry between $3 billion and $5 billion. Large banks may have to pay between $100 million and $200 million each. This can result in losses of 20% to 30%.
As the full effect of Dodd-Frank becomes clear, banks seem to be doing something right. In May, the Federal Deposit Insurance Corporation (FDIC) reported that the nation’s banks posted 11 consecutive quarters of earnings that were higher than they were a year before. The commercial banks and savings institutions insured by the FDIC had an aggregate profit of $35.3 billion in the first quarter of 2012. During the same period in fiscal year 2011, revenues were $28 billion.
Also, according to the FDIC, 67.5% of all institutions reported improvements in their quarterly net income from a year ago. Those reporting net losses for the quarter fell to 10.3% from 15.7%. Furthermore, the average return on assets increased to 1.02% from 0.8%.
One of the most interesting things about the FDIC’s report relates to the amount of money that flowed into insured deposit accounts. It slowed. For example, balances in large, non-interest bearing accounts fell by $77.3 billion. In the three previous quarters, the balances in these accounts increased by more than $532 billion. The FDIC noted that most of the losses occurred at some of the largest banks that previously received a major share of the inflows.
I think that this shows that the banks are experiencing the loss of customers, many of whom are likely choosing non-traditional banking options like prepaid debit cards. This trend will continue. More federal regulations may aggravate the situation, which can weaken the sector. The financial sector is still trying to get a handle on the exact impact of Dodd-Frank. Investors should stay abreast of the Consumer Financial Protection Bureau’s efforts to regulate the prepaid debit card industry. The extent of its proposals will impact their ability to collect from this lucrative industry, even though the vast majority of the major banks have terms that are not harmful to consumers. Furthermore, they can form relationships with a group of customers that it had previously not been able to reach, which can further improve their earnings.
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