ByLyn E. Haralson
Stored value cards resemble a typical debit card, using magnetic-stripe technology to store information and track funds. However, unlike traditional debit cards, stored value cards are prepaid, providing consumers with immediate fund availability and little risk of overdraft. In addition, there is no physical account at a financial institution in the name of the stored value card holder. This virtual existence of the card's backing raises questions about FDIC insurance coverage and consumer protection regulation coverage.
In the 1980s, prepaid cards, as they were called, first emerged in the long distance telephone service market. By the mid 1990s, large retailers realized the cost-saving possibilities of stored value cards and began issuing them in place of traditional, paper gift certificates. Over the past decade, the stored value card market has grown exponentially. Today, stored value cards are being used for many purposes, including payroll, general spending, travel expenses, government benefit payments, retailer-specific spending, and employee benefit and reward payments. Card issuers include financial institutions, individual retailers, government agencies and nonbank financial service providers.
Stored value cards fall into two categories: closed loop and open loop. (See chart, below). Closed-loop cards can only be used for the issuers' products or for other limited purposes. Open-loop cards are more widely accepted and can be either nonbranded or branded with a bank association's logo, such as Visa, MasterCard and, most recently, Discover. They can be used to make purchases or pay bills virtually anywhere the brand is accepted.
Two of the most common stored value cards issued by financial institutions are payroll cards and reloadable general spending cards.
General spending cards are typically branded, open loop and reloadable, allowing purchasers to load and deplete funds multiple times during a specified period.
Many parents are choosing to provide funds to their teens with a general spending card instead of cash. Besides being safer to carry than cash, these cards allow parents to easily monitor their teen's spending habits by using online technology.
New Americans and migrant workers find general spending cards an inexpensive way to send money to relatives in their native countries. Dollars can be loaded onto the card in the United States, and the recipient can access the funds in their country using a duplicate access card. Fees for this service average $6 per ATM withdrawal as opposed to $15 to $40 for the same transaction using money transmitter services or traditional wire transfers.
Payroll cards are another form of stored value card gaining acceptance in the marketplace. For an employer, payroll cards have a cost advantage. A typical electronic funds transmittal (whether direct to a depository account or a payroll card) is 20 cents. Conversely, the cost to process and distribute a payroll check is roughly between $1 and $2. Cost savings for a full-time employee for one year range between $20 and $50, depending on the frequency of pay periods.
Closed-loop payroll cards and ATM-access-only payroll cards provide limited access to funds at a finite number of locations. Since 2001, the majority of payroll cards issued are branded, open-loop cards that allow recipients to withdraw cash at ATMs, pay bills and initiate both personal identification number transactions and signature transactions at point-of-sale terminals. Branded, open-loop payroll cards are similar to a depository account.
Unlike gift cards and general spending cards, payroll cards are marketed to employers versus the end user. Employers as commercial customers of the financial institution are often offered payroll cards as part of a suite of services.
While cost savings accrue to the employer, what about the employee? Employees who usually opt for a payroll card are those who do not have a traditional bank account. It is estimated that 20 million Americans do not have a traditional depository account (i.e., checking or savings account). Payroll cards provide them with a less expensive way to access their pay than check-cashing outlets and money-service businesses. Payroll cards also provide a less expensive way to pay bills than the customary money order. As with general spending cards, consumers can request two cards so family members in other countries have access to the payroll account.
The rapid growth of the stored value card, both in volume and varied uses, has raised questions with the regulatory agencies. This trend triggers discussion of whether these entities should be considered deposit accounts for purposes of insurance and consumer regulation coverage. Stored value cards of any type operate in a virtual reality at the issuer level. Funds underlying stored value cards are traditionally commingled and do not exist in accounts set up under individual names. Proposed regulatory changes and guidance issued by the financial institution regulatory agencies include:
The Federal Reserve Board's Regulation D sets uniform requirements for reserves that depository institutions are required to maintain for facilitating the implementation of monetary policy by the Federal Reserve System. Institutions should note that, to the extent stored value or other electronic money represent a demand deposit or transaction account, the provisions of Regulation D would apply to such obligations.
The Federal Reserve Board's Regulation E implements the Electronic Funds Transfer Act. The act provides an array of protections to consumers who use electronic funds transfer (EFT) systems. A transaction involving stored value products is covered by Regulation E when the transaction accesses a consumer's account, such as when value is loaded onto the card from the consumer's deposit account at an electronic terminal or personal computer.
On Aug. 24, the Federal Reserve Board announced its approval of a final rule that states payroll card accounts are covered by Reg E. The rule is to become effective July 1, 2007.
Payroll card accounts can be set up either directly or indirectly by employers on behalf of employees. The accounts receive electronic fund transfer infusions of an employee's salary, wages or other compensation. They are managed by the employer, a third-party processor, a depository institution or other entity.
The rule does not require financial institutions to furnish periodic statements for payroll card accounts as long as they provide the consumer with a telephone number to call to receive the account's balance. The institution must also provide a web site at which the consumer can access at least a 60-day history of the account's transactions. At the consumer's request, an institution must also provide a written history of transactions occurring in the preceding 60 days.
The Federal Reserve Board's Regulation BB encourages regulated financial institutions to meet the credit needs of their entire community, including low- and moderate-income neighborhoods, consistent with the safe-and-sound operation of the institution.
Payroll cards have the potential to qualify for credit under the community development service test of the Community Reinvestment Act (CRA) if they are free or low-cost and improve access to financial services for low- or moderate-income individuals.
Remittance service provided either through general spending cards or payroll cards also has the potential to qualify for CRA credit.
The Federal Reserve Board's Regulation DD implements the Truth in Savings Act, which helps consumers compare deposit accounts offered by depository institutions, principally through the disclosure of fees, the annual percentage yield, the interest rate and other account terms.
Payroll cards that operate similarly to courtesy pay or bounce-proof checking accounts fall under the purview of this regulation.
Equally difficult to address in regard to stored value cards is the issue of Federal Deposit Insurance Corp. (FDIC) insurance of the underlying value of stored value cards. In April of 2004, the FDIC published notice and comment of a proposed rule to clarify the meaning of "deposit" as it relates to funds underlying stored value cards at insured depository institutions.
In August 2005, the FDIC issued a proposed rule to clarify whether funds underlying stored value cards, such as employee payroll cards or retail store gift cards, qualify as deposits for insurance coverage purposes. The FDIC considers the funds that underlie stored value cards deposits if a depository institution has an obligation to either hold or transfer the funds. In that case, the funds qualify for insurance coverage following the same guidelines that apply to other deposits.
Comments on this rule were due by Nov. 7, 2005. To date, the final rule has not been issued.
To read more on the proposed rule, go to: www.fdic.gov/regulations/laws/federal/2005/05cstoredval88.pdf.
The USA PATRIOT Act requires financial institutions to be diligent in documenting customer identification. Financial institutions issuing payroll cards or general spending cards should require adequate documentation to verify the identity of the card recipient.
In the case of payroll cards, banks should conduct due diligence with their commercial customer to ensure the controls of the company are adequate to verify identity.
Another implication of the act applies to payroll cards and general spending cards where a second card is issued for a family member in another country. The challenge is in verifying the identity of individuals living outside the United States. To aid in this process, financial institutions should engage in effective dialogue and communicate control needs to their partnering institutions in the other country.
The Bank Secrecy Act (BSA) requires financial institutions and other financial service providers to keep certain paper trails on their customers' transactions. Issuers, sellers and redeemers of stored value cards are for the most part exempt from BSA. However, they are subject to certain reporting requirements under BSA to include cash transactions in excess of $10,000. Due diligence must be employed and controls put in place to prevent money laundering through these instruments.
State payroll laws vary and should be reviewed by financial institutions to ensure compliance in the structure of any payroll card offerings. Some states have laws requiring that employees have access to pay at no cost. Other laws govern whether direct deposit can be offered or mandated.
The person who receives a gift card or general spending card and never uses it up can cause a problem for financial institutions in states where strict laws govern abandoned property. Despite the card expiring, there are dollars left unspent. Financial institutions should follow the same procedures they would in the case of an abandoned depository account to ensure compliance with the law.
Consumers who choose to use stored value cards should understand how they work and be aware of possible fees.
Stored value cards may have entrance/activation fees, maintenance fees, point-of-sale fees, domestic ATM transaction fees (in and out of network), transaction limit fees, bill payment fees, phone or online transaction fees, reload fees, money transfer fees, international ATM transaction fees, inactivity fees, overdraft fees, overdraft protection fees, payday advance fees, credit-reporting fees and dispute fees.
The issuers of gift cards and general spending cards can easily disclose fees at the time of purchase to the purchaser. However, the transfer of these cards from the original recipient to another party raises disclosure concerns regarding the fees and other terms associated with the card, such as the expiration date, the amount or existence of maintenance or other types of fees, and information about where to call for assistance.
Cost-conscious consumers should compare the cost of using the more common reloadable general spending cards in lieu of a checking account or other alternative financial services, such as a check-casher or money-transfer service. Checking account fees, money order purchase fees and check cashing fees should all be considered.
For financial institutions, the opportunity to reach new customers or expand services to existing customers has a positive potential for the bottom line. However, financial institutions developing a stored value card product must consider how they will provide disclosures, notices, periodic statements and error resolution procedures.
A survey of stored value card providers conducted by the Center for Financial Services Innovation was inconclusive as to what makes a stored value card product profitable. However, a common denominator for most was scale.
To develop a profitable stored value card system structure, providers should complete a market analysis to determine card volume potential, card load potential, anticipated frequency of use, break-even analysis of frequency of use and potential float volume.
"Prepaid Cards: How Do They Function? How Are They Regulated?" 2004. Mark Furretti. Federal Reserve Bank of Philadelphia, conference summary.
Legislative Update. Stored Value Cards and Payroll Cards. Payment Cards Center. Federal Reserve Bank of Philadelphia.
"Stored Value Cards: An Alternative for the Unbanked?" Office of Regional and Community Affairs of the Federal Reserve Bank of New York.
Community Developments Insights. Paper from the Office of the Comptroller of the Currency, Community Affairs Department. June 2005. Samuel Frumking, William Reeves and Barry Wides et al.
"Banking the Poor: Policies to Bring Low-Income Americans Into the Financial Mainstream." Michael S. Barr. Metropolitan Policy Program. The Brookings Institution.
"Stored Value Cards: Challenges and Opportunities for Reaching Emerging Markets." April 2005. Working paper. Center for Financial Services Innovation. Kathy Jacob, Sabrina Su, Sherrie L.W. Rhine, and Jennifer Tescher.
"Prepaid Cards: An Important Innovation in Financial Services." Consumer Interests Annual. 2006. Julie S. Cheney and Sherrie L.W. Rhine.