A new study from the Aite Group warns
that American banks are in danger of losing billions of dollars in
fees by relying too heavily on current account relationships as a
tool to acquire underbanked consumers, when those consumers can use
prepaid cards at a much lower cost. Charles Davis reports.


US banks risk losing up to $20.3 billion in
fees if they rely too heavily on current account relationships as a
tool to acquire underbanked consumers, according to a new report by
US payment consultancy Aite Group.

The villain, surprisingly, is the increasingly
popular prepaid card, which offers access to current accounts with
much lower fees for insufficient funds and other fees associated
with cheques. At least 14 percent of US current account customers
would pay less in fees if they switch to a prepaid debit card,
according to Aite.

Aite based the report on three sets of data:
bank statements from 1,915 current account holders between November
2007 and October 2008, compiled by Lightspeed Online Research;
account data from 8,140 prepaid debit card accountholders over the
same 12-month period, compiled by an undisclosed major prepaid card
provider; and a November 2008 Federal Deposit Insurance Corporation
(FDIC) analysis of bank overdraft practices.

The underbanked lose more in bank

The findings appear
counterintuitive, for prepaid card fees are among the highest in
the US banking industry. The difference lies in the fact that the
customers in question, most of which had lower incomes, paid 4
percent or more of the funds they deposited in current accounts
last year in fees for overdrafts and other penalties.

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“The median prepaid debit cardholder pays 3.5
percent of his or her deposit inflows in fees, compared with 0.4
percent for the median current account holder,” according to the

Financial institutions seeking to acquire
underbanked customers largely have tried to do so by selling them
traditional current accounts. Even banks that offer non-traditional
services such as funds transfers generally do so to get consumers
to open more traditional accounts. But as banks have grown
increasingly attracted to prepaid, Aite said, the realisation has
slowly dawned that as more customers become more reliant on cards,
the revenue banks once could count on is shrinking, despite the
fact that overall, current accounts generate fewer fees.

Accounts better than prepaid cards –

The study noted that, based on
current usage patterns, a current account is a much better product
than a prepaid debit card for many consumers. While only as many as
19 percent of current account holders don’t pay any fees, all
prepaid debit cardholders must pay some. And while 45 percent of
current account holders pay zero to 1 percent of their deposit
inflows in fees, only 7 percent of prepaid debit cardholders pay
such a minimum amount.

“The relative high cost of prepaid debit cards
for its current users is driven by usually modest load amounts,”
the study said. “The mean annual load amount on a prepaid debit
card is about $3,500, compared with a mean of $49,400 for current

Because prepaid debit cards’ cost structure is
heavily fixed (activation fee, monthly maintenance fee, reload
fee), they become cost-effective compared to current accounts only
after a certain load threshold.

“For most consumers, current accounts are
cheap as long as they guard themselves from insufficient funds,”
the study said. “Nevertheless, banks’ focus on maximising
insufficient funds income makes these fees pricy for a specific
customer segment. For those customers, a key benefit of prepaid
debit cards is that their issuers don’t typically authorise
overdrafts, nor charge insufficient funds fees.”

If current prepaid debit cardholders were to
increase their loads, the relative cost of use would drop

Minority would benefit from

The report said there is a strong
case for a minority of consumers to switch from current accounts to
prepaid debit cards. In addition, a strong case exists for
alternative financial services providers to seek to displace banks’
relationships for that customer segment.

Aite also believes there is a case
for banks to embrace prepaid debit cards as an alternative to
current accounts for that segment. That case, however, probably
cannot be established by pure economics, since banks would likely
lose significant revenues in the transition.

Assuming constant deposit inflows, switching
candidates could save a median $960 and a mean $720 annually by
moving from a current account to a prepaid debit card. This is good
news for the 14 percent of current account consumers who spend more
than 4 percent of their deposit inflows in fees, who would be
better off dropping their current accounts in favour of prepaid
debit cards.

If that entire segment were to switch, new
revenues associated with their use of prepaid debit cards would
amount to $11.5 billion in 2009. If banks were to orchestrate the
switch to prepaid debit cards and collect the associated new
revenues, they would lose $8.7 billion in fee income in 2009.

If all the switching candidates were to defect
from banks and start doing business only with alternative financial
services providers, those vendors could potentially collect $18.8
billion in new revenues in 2009. Prepaid debit card marketers, such
as GreenDot, NetSpend, and AccountNow could potentially collect
$11.5 billion in new revenues. In addition, payday lenders could
collect $7.2 billion in aggregated new revenues. In that scenario,
consumers could pocket a saving of $1.5 billion in 2009.

“Banks are clearly in a tough spot,” the
report said. “Based on our analysis of current account customer
statements, we estimate about 46 percent of their service-charge
fee income risks disruption from third-party prepaid debit card
providers. While the status quo is most desirable for banks, rising
competition from alternative financial services providers is
undermining it a little more every day.”

Banks could recoup some of these potential
losses by developing more co-branded prepaid products with existing
providers, the report added. Such a strategy should include
rethinking the traditional emphasis on current accounts. That will
require some help from the politicians, Aite said.

“Lawmakers and regulators should stop seeing
banks and current accounts as the only legitimate provider of basic
banking services,” the report said. “Short of government-subsidised
banking services and/or the transformation of the US Postal Service
into a bank, regulators need to wake up to the lower-cost
alternatives outside of the mainstream.”