Consumer use of prepaid gift cards grew 10% in 2012, up to $110 billion in card loads, but an increase in fraudulent use of those cards and a growing need to protect consumers could follow, a new report warns.

The popularity of merchant-issued gift cards also illustrates how newer payment schemes can pull transaction volume away from the card networks and issuers, according to CEB TowerGroup's annual report on the industry.

Gift cards also carry the potential for fraud with far less consumer protection, says

Brian Riley, senior research director and analyst with Needham, Mass.-based CEB TowerGroup.

"We are seeing several issues involving fraud with gift cards, and everything points back to the consumer holding the liability," Riley says.

While consumer acceptance of gift cards received a boost from an amendment to the CARD Act that eliminated many junk fees and expiration dates, other issues remain. Consumers now must be wary of transaction fraud because the Consumer Financial Protection Bureau has not taken a strong stance on gift card protections, the report says.

The liability falls on a consumer, rather than the merchant or bank, if a gift card is lost or stolen. As such, card fraud could directly affect product growth, especially in the electronic segment, the report adds.

"All existing fraud systems for credit cards are based on consumer behavioral patterns, but there is none of that with gift cards," Riley says. "In some cases, such as Starbucks, you can register the gift card and replace it for a fee if it is lost or stolen."

For better consumer protection, the report states, the CFPB needs to further study the issue, while issuers and processors must develop technology to thwart gift card fraud. In addition, generally accepted accounting principles should be in place even for private label gift cards, which essentially leave consumer funds in the hands of non-financial institutions.

"The key here is, what is the incentive for the issuer or processor to protect gift cards?" Riley asks. Currently, most issuers would say they should not have to pay for what the consumer essentially takes on at his own risk, he adds.

"But they are going to consumers with a product that is not totally safe, and that's the issue," Riley says. "There is no warning label on a gift card outlining potential dangers."

In addition, gift cards face the same challenges as banks regarding the uncertainty over future developments in merchant payments, whether they are co-branded relationships or alliances with networks as seen with the Bluebird prepaid card established through American Express and Walmart, the report says. 

Even though it seems unlikely that a "full-blown alternative network" will be launched in the next two to three years, the gift card industry faces threats from joint ventures such as Isis or the Merchant Customer Exchange, the report says. 

Digital gift cards will fall into the same category as other retail mobile transactions because banks, retailers and mobile network providers will continue to struggle over ownership of those consumer accounts, the report says.

Since CEB TowerGroup first began projecting gift card growth in 2006, the industry has enjoyed an overall 34% increase in card loads over the past six years from $82 billion to the current $110 billion. That increase offsets decreases that occurred during the 2008 to 2010 recession, the report notes.

CEB TowerGroup estimates gift card loads will continue to grow through 2015, when as much as $138 billion in sales is expected. Such growth confirms that issuers have definitely established gift cards as a mature financial product, available to consumers from financial institutions, restaurants, retailers and various merchants, the report says.

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