By Maria Aspan
Banks could lose up to $20 billion of annual revenue if a large number of checking accountholders move their money to prepaid debit card accounts, according to a report released last week by Aite Group LLC.

At least 14% of U.S. checking-account customers would save money if they made such a switch, the Boston-based research firm reports.

Generally, the fees associated with prepaid cards are much higher than those on checking accounts. But the customers in question, most of whom have low incomes, paid 4% or more of the funds they deposited in checking accounts last year in fees for overdrafts and other penalties, Aite says. The fees on prepaid cards, which typically cannot be overdrawn, would compare favorably for roughly 9 million households, the report says.

"If consumers become more comfortable with prepaid debit cards, loading more money on their cards, banks will find themselves losing more customers," says Gwenn Bézard, Aite research director and the report's author. "So it's better for banks to start planning now what's going to be their alternate game plan instead of crossing their fingers and hoping that alternative providers are not" going to win away customers.

Such a game plan would include rethinking the traditional emphasis on checking accounts, he says.

Financial institutions seeking to acquire underbanked customers–those with few or no traditional banking relationships–largely have tried to do so by selling them traditional checking accounts. Even banks that offer nontraditional services such as funds transfers generally do so to get consumers to open more-traditional accounts.

Community banks have been the most active in trying to develop prepaid cards that are marketed as an alternative, instead of as a supplement, to traditional checking accounts, Bézard says. The larger banks, with the most checking accounts, also collect the most "nonsufficient funds," or overdraft, fees. "The ones that are NSF addicts, if you will, are really the large banks," Bézard says. "Community banks are not as engaged in trying to maximize NSF revenues."

Jennifer Tescher, director of the Center for Financial Services Innovation, a nonprofit affiliate of ShoreBank Corp., says that, "for banks, it's all about the checking account." But she appears more optimistic than Bézard about the likelihood of larger banks developing their own directly marketed prepaid products instead of ones they issue for third-party prepaid marketers.

"Prepaid should absolutely have a place in the broader account fleet that banks offer, as a legitimate product in its own right," she says. "Prepaid cards, those that are well-priced and well-structured with good consumer protections, are increasingly enabling consumers to work their way toward financial prosperity, as they would with a checking account."

Few banks offer prepaid debit cards as independent products without going through a third-party marketing partner, and generally it is smaller banks that offer them as independent products, Tescher and Bézard say.

Tescher says she knows of two large banks that are running pilots of prepaid debit cards offered directly, though she could not disclose their names.

"What I'm recommending is that banks not only issue the card but proactively offer the card as a lobby product," Tescher says. If the two large banks bring their debit cards out of pilot to a wider audience, "they could make a real difference and could light the way," she says.

In his report, Bézard argues that more consumers might switch entirely from checking accounts to prepaid debit card accounts as they become more comfortable with loading greater amounts on the cards, which would make using them more cost-effective because the fees would not rise with higher deposit amounts.

Right now, "the mean annual load amount on a prepaid debit card is about $3,500, compared with a mean of $49,400 for checking accounts," Bézard wrote.

Another Aite report, published two weeks ago, said 30% of the 400 consumers surveyed in November and December already had a prepaid debit card. "I was really surprised to see how many of the people we talked to actually have a prepaid debit card," Bézard says. "Clearly, the level of comfort is increasing."

Aite based its report on three sets of data: bank statements from 1,915 checking accountholders from November 2007 to October 2008, compiled by Lightspeed Online Research Inc.; account data from 8,140 prepaid debit card accountholders over the same period, compiled by an undisclosed major prepaid card provider; and a November 2008 Federal Deposit Insurance Corp. analysis of bank overdraft practices.

Industry representatives reacted to the report's findings with some skepticism. "We've always said that checking accounts aren't for everyone. They do require attention and management," says Nessa Feddis, senior federal counsel at the American Bankers Association. But "it's hard to argue that free checking accounts aren't beneficial to the customers," she says.

Prepaid card accounts have their own inconveniences and indirect costs, even if they cannot be overdrawn, Feddis points out. "A prepaid card means that transactions will be denied if there are insufficient funds. If a card's being used for important payments, like a mortgage or utilities, they may have the inconvenience of returning payments and then any additional fees charged" by the payee, she says.

James P. Maloney, chairman of the $79 million-asset Mitchell Bank, says the Milwaukee-based issuer has had a difficult time selling prepaid cards. "Our card is very cheap"–$3 to buy and $3 to reload–but "we have very little uptick on our card," he says. "We offer it, and nobody's knocking down our door."

Mitchell has not "given up" on prepaid debit, Maloney says, but for the time being he prefers consumers to sign up for traditional checking accounts.
"We really encourage people to use a checking account. Just be careful, and don't overdraw your account," he says.

Mitchell Bank does not offer fee-based overdraft protection, which Maloney calls "no better than a payday loan."

Maria Aspan is a reporter for American Banker.

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