Approximately 37 million adults in the United States — a number roughly equivalent to the population of California — do not have a checking account. Some of those individuals have never relied on traditional banking.
However, our research shows the majority previously had bank accounts. The primary reason these "unbanked" consumers gave up on traditional bank accounts? Overdraft penalty fees.
Instead of accounts associated with surprise fees, unbanked consumers have been using prepaid cards. The product, which lets consumers load funds via direct deposit or with cash, can be used to withdraw funds from ATMs or to make purchases at retail outlets — just like checking accounts. But unlike checking accounts, prepaid cards have predictable, upfront costs without unexpected charges such as overdraft fees. The pricing model needs to stay that way.
As the Consumer Financial Protection Bureau prepares to finalize its rule on prepaid cards, there have been many comments — including in the media — on whether to allow overdraft fees on prepaid products. Some of the discussion concerning the bureau's impending rule has underestimated the impact of overdraft fees on consumers. Industry advocates argue that overregulation has limited free checking options, thereby causing consumers to abandon checking accounts.
However, any discussion about how to provide better financial services to the public has to start with understanding that overdraft fees drive people away from banks — and this has consequences. Specifically, once consumers leave the banking system — either because they don't want to pay the high fees or because their account is delinquent — their options for affordably and safely managing their finances are limited.
This is supported with data. For a typical fee of $35, most U.S. banks allow consumers to overdraw their accounts — often referred to as a negative balance — when they don't have sufficient funds to cover debit card point-of-sale and ATM transactions. However, the CFPB has shown that most debit card purchases that incur the fee are under $25.
Prepaid card products with transparent pricing and no risk of overdraft fees can help solve this problem. In nationally representative surveys, consumers say they rely on prepaid accounts to avoid debt, manage their spending, and — notably — escape overdraft fees.
Allowing overdraft programs on prepaid accounts would not level the playing field or ensure consumer access to needed financial products. Rather, it would endanger consumers' ability to use prepaid cards as a way to get back on track and build a secure financial future. It is essential for the agency to follow through on its proposal that effectively bans overdraft fees on prepaid cards.
To be sure, some commentators have raised legitimate concerns about the bureau's proposed rule. For example, the rule, as it is written, could be interpreted to punish prepaid providers when a consumer's account inadvertently drops to a negative balance. If this scenario happened, heavy burdens could be placed on providers to maintain only positive balances on all accounts at all times.
The solution to this problem, however, is simple: The CFPB should prohibit imposing fees or other charges as a result of negative balances. Further, the agency should allow providers flexibility to honor transactions, such as preauthorized account withdrawals, that periodically take account balances slightly negative.
The prepaid market has thrived for years as a safe haven for consumers who were not well-served by traditional banking products. For the most part, the bureau's proposed rule mandates policies that most providers already follow voluntarily. Prohibiting overdraft fees would not derail the prepaid market because so few providers currently offer overdraft protection. The bureau should move forward expeditiously to finalize its proposed rule and clarify that automated overdraft products are not allowed on prepaid accounts. Doing so will provide marketplace certainty and better protect consumers.
Thaddeus King is an officer with the consumer banking project at The Pew Charitable Trusts.