Meet Virginia, Ariel and Leo (the names used in this article are pseudonyms). For varying reasons, each manages his or her financial life with little or no use of a traditional bank account.
Their stories don’t fit the stereotype of people who shun banks for cash or alternative payment methods. Virginia has a college degree and a good job that pays more than $2,000 a month. Ariel has a high school education, works two jobs and dreams of sending her two children to good colleges. Leo has a full-time job and is completing a college degree.
They all have had past experiences with banks. But for one reason or another, they ran into financial trouble or, in Virginia’s case, simply prefer the freedom of using cash. Ariel’s financial life is complicated by a costly chronic illness. Leo has difficulty controlling his spending. In the past, such consumers were likely to use payday lenders, check cashers, money orders and pawn shops to cover their financial needs. Today, they have discovered that prepaid cards help them manage money while avoiding the financial traps to which they are vulnerable, such as overdrafts and other bank fees.
These three are among the 106 million Americans in 40 million households who are considered financially underserved. The past decade has witnessed rapid transitions in the financial services available to households that do not use conventional checking and savings accounts. Banks and credit unions, retailers, nonprofit organizations, technology companies and others increasingly offer products that fall within the gap between mainstream bank accounts, which are inaccessible to some consumers, and “fringe” financial services such as checkcashing or payday loan services.
The big question today is whether prepaid cards and other newer products actually help people improve their financial well being. Fringe financial services do not provide access to the type of wealth-building opportunities offered by mainstream institutions. The hope is that ultimately the “bridge” products will do so. By keeping people from the trap of excessive fees that they can encounter with check cashers and checking accounts, these products may help them save for long-term goals and improve their credit scores, thus helping them toward prosperity. General purpose, branded (e.g., Visa, MasterCard, Discover, American Express) and reloadable prepaid cards are among the most popular of these “bridge” products.
The Unbanked: A Matter Of Choice?
For the millions of low- and moderateincome Americans without access to well-designed and reasonably priced financial services, meeting short-term and long-term financial needs can be difficult. Of the estimated 40 million American households that are financially underserved, roughly half — 18.5 million — are unbanked, meaning they have no checking or savings account with a bank or credit union. The others, 21.5 million, are underbanked. They may have an account, but they are not using it to its fullest, instead relying on a broad array of financial service providers to meet their short-term financial needs. Households are underserved for several reasons. For some households it is a matter of choice. The most frequently cited reason for having no checking account is that the household does not write enough checks to make it worthwhile.
For others, banklessness is involuntary, as financial institutions have created barriers, both intentional and unintentional, that have restricted access to traditional checking and savings accounts. These products are primarily sold in locations that are intimidating and inconvenient in terms of both geography and operating hours for working families. In addition, the marketing messages around these products are poorly tailored and fail to resonate with underserved consumers. Many households may not have enough money to meet account minimums. Similarly, because many financial institutions pull credit reports as part of the account-opening process, the millions of potential account holders with thin and non-existent credit histories are ineligible.
When consumers’ short-term financial needs are not well met, their ability to save, access credit and build assets in the long run is compromised. Without a safe place to store funds, underbanked consumers lack a financial cushion to weather crises. They are also more challenged to build a strong credit history, making it more difficult to access the credit they need at a reasonable price. This in turn makes it more likely that they will turn to products and providers that may cost more and potentially strip assets instead of helping to build them. The result is a two-tier financial system that is leaving a growing number of American families economically stagnant and vulnerable.
The Voice Of The Consumer: A Study
To learn how consumers use prepaid cards and whether the cards help financially underserved consumers manage their money and start down a path toward financial prosperity, the Center for Financial Services Innovation selected two prepaid provider firms for study — AccountNow and NetSpend. Both are leaders and innovators in the prepaid card industry. AccountNow distributes cards primarily over the Internet, while NetSpend sells cards primarily through grocery and convenience stores and checkcashing outlets.
This study investigated consumers’ use of and views about prepaid cards. At this point, industry and policy decisions to create financial products for currently unbanked households rest largely on analysis of the sources of banklessness and faith in households’ motivation and ability to use available services. Although individual firms have conducted proprietary market studies of their own products, there is little public knowledge about how new services are used or whether they are improving consumers’ financial lives.
Our study was designed to create general knowledge about how customers use innovative financial services and about whether these services can indeed serve as a gateway to long-term financial stability and prosperity. We found evidence to answer the following empirical questions:
By interpreting the findings from these questions, we addressed the larger question of whether prepaid cards improve the short- and longterm financial well-being of underbanked households.
Study Of Financial Situations
The study’s interviewees gave a variety of reasons for no longer having conventional accounts. Most had either closed their accounts or had their accounts closed by the banks for various reasons. The four main reasons included overdraft fees, unexpected or unanticipated fees, unauthorized account access and being a victim of identity theft. Interviewees also identified their own personal spending or money-management habits as contributing factors. In many cases, the consumers and banks attempted to reconcile the problems, with mixed results.
These were not unique or isolated incidents. Nearly all of the interviewees discussed incidents in which they had disputes with their banking institutions, and the manner in which the bank (or its officials) handled the incidents left them with a great mistrust of conventional checking and savings accounts.
Although a theme seems to be emerging that negative past experiences have turned some consumers away from banks and toward prepaid cards, six of the 22 respondents said they had both a conventional checking account and a prepaid card. Reasons for having both varied widely. The most common explanation was to keep funds for a specific purpose separated. Our findings suggest that prepaid cards appeal to unbanked consumers (both never-banked and previously banked) as well as underbanked consumers.
The Switch To Prepaid
Before becoming AccountNow or NetSpend customers, our interviewees had similar experiences with banks, financial problems and money management. Nine of the 12 AccountNow customers recalled coming across the product online either on their own or through a friend or relative. To some it was an accidental, but rather welcome, encounter. All NetSpend customers remembered coming across the product in a retail location. A majority of the interviewees had gone in to the store to cash a check, and they either noticed the prepaid card advertised or an attendant offered it to them. In many instances, NetSpend customers could not differentiate the card company from the check-cashing outlet. They often thought that NetSpend was an additional financial product of the check-cashing place. Customers signed up for cards because they thought the cards would be useful.
We asked interviewees about income and expenses, tracking details for each source, including the typical timing, the transaction method, the labor involved and the consumer’s subjective experiences around the transaction. It was clear that prepaid cards played an important role in interviewees’ day-to-day financial lives.
All interviewees regularly used their cards for bill payment or retail transactions. All but one used the card to pay at least one monthly bill, and the average number of bills paid was 2.4. The most common single bill-pay method was to call the payee and enter the prepaid card number as if paying by credit card, but most customers also used a mix of payment methods. Several customers also mentioned non-routine expenses, such as online purchases or car rentals. In general, however, most of our respondents’ budgets had little room for such discretionary spending.
The Advantages and Disadvantages
Overall, these consumers liked using their cards. They appreciated the convenience, simplicity and immediacy.
Convenience — Nearly all of the interviewees said their cards had made their lives easier. For instance, one respondent described the key attribute of AccountNow as, “It’s just convenience. That’s very important to me. I don’t have to go to a bank. I don’t have to [do anything else]. I mean, my money is direct deposited, so I don’t have to do anything there . . . and that I like.” Another respondent reported that she was impressed with how convenient it was to use her prepaid card. “I don’t know where it’s been all my life,” she said. “It just keeps getting better.”
Commonly, respondents compared their experiences with prepaid cards to prior money management routines, noting that the card kept them from having to run multiple places to cash a check, buy money orders, and then deliver payments. The only inconvenience mentioned involved loading cards for those who were not using direct deposit. Six of the 20 customers interviewed did not have direct deposit set up. For instance, as a freelancer and contract worker, one NetSpend customer found direct deposit unrealistic for much of her income. To load her card she has to physically take cash to a retail outlet. When outlets close or switch locations, routines are disrupted.
Accessibility — Because the cards carry Visa or MasterCard logos, they are accepted almost universally, and customers can buy whatever they want. This is useful, since customers can conduct transactions that are difficult with other means, such as buying online or renting cars. Virginia, who has no credit card, has used her card for travel.
At a second level, having a card gives customers a way to pay that does not differentiate them from other consumers who may be more financially advantaged. Whereas using a money order is a visible sign of not having a checking account, the prepaid cards act and look just like conventional credit or debit cards. There appeared to be a symbolic value of being able to get a Visa-branded card despite bad credit. Because the cards carry Visa or MasterCard logos, they are accepted almost universally, and customers can buy whatever they want.
The general acceptability of prepaid cards made one minor exception stand out. Both AccountNow and NetSpend customers complained that their cards could not be swiped at gas station pumps without a hold being placed on the available funds. “I wish they’d make it so I didn’t have [to do this],” one AccountNow customer lamented.
Immediate Liquidity —Customers, particularly those who use direct deposit, said they like that their money is available immediately. One respondent explained how she gets paid: “We don’t get checks in the mail. I get direct deposit on my NetSpend card. So I don’t see my pay stub. I don’t see a check. I just know that on Friday I can start spending money.” She compared that with her understanding of depositing a paycheck at a bank account: “Because the bank holds your check down even if it’s your regular payroll check, you know, they hold it for three days — you can have your funds in three days.”
Another plus is that account updates are available on demand. Customers said they get and use information about their balances by phone, by text, by e-mail, and by logging into their accounts online.
Simplicity and Transparency. Customers said they appreciate the easy-to-understand fee structures of the prepaid cards. They know the fees for their transactions and know that there will not be unexpected fees. Several compared their experiences with prepaid to banks. This respondent’s experience was typical:
“When I used the banks, every time I was turning around I was being charged for this, I was being billed for that, and if I went into the bank too many times they would charge me for [that]. If I, you know, ask for a copy of my statements they would charge me for that. Any little thing that I needed they would charge me for. With [prepaid cards] there is none of that. I know how much I spend a month to have them and that’s all that is.”
Built-in Discipline — For customers, prepaid cards provide much of the ease of a checking account with one major advantage: they cannot be overdrawn. If there are not sufficient funds to cover a point-of-sale transaction or requested debit, the transaction is turned down without a penalty to the cardholder.
Many users found this check on spending helpful, particularly those who have gotten into trouble with overspending and fraudulent (or merely over-optimistic) check writing in the past. Leo is one of them. He blamed his own poor money management for his inability to save enough to pay off his debt. He said he tends to spend too much and has even used his credit cards as “paychecks,” putting a strain on his health and well being.
Another respondent, freely admitting her trouble managing money, said she too appreciates this feature, noting, “The good thing about this though is that you can’t write checks and have them bounced. It’s like the funds are either there [or not]; the transaction either passes or doesn’t. So it’s a good discipline for me.”
Goals and Advancement
Prepaid cards are definitely useful for these customers’ day-to-day money management needs, but are the cards helping them achieve larger financial goals? As part of the interviews, we spoke with customers about their future financial plans and hopes. Saving enough to move into a different apartment, paying off a particular debt, buying new furniture or generating emergency savings was a top priority for many respondents.
Others mentioned goals that might take several years or more to achieve. Goals such as further education, career changes, or starting a business have longer timeframes and require effort and initiative beyond accumulating savings or improving credit. In their most basic transactional form, prepaid cards are not sufficient to help customers achieve longer-term goals that require combinations of savings, access to credit and other preparation.
How well do the services and features of prepaid cards align with the respondents’ goals? Prepaid cards may help customers achieve specific short-term goals that require a safe and secure way to transact or save money. For instance, one man who was surveyed would like to get his car paid off within a year. He said he currently pays his car payment over the phone with his AccountNow card. When funds are available, he can send more than the minimum to pay down the principal.
In any case, achieving short- or longterm goals requires behavioral change or commitment that stretches beyond the features of a particular financial product or service.
The Road Ahead
What do consumers’ experiences tell us about the usefulness of new financial products that are emerging across the financial services marketplace? Do the so-called “bridge” products provide a way for consumers to move toward greater financial wellbeing? In what ways could current products — and the current financial services market — be changed to better meet the needs of consumers not currently using conventional checking and savings accounts? We have only scratched the surface when it comes to answering these questions.
As to whether prepaid cards can help cardholders advance financially, there are few fixed conclusions. For consumers who don’t trust banks, the cards can offer a measure of financial stability. In addition, some goals, such as creating emergency savings, can be achieved with the current prepaid cards. Others, such as accessing mainstream credit for large purchases, will require products beyond prepaid. The bill payment reporting and savings products here represent a step toward that end but are not yet fully embraced by consumers. All goals will require effort and spending discipline on behalf of the customers in addition to well-designed financial products and services.
EDITOR’S NOTE: This article is adapted from a research report for the Center for Financial Services Innovation, April 2009. The report may be downloaded at no charge here.
About the Authors
Sarah Gordon is nonprofit relationship manager at the Center for Financial Services Innovation (CFSI). CFSI is a nonprofit affiliate of ShoreBank Corporation that facilitates financial services industry efforts to serve underbanked consumers across the economic, geographic and cultural spectrum. CFSI works with banks, credit unions, technology vendors, alternative service providers, consumer advocates and policy makers to forge pioneering relationships, products and strategies that will transform industry practice and the lives of underbanked consumers.
Jennifer Romich, Ph.D., is an assistant professor of social welfare at the University of Washington, where Eric Waithaka is a graduate student.
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