Prepaid (Stored Value) Cards

The market for prepaid cards, sometimes called stored value cards, is one of the fastest growing segments of the retail financial services industry.  While the terms prepaid cards and stored-value cards are frequently used interchangeably, differences exist between the two products.  Prepaid cards are generally issued to persons who deposit funds into an account of the issuer.  During the funds deposit process, most issuers establish an account and obtain identifying data from the purchaser (e.g., name, phone number, and etc.).  Stored-value cards do not typically involve a deposit of funds as the value is prepaid and stored directly on the cards.  Because its business model requires cardholders to pay in advance, it substantially eliminates the nonpayment risk for the issuing financial institution.  The functionality of this product is leading to a wide range of card programs that operate in either closed or open-loop systems, and program innovation has resulted in the development of systems that operate in both structures.  Closed-loop systems are generally retailer/issuer business models, while general-purpose cards issued by financial institutions tend to operate in open-loop systems.  Open-loop system prepaid cards are processed using the same systems as the branded network cards - MasterCard, Visa, American Express, and Discover - and offer the same functionality.

In the past, prepaid cards were mostly issued by nonfinancial businesses in limited deployment environments such as mass transit systems and universities.  In recent years, prepaid cards have grown significantly as financial institutions and nonbank organizations target under-banked markets and overseas remittances.  Technological innovations in the way information is stored (e.g., magnetic strip or computer chip), the physical form of the payment mechanism, and biometric account access and authentication are converging to create efficiencies, reduce transaction times at the POS, and lower transaction costs.

There are several types of prepaid cards, including gift, payroll, travel, and teen cards.  Either the consumer or an issuer funds the account for the card.  When a consumer uses the card to make a purchase, the merchant deducts the amount of the purchase from the card.  Transaction authorization can take place through an existing network, a chip stored on the card, or information coded on the magnetic strip.  Once the stored value in the card is exhausted, customers may either replenish the value or acquire a new card.

In addition to cards, stored-value payment devices are emerging in a variety of other physical forms, most notably key fobs.  With the recent introduction of contactless payment technologies, use of chips (smart cards), radio frequency identification (RFID), and near field communication (NFC) payment devices are becoming more innovative.  Initiatives are underway to introduce mobile phones with integrated microchips that can initiate a payment when waved over a specially-equipped reader.  The integrated chip can store value, authenticate a consumer, or contain consumer preferences and loyalty program information that can be used for marketing purposes.

Prepaid cards may be subject to legal and regulatory risks.  For example, the Federal Reserve Board's final rule on Regulation E, issued August 30, 2006, extended its applicability to prepaid cards used for consumer's payroll.  The Federal Reserve Board noted that it will monitor the development of other card products and may reconsider Regulation E coverage as these products continue to develop.  State laws vary widely with regard to fees.  Additionally, financial institutions should ensure that prepaid card product programs comply with the BSA and anti-money laundering guidance.

 

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