Beyond Compliance, the Precedent and the Opportunity this Rule Represents
The Consumer Financial Protection Bureau’s (CFPB) Prepaid Final Rule adds significant compliance requirements to prepaid products that will be especially cumbersome for non-bank issuers unfamiliar with Regulation E and Regulation Z. Reading between the lines, however, this rule will potentially have lasting effects on all financial institutions, even those that do not offer prepaid products. Its philosophy and mandates provide likely clues for overdraft rulemaking, still anticipated as a high priority by the CFPB.
On the other hand, the rule is likely to cause a significant shakeup in the prepaid product industry, presenting financial institutions with a timely and unusual opportunity to attract the difficult-to-reach unbanked and underbanked customer populations.
Responding to the Prepaid Final Rule Requirements
According to the CFPB, “Prepaid accounts are among the fastest growing consumer financial products in the United States.” Its news release announcing the prepaid rule notes that less than $1 billion was loaded onto prepaid products in 2003, but nine years later, that total had risen to almost $65 billion. Until now, these alternative financial products, which consumers use much like debit cards, were not subject to all the regulations that apply to traditional financial products.
On Oct. 1, 2017, that will change as part of the CFPB’s effort to alleviate consumer concerns with these products. The CFPB’s October Monthly Complaint Snapshot, published just three weeks after the Prepaid Final Rule, sheds light on the CFPB’s perspective two years after it began accepting complaints in this category: “As of October 1, 2016, the Bureau had handled approximately 6,000 prepaid product complaints.” The three biggest complaint areas—unauthorized transactions, product registration difficulty and error-resolution problems—closely mirror the rule’s regulatory requirements.
Beware if Your Bank Offers a Digital Wallet Product
Financial institutions may assume this rule does not apply to them if they do not offer reloadable prepaid cards, but this rule includes multiple digital banking services–one in particular–that many banks offer today: digital wallets.
In its summary, “What to Know About CFPB’s Prepaid Card Rule,” the legal news source Law360 explains that, “In particular, digital wallets capable of storing funds (and not simply storing payment credentials) that can be used, for example, for purchases at multiple unaffiliated merchants or to conduct P2P transfers are considered ‘prepaid accounts,’ even if only a portion of the wallet can store funds, and even if the consumer does not use the funds-sharing functionality of the wallet.”
The full list of covered products per the rule includes the following:
- Prepaid cards, including general purpose reloadable cards
- Digital wallets
- Person-to-person payment products
- Other electronic prepaid accounts that can store funds, such as payroll, student financial aid disbursement and tax refund cards, as well as certain government benefit cards
Aspects of Regulation E and Regulation Z Now Apply to Prepaid Products
The 1,689-page rule boils down to these four requirements:
- Prepaid protections: The law firm of Kilpatrick Townsend advises bank clients that covered prepaid products would be subject to Regulation E’s limited liability and error-resolution requirements “regardless of whether the financial institution has completed the consumer identification and verification process with respect to the account.” These protections include free and easy access to account information, error-resolution rights, and protections for lost cards and unauthorized transactions.
- Disclosures: Kilpatrick Townsend also explains that, “Financial institutions will generally be required to provide both a ‘short form’ disclosure and a ‘long form’ disclosure before a customer acquires a prepaid account.” This new requirement for standard and easy-to-understand disclosures applies the “Know Before You Owe” concept to prepaid products and will likely necessitate significant changes to the product packaging currently found on retail shelves.
- Credit protections: The rule “amends Regulations E and Z generally to regulate prepaid accounts that offer overdraft features,” says Kilpatrick Townsend. The CFPB states that, “Prepaid companies must now generally offer protections similar to those for credit cards if consumers are allowed to use credit on their accounts to pay for transactions that they lack the money to cover.” These protections include an ability-to-pay standard, monthly billing statements, reasonable payback timeframes, and limits on interest rates and fees.
- Other protections: The rule “requires companies to wait 30 days after a consumer registers the prepaid account before offering the credit feature to the consumer.” It also demands that a wall be placed between the product’s prepaid fund feature and its credit repayment feature.
Reading the Precedent This Sets for Overdraft Rulemaking
Kilpatrick Townsend points out that, “This final rule highlights how the ability-to-pay/ability-to-repay requirement has become a benchmark for the Bureau.” Already applied to multiple consumer lending products, including credit cards, mortgages and small-dollar loans, the requirement will likely be part of any future overdraft rulemaking issued by the CFPB. Even though that rulemaking has been on the table for some time without a verdict, the CFPB continues to identify it as one of its priorities for the near term, categorizing it as “Open-use Credit,” which includes overdraft products.
In “CFPB Targets Overdraft Programs,” Law360 explains that open-use credit is a product “offered without an expectation that the loan will be used for a specific purchase.” Finding this connection to overdraft products worrisome, it warns that, “By characterizing the payment of an overdraft as a ‘loan,’ the CFPB is indicating its intention to use its authority to regulate overdraft programs similar to other consumer lending.” This could spell major changes to existing overdraft products.
Recognizing the Opportunity to Attract the Unbanked and the Underbanked
The rule’s changes to Regulation E will require some work by financial institutions, but it should be mostly a matter of expanding existing Regulation E compliance programs to include prepaid products. This is not necessarily the case for non-banks, many of which are completely unfamiliar with Regulation E’s error-resolution rights and other protections. As a result, this non-bank portion of the prepaid industry will most likely shrink down to the major players, like PayPal and Green Dot, whose size will allow them to absorb the jump in compliance costs or pass it on to consumers in the form of higher fees.
Who Uses Prepaid Products and Why
Although the FDIC’s 2015 National Survey of Unbanked and Underbanked Households found that recent growth in prepaid card use “occurred broadly across socioeconomic and demographic groups,” it also discovered that, “Use of prepaid cards was most prevalent among unbanked households.” Specifically, “An estimated 27.1 percent of unbanked households used a prepaid card in 2015, compared to 15.4 percent of underbanked households and 6.9 percent of fully banked households.” The survey identified almost nine million households as unbanked and 24.5 million as underbanked. That means more than 6.2 million households are intentionally choosing an alternative financial product rather than traditional institutions’ checking account or debit card products.
According to the FDIC survey, the unbanked cited insufficient money to maintain an account as the most common reason for not using a traditional bank. While that may not make them particularly attractive as potential customers, other unbanked consumers cited wholly different reasons: privacy concerns, lack of trust in banks and high or unpredictable fees. Within that group are potentially profitable customers who need to be convinced of the benefits of traditional banking. If one of their favorite alternatives of choice, the prepaid product, becomes less available or incurs higher fees as a result of the CFPB’s Final Prepaid Rule, as is likely, they may be much more receptive to that message.
Banks that can assure such consumers of their commitment to consumer privacy, customer well-being and reasonable fees—all standards long associated with community banks—have an opportunity to seriously court an untapped segment of the population. Such customer acquisition is crucial in today’s competitive environment and vital to long-term profitability.
But, What If …
Having said all that, there is still an unknown variable. After an election that defied almost all political precedent, it is difficult to predict what action the new administration will take in regard to the Dodd-Frank Act or one of its key components, the CFPB. Yes, the Trump campaign rhetoric included arguments for reducing regulatory burdens, but it is still unclear where this falls among the president-elect’s priorities or how much or how quickly it will impact the regulatory environment. Some have suggested the administration will shut down the CFPB; others think it will be restructured, replacing the lone directorship with a five-member nonpartisan commission.
One thing is for sure, as American Banker reports, Senator Elizabeth Warren, one of the original advocates and most vocal proponents of the CFPB, is already garnering her party’s support to ward off significant changes to it. Until the long-term impact on the CFPB from a Trump administration becomes clearer, financial institutions offering covered prepaid products have no choice but to prepare for compliance, and it is in their best interest to understand the precedent it sets for overdrafts and the opportunity it presents for new customers.
Amber Goodrich, compliance strategist for CSI Regulatory Compliance, has more than 10 years of financial industry experience. She is a Certified Regulatory Compliance Manager (CRCM) and Certified Bank Secrecy Act (BSA) Professional (CBAP).