Mastercard Europe 2^nd Annual Prepaid Conference , Cannes, 8 May 2008

I’m flattered to be here opening your prepaid conference. Because I’m not a prepaid person. I’m not here to tell you about how great they are or explain the business opportunities. I have been asked to look at prepaid cards from the point of view of the consumer. Or at least the consumer journalist because that’s what I am.

I’ve been a financial journalist for more than twenty years. And my bias is towards the consumer. So I’m not here to give you the big picture, the wonders of prepaid cards. I am here to analyse the detail. I’m on assignment if you like to look at prepaid cards and write about their strengths and weaknesses. And as prepaid grows that is the analysis you will have to face.

But I am not here on behalf of Money Box, or still less the BBC, but as a freelance, as myself.

I’ve called my talk 5 grams of PVC. This little standard plastic item now forty odd years old that outnumbers human beings in many countries in the developed world. We already have two kinds of plastic – debit cards and credit cards. And many people don’t understand the difference between them. That’s certainly my experience writing and talking about finance in the UK.

And in the US the National Consumers League found that three out of four people were unclear about the difference between a credit and a debit card. So with two identical bits of plastic that have different functions why a third card?

Let’s look first at what we have – or had. You can think of it like this.

I don’t have to tell you – but I’m going to just in case anyone here is three out of four Americans and hasn’t really thought about it – that a credit card buys the item now but the user pays in the future. With a debit card you buy the item now but the user also pays now. The money is debited from your account that day. You might say a credit card is a pay sometime card. A debt card is a pay today card. We can look at it like this.

We can see that there is a gap in this table. To complete the matrix you need a card that you have paid in the past. Step forward, prepaid cards.

There’s a certain neatness, a completeness. It’s like the periodic table of elements or the table of elementary particles physicists use. Past present future. It’s the set, it’s neat.

How do the card providers make money from these three different products?

Credit cards are very clear of course. The people who run up a debt pay interest, usually at a very high rate – 16.4% is the average in the UK. The people who pay late or miss payments or exceed their credit limit pay a penalty – fixed now at £12 in the UK but it used to be £25 for a simple error. At one time nearly half the income of credit card companies came from these penalty fees. When the amount of the penalty was halved by the Office of Fair Trading interest rates rose from an average 14.9% to 16.4%. Or perhaps that was the credit crunch. Whatever the reason interest rates are about three times the overnight LIBOR rate. Then there is the profit on insurance against not being able to meet the repayments or against losing the card. Largely useless and very expensive but an income stream for the banks.

And for those who don’t run up a debt, make errors or buy insurance there are still the merchant fees paid by the retailer. Based not on what it costs to process a payment but on a percentage of the price paid. A sort of bank tax on the cost of buying goods using your 5g of PVC. All in all a very profitable business.

Debit cards – the second use of plastic – are not quite so good for banks. There is no debt so no high interest rates. There are merchant fees of course, but they are small and usually a fixed amount not a percentage. There is another source of profit – and I’m talking the UK model here. Not every transaction is checked against the balance it is drawn from. In the UK that can mean that it is possible to go overdrawn. And if that overdraft is unauthorised – or as the banks like to call it now an informal request for an overdraft – the charges are very high. Up to £35 a time just to let through a payment that isn’t authorised. And it’s the same charge if the payment is refused. These amounts are so high that in the UK the courts are considering whether they are lawful or not. And of course there are insurance sales opportunities here too.

So what are the profit opportunities from prepaid cards? There’s no credit, no debt so no income there. And because prepaid prevents debt and errors there are no penalty fees – that profit stream is dry. With a prepaid card the bank actually holds the customer’s money. So really it should be paying interest on that money. If it doesn’t do that – and none do – then the bank makes interest by lending it out. There are also merchant fees. But would they be a percentage like a credit card or debit card flat fee? And there may be insurance opportunities, though they are clearly not very good.

So what’s left? Fees.

To charge fees you need demand. And apart from the neatness of filling all the boxes why invent prepaid – or as one industry magazine now calls it – PayBefore?

Because prepaid is not for everyone.

If you have a credit card that you pay off in full each month –no need for prepaid – where’s the advantage?

If you have a debit card and never go overdrawn – no need for prepaid – where’s the advantage?

There are niche markets I know – travel money; online use where it is safer than a credit card – but these are small and of course all they do is correct problems of credit or debit cards that could be sorted out anyway.

So who is prepaid right for? Who should use it as their day to day spending card?

They are for people who don’t have a credit card; people who don’t have a debit card. Or people who don’t want them. Now that is not to say these people are bad with money. There is a middle class view – and I’m sorry to give you my English take on the world – but a view of those comfortably off shall we say that the poor are feckless, hopeless with money and that’s why they’re poor. It’s not true. Generally those who have very little money are very good with it.

David Frost – a TV entrepreneur – once said that wealth is having so much money that spending it is just like turning on the tap. Whether you want a glass of water or to fill a swimming pool you just turn that tap – it’s neither here nor there.

And it is a useful analogy. Who is careful with water? Is it the person whose water comes out of a tap in whatever quantity they want? Most of us I’m sure. Or is it the person who walks five miles to fill ten gallon plastic containers and whose children have to help carry them back to their home? Every day? Like this family in southern Sudan?

Photo: Emma Lynch 2007

Which of them looks after their water and treats it with respect?

And it is the same with money. Low income families traditionally manage their money in cash – cash is the physical representation of what they own. You are paid in cash on a Friday, have a bit of a drink on Saturday night, and then allocate the notes and coins to deal with food, rent, and travel. And you put aside a small amount each week to save for clothes or larger items.

But in a plastic card and bank account world those who pay only with cash and live in a cash economy pay dear for it. If their employer pays them by cheque then they have to go to a cheque casher to convert the cheque into cash. 5% to 8% though up to 13% and there are often fees on top. If they want credit then they have to rely on a doorstep lender. Britain’s biggest and best known is Provident. They lend for example £300 with 56 easy weekly repayments of £9. Total repaid is £504. In other words of those 56 payments 33 are repaying the loan and 22 are paying the interest, one is mixed. And the APR is 183.2%. If you want a loan over a shorter period you can borrow over 31 weeks. The same £300 will be repaid at £15 a week. Total cost £465. 20 payments clear the bill, 11 payments are the interest. APR is 365.1%.

Even worse are the so-called payday loans. Payday Bank for example lends you £400 for a month and you repay £500. APR is 1355%

In some countries in Europe such interest rates would be illegal. In Germany the interest rates charged on some UK credit cards would be illegal! But not in the UK.

These companies are taking advantage of the cash economy. They lend to people with no credit record, the repayments are in cash and every week, and they are collected in person by someone you may well know who lives nearby. And although the APRs seem huge, what the borrower focuses on is repayability. Can I afford that repayment of £9 a week? If so I’ll take the loan. Do I need to get this cheque cashed when perhaps there’s an overdraft on my current account – and 85% of those who use cheque cashing services have a bank or building society account – if the answer is yes, then I’ll pay the fee.

People who pay their bills in cash also pay more. The cheapest deals are not available to those who don’t have a bank account and a direct debit facility. Some phone companies simply won’t deal with you. Others like British Gas and the other energy companies offer a discount, around 5%, for paying by direct debit. Some companies like the major telecoms supplier BT have turned this round and now set their charges and then add a surcharge of £4.50 for those who pay by cash.

In the UK low income households pay more for their gas and electricity. If you want to pay as you go then you can have a pre-payment meter. That takes a token which you recharge at your local shop with PayPoint. But prepayment tariffs on average cost £145 more per year than a direct debit account.

So the cash economy is expensive. Both for access to credit and for paying regular bills. It’s why the poor pay more.

Lack of a bank account also means it is difficult to get access to benefits or to wages as employers demand a bank account to credit them to.

That is why routes into the banking system are seen as important. If you don’t have a bank account you are called

unbanked

Research which is now quite old – 1999 – found that 1.5 million UK households, about 7%, had no bank or building society account. And 4.4 million – about 20% or one in five – had only very limited access to financial services.

Then the government got interested in financial inclusion. And launched its own research into the number of the financially excluded. Using its own Family Resources Survey it decided there were 1.8 million households – containing 2.8 million adults – without access to a bank account. Those are 2002/03 UK figures.

The latest figures show that fewer people are now completely unbanked. Figures for 2005/06 show that the number had fallen to 2 million adults in 1.3 million households – a fall of 28% or 800,000 adults who had gained access to a bank account.

That reduction has been due partly to the introduction of basic bank accounts. The Government leant on the banks to introduce these ‘basic bank accounts’. And they are now provided by 14 banks and 3 building societies. All allow direct debits and all provide a cash card to withdraw money from an ATM. But only 5 provide a debit card to pay from the account by plastic in shops and online. None offers an overdraft, a cheque book, a cheque guarantee card, or a credit card.

The government recognises that access to bank accounts is just stage one of financial exclusion. Its latest report published in December 2007 added access to cheap credit, access to savings accounts, access to insurance – I don’t know how the industry sneaked that one in! Let’s help people who can’t afford to have a bank account and struggle to pay for food, rent and clothes – I know we’ll sell them insurance, preferably against things they are unlikely to suffer from and when they do we won’t always pay up. Mmmm.

Unfortunately the plan did not include anything about access to plastic money. Though it is to do what it calls a ‘scoping study’ of the emergence of new payment technologies such as what it calls prepaid debit cards. Consider yourselves scoped.

In 2004 the Government announced a financial inclusion fund for 2005-2008 with £120mn and a financial inclusion taskforce. In 2008-11 that

was extended – the taskforce got another three years and will run to March 2011 and the fund now gets £130 million over the three years 2008-2011; and just to show how seriously the Government takes it there is also to be a ministerial working group.

It makes you think doesn’t it – with around a million households unbanked – most of them poor – wouldn’t the money be better spent by giving them all £250 over six years?

My view is that a bank account is indeed step one of financial inclusion. But financial exclusion is not just the unbanked. It is also the

unplasticked

Access to this 5g of PVC is the key to many financial needs.

• Payment over the phone
• Payment online

• Feeling a part of financial society.

People don’t have a plastic card because

Some have

• No choice
  • Don’t have a bank account
  • Can’t get credit

Others

• Choose
  • They don’t want credit
  • Don’t want to risk an overdraft

Still others are just

• Used to cash

So these are people who might like prepaid cards – those who don’t want or cannot get credit. Who don’t have a bank account or are afraid of going overdrawn. Those who manage in cash. And they are those who have been

• Refused credit, or
• Are credit averse, or
• Just have a low income

So what does prepaid offer them?

Certainly financial inclusion in the plastic economy. And not just being in it – seeming to be in it. It’s interesting that while credit cards are branded Mastercard and debit cards are branded Maestro there is no brand for prepaid. They adopt one of those other two brands (or Visa) so people think they have – even pretend they have – a credit card or a debit card when in fact they have a prepaid card. And even the merchant fee follows the brand so a MasterCard transaction incurs a percentage charge – the bank tax on our purchases – a Maestro payment incurs a debit card fee. It’s a chameleon card.

It also helps avoid debt. Because you cannot get a debt on a prepaid card. When it’s gone it’s gone. And in that way it is a bit like cash.

But if the main reason is that it helps you manage your money like cash, then that does beg the question why not just use cash?

Advantages over cash

1. Safety – useless if stolen
2. Looks and feels like plastic

But the big disadvantage

1. Not physical so can’t easily see how much is left
2. Costs more.

So prepaid gives you financial – or plastic – inclusion. It carries no risk of debt. It’s secure. It helps you manage your money like cash itself . Now those are big advantages. Perhaps worth paying for. But how much does a prepaid card cost?

Let’s go back to our original scheme and our box that was just labelled ‘fees’ and look at what fees they are.

They won’t all fit in the box so let’s spread them out.

Fees for having the card

1. Application fee – up to £13.95
2. Monthly usage fee – up to £5.95
3. Annual renewal fee – up to £9.95
4. Replacement fee – up to £10

Fees for putting money on the card

1. Loading fee – up to 5% or £8
   1. credit card – up to 5% or £3
   2. debit card – up to 5% or £3
   3. Post Office – up to £1
   4. PayPoint/payzone etc – up to 4%
   5. own bank – up to 1%
   6. online – up to 5% or £3
   7. SMS

Fees for taking money off the card

1. UK
   1. ATM withdrawal fee – up to 2.95%; up to £7.50
   2. face to face retail fee – up to 2.5% up to £1.50
   3. internet purchase fee – up to 2.5% up to £1.10
2. Abroad
   1. Loading fee (foreign transaction fee) – up to 3.5%
      1. ATM withdrawal fee – up to £3
      2. face to face retail fee – up to 2%

Fees for not using the card

1. Inactivity fee – up to £2.99
2. Cancellation fee – up to £10 + 2% of balance

Other fees

1. Paper statement fee
2. Forgotten PIN fee
3. Postal ID check fee
4. Card activation fee
5. Currency conversion fee
6. SMS balance fee
7. Cash out fee
8. Additional card fee
9. SMS block/unblock fee
10. Refund fee
11. Decline fee
12. Retail refund fee
13. Retailer cashback fee

That’s 32 fees and if I had another slide I could get up to 40. Who said bankers have no imagination?

And that’s before we take account of loss of interest on the money, high costs for calls to the helpline, and of course those merchant fees – not paid indirectly by the customer through higher prices. That point was made recently by the British Retail Consortium – which represents British shopkeepers and is campaigning against the replacement of cash by plastic because of the cost that introduces – and which ultimately the consumer pays.

Banks make more money than the rest of us because they are better at arithmetic. They know that taking £1 off 1,000,000 people is easier than taking £1,000,000 off one person. Now it seems that they are also more imaginative than the rest of us. The taking-money-off-customers-without-them-noticing department has been working overtime hasn’t it?

I mentioned my fictional taking-money-off-customers-without-them-noticing department once on the television. Within an hour I had an email back from someone who said. ‘It’s true. My Dad used to work in it. They called it the Retail Innovations Unit!’

When I came to look at prepaid cards – which are still a relatively new phenomenon – I turned of course to arithmetic and a spreadsheet. What are the charges? And what would it cost to use one regularly? This mind boggling array of charges defeated me at first.

So I tried one card at random. The News of the World Pay Monthly card. And I imagined a story for its use.

Maria is Patrick’s aunt. And when he got great exam results she set up a prepaid account and put in £100 using her debit card. Fee £1.95. Balance on card £98.05. Then there’s the application fee of £6.49. Balance £91.56. Then £5 of that is credited back. Balance £96.56. Her nephew Patrick keeps the card for three months. So he pays three monthly fees of £4.99 which is £14.97. Patrick thinks it is a glorified cash card. So he uses it at the ATM. Five times. Paying 50p in fees each time and he only takes out a tenner. Now he’s down to £29.09. Maria takes Patrick to Ireland to see a relative and he draws out €20 there paying £2.25 for the privilege. Those €20 cost him £16. Which leaves him with £10.84 on his card. He checks up on his balance when he gets back. Thinks ‘this is a rip off. Maria paid in £100 and I’ve had £66 and it’s nearly empty’ I don’t want to use it any more and cancels it. There is a £10 fee for that and his aunt is credited with the 84p.

So out of the original £100 his aunt paid Patrick has had £66 and, but for 84p, the card provider has had the rest, more than £33. Now, I am sure that Patrick and his aunt used the card in exactly the wrong way. But who’s to say what people will do with a card? Especially among consumers who use cheque cashing, payday loans, and doorstep lending? Not exactly financial sophisticates are they?

The costs were so high I thought I might have misunderstood the rules. So I contacted the people at moneysupermarket.com who are the professionals at this kind of thing. I was very glad to hear it had defeated them at first. But they do now have a new measure – the monthly cost of ownership of a prepaid card.

To get that of course you have to make assumptions and here they are.

You load on £310 in one go by the cheapest means for that card – which is often zero.You spend that £310 over a month in 5 purchases of £50 each in the UK and two ATM visits of £30 each also in the UK.

I am grateful to Steve Willey at moneyspermarket.com for letting me use this information which is about to be published on the website.

Moneysupermarket.com compared the 28 cards on its database – 16 of which are run by Newcastle Building Society. Though the Society says in its annual report it has 50 separate brandings – and indeed was a winner this time last year at the first Mastercard annual prepaid conference. Inevitably the cards are produced by Newcastle’s ‘Card Solutions department’ – solution to what I wasn’t quite sure.

Moneysupermarket found that the cheapest monthly cost was Club 18-30 at £3.75 a month. And the most expensive was JustCash at £16.91 a month. To run an account that has £310 in it.

As a percentage of the £310 that is from 1.2% to 5.4% a month. And if that is your pattern of use that works out roughly – and I think it’s a negative AER rather than an APR – but just taking it at its simplest it’s:-

From -15% gross interest of the monthly balance per year up to

-65% gross interest of the monthly balance a year.

In other words very expensive. And that’s with some cost saving assumptions made by moneysupermarket.com

• No foreign use – omitting those surcharges
• Mainly used for retail purchases – avoiding high cash charges
• Always use cheapest upload system – which is sometimes free. But if the cheapest is not used can be very expensive –typically 3% of the money loaded and up to 5% in some cases.

Though I am sure there are also ways of using the card that would be cheaper than this, in many ways the moneysupermarket work understates the real cost as used by real, fallible people. It takes no account of annual fees, of cancellation fees, of inactivity fees, of forgetting your PIN fees, the whole panoply I mentioned earlier. So there are other ways of using the card that would undoubtedly be more expensive than its analysis.

From July moneysupermarket.com will put a calculator on the website so that you can put in your use and see what the monthly cost of ownership will be. Assuming of course you know how you will use the card.

Now you may say that all this variety – 28 cards plus a few others with specific uses like plastic travellers cheques – is just competition. And competition needs choice. Though I am not sure where competition comes in when 16 out of 28 cards are run by Newcastle Building Society! But it only works if comparison is easy – or even possible. And comparison must involve understanding of the product and its charges.

Having looked at prepaid cards for the first time in any depth over the last few weeks I see the confusing hand here of what I call

complexification

Making things so complex that no human brain can possibly take in all the variables and make that rational choice. Even people like me who are used to the ways of the financial services industry find it difficult, time consuming and ultimately not possible to compare the offers and work out the true cost. There are too many variables, too many unknowns, too many future events.

One of the greatest physicists of the 20^th century Neils Bohr the man who is the father of quantum physics on which all these clever devices we use depend – from phones, to computers, to blackberries, to GPS, even the chip on this card – said "prediction is very difficult. Especially about the future."

But to work out the true cost you need to know about future use. So it is literally impossible to predict precisely the cost of owning and using a prepaid card.

It’s not just me that’s baffled. The comparison experts are too. Of the half dozen or so comparison websites only one as far as I know – moneysupermarket.com – does any full comparison of prepaid cards. There is a tool on the what-prepaid-card.co.uk site where you can enter your expected use of the card and it finds the best one for you. But when I tried it all I got was an error page – so its computers were clearly baffled too. Another site knowyourmoney.co.uk also does some tables but with only ten cards to compare and no calculator or best buy tools.

So although I think prepaid cards have a place for some consumers their uses are limited and they are for a limited group of consumers. If you manage your money well – by which really I mean you have at least enough – prepaid has very limited use. Perhaps for travel. Perhaps for online shopping if you're paranoid enough about security to pay the costs. But otherwise it is better to use a cashback credit card and pay it off in full each month or a debit card if you are credit averse and know that your current account is up to it.

Prepaid is attractive to people at the bottom of the financial services pyramid. The ones who are most likely to be in debt or have been in debt. The ones who like to control their money through cash but need to have a toe in the plastic economy. And if the banks can baffle the rest of us with the complex choices and dozens of overlapping and interlocking charges many of those people – who may already have failed to understand other financial products – don’t have a hope. They deserve more than being taken advantage of. With prepaid the poor shouldn’t pay more. This is a new industry, a new kind of card, aimed at a different kind of customer. So threat them well.

Prepaid is an interesting product. It has its uses for some people. But it comes at a cost. It is essential that the charges are made simpler, clearer and lower. Otherwise you will find many journalists writing negatively about these cards. Though perhaps not in The Sun, The Times, the News of the World, or the Mirror all of which are already making money themselves out of prepaid cards.

Not that I am suggesting that would affect their editorial judgment.

Thank you.