Prepaid Cards: the New Wave of Innovative Banking?
The banking sector is set to undergo significant changes in 2009, with new and existing regulations driving the need for banks to adapt the way they do business. As well as placing pressure on banks to change their operating structures, regulations will have a significant impact on the competitive landscape. As a result, banks will have to reassess their relationships with customers and put in place measures to renew trust and deliver greater value to the consumer.
One regulatory example is the Payment Services Directive (PSD), which aims to provide a harmonised legal framework for all payments made in the European Union (EU). As such, it is a crucial milestone in paving the way for the implementation of the single euro payments area (SEPA), which aims to achieve integrated payment infrastructures and products for all euro credit transfers, direct debits and debit card transactions. As the PSD looks to encourage more players into the payment sector, competition for the retail customer is on the increase. This in turn will drive the need for retail banks to adopt innovative solutions to stay ahead of the competition and position themselves for market recovery.
The PSD is due to become part of national law in November 2009 and banks are already busily preparing their own systems ahead of this deadline. However, the directive significantly changes the landscape, with the creation of licensed payment institutions across the EU. This means the market is opening up new routes for institutions to become entities licensed to handle customer funds and also to be members of schemes such as VISA and MasterCard. In confirmation of this, the European Commission (EC) aims to treble the number of electronic money institutions, just one of the categories of competitors to the incumbent banks, over the next two years.
Innovation will be a major factor for banks in addressing the challenge of changing regulation and intensified competition. However, for innovation to be successful, it must be applied within the right context and deliver results. The approach therefore needs to consider those business models that have already achieved a degree of success and are ripe for further development. Virtual prepaid cards is one such innovation and is fast becoming the ‘one to watch’ in the payment space.
The prepaid industry, when compared with other elements of banks’ card businesses, is relatively young. As with any line of business, it is important that prepaid schemes are both successful and profitable for them to become an attractive proposition. As the market continues to mature, as well as in these turbulent times, prepaid offers banks a number of opportunities to achieve growth, increase customer acquisition and sustain a competitive advantage.
Prepaid offers banks a highly secure alternative to credit cards by, in particular, allowing them to remove some of the associated risk. In the UK, Equifax estimates that some two-thirds of credit card applications are declined. Many of these could be fulfilled through other profitable routes such as prepaid accounts.
A further advantage is in making cross-border payments. While the SEPA initiative is opening up the payment market across Europe, there is a real opportunity for banks to make quick, safe and prompt cross-border payments on a global scale. With SWIFT catering to higher value payments, typically over £1,000, prepaid will enable banks to maximise the potential of smaller payments and therefore act as a complement to their existing business models.
Virtual prepaid enables businesses and consumers anywhere to pay quickly and avoid many of the costs traditionally associated with e-commerce. Business users can cost-effectively send payments to consumers around the world, while consumers can benefit from protection against ID theft and fraud when they make purchases online. Consumers also inherently benefit from the reduced credit and other risks associated with prepaid, which is particularly relevant in today’s tough economic climate.
Banks are in a prime position to take the lead on innovation in the virtual prepaid area, realising the benefits and bringing it into the mainstream. However, with their reputations at stake, they must first address the risks and help build an industry standard that will ensure integrity throughout the prepaid sector. There are three broad areas to address.
The first area is proactive management of fraud. Successful and safe e-commerce is paramount to the success of virtual prepaid if it is to appeal to the end user. The current unstable economic climate, coupled with the proliferation of stories about data losses, has led to growing consumer concern about the safety of their personal data and money. Virtual prepaid introduces safety into this process through the protection of customer data and balances. Customers can limit the amounts on their prepaid account and create new payment instruments, such as virtual Visa cards, for each purchase.
The second area is to ensure the safety of customer funds. Following high profile collapses of financial institutions, customers need reassurance that their cash is in safe hands. For prepaid, particularly for the small business community, this means providing an equivalent of the government deposit guarantee to provide peace of mind to the customers in terms of securing the funds loaded into their prepaid account. In practical terms, this would mean separating and legally protecting virtual prepaid funds appropriately.
Finally, banks must provide clarity of terms to their customers. While the PSD seeks to create transparency of fees across the EU, banks must take the global view. The right approach here is for banks to spearhead a full disclosure policy in terms of their prepaid fees. This will be vital if the industry is to maintain customer trust in what is perceived to be a new banking innovation.
With regulations driving the need for greater innovation in the banking sector, the prepaid industry represents an enormous opportunity. Banks can not only reach new markets through innovative solutions that meet customer needs, but also minimise and better control their and their customers’ risks.
When considering the right approach to prepaid, banks should look to proven business models that can deliver value. In adopting a best-of-breed approach, they should ensure they have access to the expertise, technology and resources to stay competitive and establish a stronghold ahead of the increasing number of non-bank players. Only then will they be able to ride the waves of an innovating, turbulent, regulatory-driven market.