Blake Taylor
Last December, the Consumer Financial Protection Bureau proposed rules intending to improve consumers’ understanding of their choices in the prepaid debit card market and to protect them from unreasonable fees. There is little to no evidence that the proposal will have desirable consequences related to either consumer or seller behavior. What is likely is that the rule will increased compliance burdens for sellers and limit consumer choice.
The market for prepaid debit cards has grown over the last decade, and intensely so in the last few years. These products have changed from being a relatively obscure financial product to an essential component of many individuals’ and families’ access to a financial and payment system in which use of noncash payment methods is increasing. Although prepaid cards are virtually indistinguishable from traditional debit cards or credit cards, they are currently not subject to the federal Regulation E and Regulation Z, which govern electronic fund transfer and consumer credit, respectively. The proposal imposes new requirements for disclosing information about fees and terms of use, and tightens rules on overdraft features.
CFPB employs flawed analysis in its diagnosis of information asymmetry as a market failure in this scenario, and they assume their solutions to the problem will work despite evidence pointing to the contrary. The market for prepaid cards is heterogeneous: various options and features abound to cater to a population with diverse characteristics and preferences.
Although CFPB intends for these standards to lower consumer search costs and increase efficiency, in reality they will likely do little to inform consumer decision making. In certain parts of its economic analysis, CFPB assumes that provision of information leads to absorption of information. In order for absorption to occur, consumers must (1) read the information, (2) understand it, and (3) act upon it. CFPB does not provide sufficient evidence that such a sequence will occur. Additionally, findings in the economic literature on numeracy and financial literacy would suggest that even if all consumers attempted to read and absorb the information, a sizable portion would be unable to use it correctly to their benefit.
The second reason the information disclosure standards are unlikely to have much of an impact on consumers’ understanding of fees and terms is because in recent years sellers have already begun to disclose fee information in a reasonably transparent manner. It is possible that at one point—when the market for prepaid cards was relatively uncompetitive—the few sellers did indeed underprovide information and subsequently collected economic rents from uninformed consumers. However, such a scenario is far from reality today. It is not only the case that fee information for the most part is clearly disclosed to consumers. The market for these products has become so competitive that many of the fees have disappeared entirely: one of the leading products charges no fees beyond a simple one-dollar monthly service fee. It is clear that this proposal was drafted and its ideas conceived at a time when the market was materially different from the one that actually exists today. Increased entry of sellers and subsequent competition has largely deemed the information disclosure problem moot and diminished the need for regulatory intervention.
Although the information disclosure requirement would likely have little impact, the proposal to subject products offering overdraft services for a fee to Regulation Z’s consumer credit requirements would probably have a noticeable impact by limiting consumer choice and access to a service that many depend on. Today, consumers suffering a financial shortfall have a number of options for making purchases: they may use a credit card; arrange informal loans from friends and family; draw on their savings; use payday, auto title, or home-equity loan products; or use overdraft services, which normally result in a fee. Unbanked and underbanked individuals and households—who constitute a large portion of the prepaid card using population—do not have access to all of these services, and in some circumstances prepaid overdraft services may be the most reasonable and affordable options for short-term liquidity in dire circumstances. Subjecting the few products offering affirmative opt-in overdraft services (overdraft is never a default option for these products) to federal consumer credit regulations may raise the cost these services or eliminate them entirely. Consumers relying on this service would then be forced to use options that may be more expensive, less convenient, or both.
CFPB should reconsider this proposal with newer and more comprehensive data for prepaid card buyers and sellers. It is clear that it is applying standards as if the market was static—as if it was the same today as it was when the regulators first began to consider the need for regulation. On the contrary, the market is exceedingly dynamic. Competition has attracted sellers offering products with more transparency and better features in exchange for lower and fewer fees; sellers unable or unwilling to keep up have been forced out. CFPB should also reassess the impact the proposal would have on consumers who rely on prepaid overdraft services to access short-term liquidity in emergency situations. Removing this option from consumers in the name of protecting them could have quite the opposite effect.