The Cost of Issuing Credit vs. Prepaid Cards

The LinkedIn Post

Last week, I saw a LinkedIn post where the author stated issuing prepaid cards or credit cards would be the same cost as both products (in his market) use the same messaging and infrastructure path. The logic was good and true, as far as it went, but was incomplete – and that incompleteness made the conclusion wrong.

What is the Same

As the author stated, in many markets, both credit and prepaid cards can run using the same payment network setup (dual message POS; single message ATM – or, on some networks, all transactions dual message to the issuer). He correctly noted that the only difference at a transaction flow level would be the type of account attached to the card. The credit card would be attached to an unsecured loan account, while the prepaid card would be attached to a prefunded account.

Why This is Incomplete – and Therefore Inaccurate

What the author failed to capture in his post were the non-transactional differences between credit and prepaid products. These differences are tied to things like product construct and target market. These significantly impact the cost of creating and running a credit or prepaid portfolio – and in different directions. Not recognizing or accounting for these differences will cost the issuer significantly more than they expect to pay and, in many cases, can jeopardize their product’s viability.

So, What is Different?

Here is a list of some of the significant differences between credit and prepaid card products that have cost implications – especially if they are not considered when building the card product and its supporting infrastructure:

1.      Target market:

1. Prepaid cards products are often used as niche transactional payment devices. If a person has a hobby or a side pastime, especially one they want to keep disconnected from their “main identity”, they use a prepaid card.

2. Credit cards polarize to “first in wallet” or “xth in wallet”. The first in wallet would reflect typical general spend with this card being the primary go-to card. A second (or xth) in wallet typically is a cobrand card used at the specific merchant or at merchants affiliated with the cobrand partner.

2.      Fraud profile.

1. Prepaid cards tend to have disproportionate spend at niche and higher risk merchants – both of which require specialized fraud tools or fraud settings to distinguish between niche spend and fraud. Attempting to use standard credit fraud models can cause excessive false positive declines (reduced revenue and cardholder abandonment of the card) or excessive fraud (and fraud losses).

2. Credit card spending patterns (whether first in wallet or “xth in wallet”) are more predictable than prepaid cards and match mainline fraud models well.

3.      Acceptance footprint:

1. Prepaid cards have gained a “second class card” reputation among merchants. There have been several compelling reasons for this. Unfortunately, not only do perceptions live beyond the facts, but perceptions also impact more than the culprits. In some markets, governments have passed legislation allowing merchants to not accept prepaid cards – just because they are prepaid. In other markets, merchants have made this same decision without the support of government legislation. This gives prepaid a smaller acceptance footprint than credit cards. This not only reduces an issuer’s potential revenue stream, but it also can cause cardholders to abandon the prepaid card in favour of a credit product.

2. Credit cards are the product that live up to the networks’ “accepted everywhere” boast. This makes them a more reliable product than a prepaid card, and, in turn, gives the cardholder more confidence to use the card everywhere.

4.      Issuer finance cost of accounts:

1. Prepaid cards are prefunded by the cardholders. Therefore, though the issuer will likely have an operational float to manage daily settlement, the bulk of the funds are “other peoples’ money”. However, due to the legislative requirements and the fluid nature of the funds, an issuer cannot necessarily turn this pool of funds into an interest-bearing revenue stream.

2. Credit cards use line of credit accounts. These are typically unsecured lines of credit. Therefore, the issuer bears the cost of maintaining the financial float of the aggregate account spend from transaction settlement date to the cardholders’ “statement due” dates. As well, since the loans are unsecured, the issuer must also have financial provision for defaulting accounts.

5.      Processor expertise:

1. I remember years ago hearing that a very capable credit card issuer processor refused to handle prepaid or debit products. At the time, I knew just enough about payments to think this was a strange stance. However, over time, I have come to recognize the deep wisdom of this issuer processor. Though the “rails” are the same, each of these products have unique features that make them very different. A good processor will know their core competencies and will be upfront on where their expertise lies.

2. I have seen far too many smaller issuer processors make emphatic claims that their platform supports “any product”. Unfortunately, customers on these platforms have experienced significant inconvenience, financial impact, and reputational damage when their product is different than the “core competency” of the issuer processor. Be sure to ask the processor for a list of issuers AND products AND markets they CURRENTLY support.

6.      Country or Region level differences.

1. In some markets, prepaid is seen as a product similar to credit. Though it has differences, the risk profile of the two products allows them to have the same interchange rates.

2. Other markets view the prefunded nature of prepaid cards and classify them as “debit” products. In these markets, issuer revenue for prepaid cards is significantly lower than credit cards.

3. As mentioned previously, some markets, like the European Economic Area (EEA), allow merchants to not accept prepaid cards because they are prepaid cards. This impacts all prepaid cardholder who spend in the EEA, not just prepaid cards issued in the EEA. I recall this being an impact in Canada when one of the ride-sharing platforms chose to acquire their Canadian transactions through an acquirer in the Netherlands. Canadian prepaid cards stopped working at that merchant.

7.      Product definition:

1. Each network’s products have core product construct requirements that impact the cost of the product. These requirements sometimes differ between the payment network’s regions. Credit products have requirements that prepaid issuers don’t have to provide like Stand-in non-zero minimums (risk cost) and product features that can range from purchase insurance to airport lounge access.

2. There are also market norms. For example, in North America, don’t try to issue a credit card that doesn’t have some kind of points or rebate feature. Though not necessarily mandated by the network, these have become a norm for credit card products. Not having a rewards component will significantly disadvantage your card in the market. Markets don’t currently have this same expectation for prepaid cards.

Conclusion

“The devil is in the detail” is a very old and very accurate statement. It holds true in card product issuing as much as in flying airplanes or constructing buildings. Each card product needs to be vetted by people who do understand the nuances, details, and hidden pitfalls of the card payments industry. I have seen far too many card product teams attempt to build a viable card product using only surface knowledge of the industry, or worse, by simply copying a flawed product construct from a competitor. The industry’s trail is littered with these failed products that have cost their issuers significant money, market credibility, and, in some cases, have even put their company out of business.

Are you contemplating issuing a card product? Do you have a card product currently in market that, if you were honest, was not adequately researched? Please do yourself, your cardholders, and your shareholders a favour – engage me or others like me who have years of experience building and implementing card products. Let us audit and improve your card product so that its chances of success can be significantly improved.