NCUA and OCC Look at Payroll Cards by zyc19183


									NCUA and OCC Look at Payroll Cards
There are an estimated 10 million unbanked households in the U.S. Financial institutions
frequently evaluate ways to get these people into the financial mainstream. Already, several low-
cost basic financial products have been designed for this demographic. Many of these encourage
electronic transactions such as direct deposit and ATM withdrawals in order to limit the cost of the
products. The government is interested in seeing the unbanked in the financial mainstream to avoid
their being victims of predatory lenders. It is also interested in reducing costs to the federal
government so the Treasury Department introduced the Electronic Transfer Account (ETA). The
National Credit Union Administration (NCUA) and the Office of the Comptroller of the Currency
(OCC) recently addressed this issue.

The NCUA’s pronouncements came in the form of an opinion letter (03-0908) that was issued in
response to a question as to whether a federal credit union (FCU) may provide payroll cards as a
replacement for payroll checks that a member distributes to its employees. The question was posed
by a credit union association that owns a company that wants to provide payroll card services to
credit unions. The NCUA opined that this is a permissible activity under the FCU’s incidental
powers provision.
The FCU would place the employees’ pay on the card through a direct deposit arrangement
between the employee and employer, the FCU’s sponsor-member. The employee-cardholder would
activate the card by phone or over the web and could use those same methods to replenish the
balance on the card. The cardholders could then access their funds through ATMs, use the card at
point-of-sale (POS) terminals, and obtain balance information through the Internet, telephone, and
The NCUA emphasized that the activity is permissible under the incidental powers provision of
paragraph (c) of Section 721.3 of the NCUA Rules and Regulations (electronic financial services) and
not paragraph (k) that authorizes FCUs to issue stored value products to members.

The OCC surveyed banks it regulates, analyzed the responses, and issued a report (Payroll Cards:
An Innovative Product for Reaching the Unbanked and Underbanked) describing how it sees the payroll
card market. The report describes a payroll card as a type of stored value or prepaid card. It is
designed to streamline the payment process for the recurring use of goods and services. Some
examples of stored value cards with which most people are familiar include prepaid phone cards,
mass transit cards, and prepaid debit cards.
The stored value card operates in a “closed loop,” allowing the card to be used only for products or
services at certain merchant locations, or in an “open loop,” allowing the card to be used through a
universal network for PIN-based or signature based transactions. Payroll cards use the open loop
The OCC’s report indicates that earlier generations of payroll cards have not been widely accepted
because they provided limited ability to withdraw funds. Many of the newer cards now carry a Visa
or MasterCard brand. Employees using these cards can receive cash back from numerous retailers
just like a traditional debit card, so they are not restricted to ATMs for their transactions.

Benefits to Employers
The main benefit to employers is the opportunity to lower internal costs by avoiding the costs of
producing, handling, and distributing paper checks. Statistics show that it costs approximately $1
to $2 to print a paper check.                                                              October 2003
Also, the costs associated with lost and stolen checks can be avoided. There are approximately four
million payroll checks lost or stolen every year. When one considers that it costs an average of $8 to
$10 to replace each of these, it quickly becomes apparent that it is easily a cost to employers of at
least $48 million annually.
Another benefit to employers is that payroll can be electronically transmitted to remote employees.
Even under good conditions, getting checks to remotely located employees can be a challenge.
When extraordinary events like 9/11 and the grounding of air transportation occur, electronic
transmission looks even more appealing.

Benefits to Employees
For those who are unbanked, whether because they choose to be or because they do not qualify to
open a bank account for some reason, the payroll card offers a safe way to obtain their pay. Its
benefits may also encourage those who do not want to manage a checking account to choose the
payroll card. Such benefits include eliminating the need to stand in line at a bank or check casher;
immediate access to pay; greater safety since small amounts of currency can be withdrawn as
necessary; and with branded debit cards people can shop or pay bills online.
Payroll cards can also save money for employees since Americans currently spend about $8 billion
annually in check cashing and other financial services. Using a payroll card avoids check casher
fees that are usually more expensive than financial transaction fees they would pay at a bank. And,
a lot of banks provide a monthly statement so people can keep track of their spending. Some issuers
of payroll checks call them the “checking account without the check.”

Concerns for Employees
Those using payroll cards should check into whether their funds are covered by deposit insurance.
It depends on the way the program is operated. If a non-bank vendor operates the payroll card
program and it is structured so that the owner of the account is the program operator, there is not
only the risk of operator insolvency, there is also the risk that deposit insurance does not apply.
Some programs are structured so that the funds are transferred to individual accounts for each
employee, and each account qualifies for deposit insurance. Other programs are structured so that
funds are commingled in one company account and sub-accounts track the amount of money that
“belongs” to each employee. Under this method, the employee is not covered because the money is
in an account in the name of the program operator.
Also, card holders should watch for programs that are structured with multiple bank fees that
could make it more expensive than using a check casher.

Benefits for Banks
Payroll cards provide another product to offer to commercial customers. This was the main benefit
noted by the banks surveyed. They believe that improving customer cash management services by
reducing the number of paper checks issued and thus the payroll processing costs would broaden
the relationship with the commercial customer and increase the likelihood that the customer would
not change institutions except for some drastic reason.
Revenue can be increased by charging fees such as interchange, foreign ATM, monthly or other
service fees; and other fees such as overdraft, replacement card fees, etc.

Concerns for Banks
Even with all the benefits, there are obviously concerns and risks associated with payroll cards,
including the following.
•   Overdrafts – can result when delays in processing transactions preclude accounts being
    debited immediately after a purchase is made; when inadequate authorization system
    controls are in place, and when employees are allowed to round amounts below $20 at
    ATMs up to the next $20 increment for withdrawal.                                                                October 2003
•   Customer identification – some kind of identity check, such as Chexsystems, is generally
    needed to ensure the social security number is valid and matches the name of the employee.
    Some banks use credit history to deny a payroll card to those who have committed fraud,
    but not to those who may have bounced checks.
•   Consumer compliance issues -- while the Federal Reserve Board has not ruled whether
    electronic deposit accounts are subject to disclosure under consumer protection regulations
    such as Regulation E (Electronic Fund Transfers), most banks surveyed indicated they provide
    the required disclosures to payroll card customers.
•   Small banks – the OCC urged smaller banks to be particularly careful when choosing a
    provider. There is a risk that third-party operators of this product might approach smaller
    banks that lack the capability to effectively oversee the program with the intent of
    defrauding them

Time will tell whether newer payroll cards with more flexible features will be more widely accepted
than the originals. Will this be a tool that will serve the major needs of unbanked individuals? That
remains to be seen as do the answers to the questions of whether commercial customers want this
product, whether banks see the unbanked community as a potential market for cross-selling other
bank products, and whether the product is profitable enough for banks to offer.                                                               October 2003

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