Squeezing pennies: Big profits from pre-paid debit cards, payday loans

With all the Nobel Prizes being awarded this week, I am reminded that Mohammed Yunus won the Nobel Peace Prize in 2006 for founding Grameen Bank, a micro-lender to the very poor. Yunus's idea was to use finance to help needy people in Bangladesh dig themselves out of poverty.

But micro-lenders in developing nations aren't the only ones addressing the financial needs of people who are too poor to access the mainstream banking system. Visa (V) and MasterCard (MA) have their own version of micro-lending -- though one that is unlikely to receive any awards. Instead, they lend out small amounts on their co-branded, pre-paid debit cards, which are sold largely to the working poor in the U.S., and then collect millions in fees and penalty charges.

What is a pre-paid debit card? The New York Times reports Tuesday that people buy them at drugstores and mass merchandisers in denominations of $25, $100 and $500. Consumers pay for the cards in stores to give them access to cash for ATM withdrawals, store purchases and ecommerce. In that way, the cards help enable commerce for a wider group of consumers.

There's just one little thing: fees. Or more specifically, lots of little fees -- for example, some cards have a $9.95 activation fee; $1.75 for each ATM withdrawal; $1 per ATM balance inquiry, 50 cents per purchase, $4 for monthly maintenance, $2 for inactivity after 60 days and $1 to call customer service. Somehow I doubt Grameen Bank charges fees like that.

This sector of the banking industry is growing fast. The Times reports that in 2008, prepaid debit purchases totaled $8.7 billion -- 125 percent more than in 2007. And by 2012, consumers are expected to purchase about $119 billion worth.

These pre-paid cards are co-branded with obscure companies that issue the cards, with names like Green Dot, NetSpend and AccountNow. But Visa and MasterCard -- who have their names on the cards as well are getting their share of the action -- receive between five and 20 cents each time a consumer or register operator swipes them. Who knows the regulatory and/or marketing reasons why these big name companies don't issue the cards all by themselves.

Needless to say, only the poorest or least knowledgeable people would agree to such a lousy deal. And these cards are also popular among those who are in this country illegally or lack U.S. citizenship.

These prepaid debit card companies are not alone in preying on the poor. Wealthy investor Thomas W. Smith owns big stakes in two companies that profit from the poor, payday lender World Acceptance Corp. (WRLD) and legal insurance provider Prepaid Legal (PPD). As I wrote in 2003, Prepaid Legal, in which Smith owns 488,434 shares, makes its money through associates who recruit other associates trying to sell legal insurance -- mostly to poor people, who are convinced that it's smart to buy insurance against legal fees.

Prepaid Legal just received a subpoena today from the SEC, related to its stock trading program and its membership statistics, and its stock plunged as much as 21 percent.

Smith is also a big shareholder in World Acceptance, a major payday lender. Specifically, he owns 1,076,020 shares in the company which, as I noted, charges interest rates as high as 140 percent for loans in the $300 to $1,000 range. For example, payday lenders typically charge $2 for every $20 borrowed. Based on a 30-day repayment period, that's 120 percent annual interest earned lending people money against their weekly paychecks.

There are different ways to bank the poor. And I'd be surprised if either the people who benefit from prepaid debit cards, prepaid legal services, or payday lending will win any Nobel Prizes for their way of banking the poor.

Peter Cohan is a management consultant, Babson professor and author of eight books including, You Can't Order Change. Follow him on Twitter. He has no financial interest in the securities mentioned.

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