Putting payrolls on plastic — and reaching the unbanked
by Sam Frumkin, Community Affairs, OCC

Q: What’s rarer than a community banking product that serves both the biggest businesses in town and the unbanked?

A: A product that does both and that also can generate revenues for the bank: payroll cards.

Many U.S. employers are switching from paper payroll checks to plastic payroll cards. Essentially a debit card funded by a direct deposit, a payroll card may also carry the Visa or MasterCard logo. Carrying one of those two national brands or not, a payroll card functions as a stored value card that can offer important advantages to employers, employees — and banks.

Why should banks enter this market?

• Commercial customers using payroll cards see cash management benefits, such as increased direct deposit adoption rates and reduced payroll processing costs.

• Payroll cards provide income for banks, which can collect usage fees from the employer, the employees using the cards, and the merchants accepting them.

• Payroll cards are an entry point into the banking system for consumers without traditional bank accounts. As they become comfortable using the product, they can be cross-sold other products, such as checking and savings accounts, CDs, credit cards, and loans.

Consumers using payroll cards can avoid paying the high fees charged by some check-cashing businesses, and with a branded card, can make retail purchases. For the unbanked, a payroll card functions like a checking account without the checks.

Employers benefit, too. When an employer loads its employees’ pay onto payroll cards, instead of issuing, distributing, and accounting for paper payroll checks, the employer saves money by reducing check volume, reconciliation time and expense, and check fraud risk.

Are payroll cards for you?

Like all business lines, payroll cards involve risks. Issues include:

• What resources are needed to manage the program?
• Who will service the accounts?
• Has the bank performed due diligence on third-party vendors that may be used?
• Is the fee structure fair to consumers?
• Do payroll cards fall under Regulation E?
• Does deposit insurance apply?

Unresolved regulatory issues

The OCC has published guidance on this topic in Advisory Letter 2004-6, Payroll Card Systems, May 6, 2004. Several significant regulatory issues relating to payroll cards remain unresolved. Still to be clarified is whether payroll cards are subject to the Federal Reserve Board’s Regulation E governing disclosures and other consumer protections for electronic fund transfers, such as consumer liability for unauthorized transactions and notification of any changes in fees or costs and of error resolution procedures. Rather than wait for formal clarification, however, some banks are applying Regulation E guidelines to their payroll cards merely as a good business practice. (In September 2004, the Federal Reserve Board published for comment proposed amendments to Regulation E. See http://www.federalreserve.gov/BoardDocs/Press/bcreg/2004/2004913/default.htm.

Another regulatory issue involves deposit insurance coverage, which may vary depending on how the payroll card funds are held by the bank. In an effort to clarify whether deposit insurance covers evolving products, such as payroll cards, the FDIC recently published for comment a proposed rule discussing whether the funds underlying stored value cards meet the definition of “deposits” under the Federal Deposit Insurance Act. The proposed rule is available online at www.fdic.gov/regulations/laws/federal/04DEPDEF.pdf.

Finally, there are state laws to consider. For instance, some states require employers to provide employees with a means of accessing their pay at no cost. How these laws apply to payroll cards is still not clear.

Choose partner wisely

Banks can serve as program operators, but only those with large-scale credit card operations are likely to do so. Others will likely turn to non-bank vendors, including credit card merchant processors, human resources firms, or payroll firms.

Banks partnering with other firms must establish from the start whether the partner or the bank will handle the new tasks created by the payroll card program, including fiduciary responsibilities for disbursed funds, transaction settlements, record-keeping, and funds storage. Banks also must consider vendors’ experience and ability to oversee a payroll card program. Even if the program is totally outsourced, the bank will need to monitor the arrangement to ensure that the bank does not incur financial harm or risk damage to its reputation.

What’s ahead

While most banks are offering payroll cards only through employers, a few are going directly to consumers. One bank saw payroll cards as a way to reduce the costs it incurred from cashing 9 million payroll checks annually. The bank figured that customers who stood in line for 45 minutes on paydays to cash a payroll check might be receptive to hearing about payroll cards from tellers (who were paid an incentive for promoting the cards). The plan is working — and the bank’s payroll card program has converted 1,700 unbanked persons into new customers.

Other banks are using payroll cards to serve immigrant populations. They are offering a payroll card that can be used, in combination with other bank products, to make low-cost transfers of funds to customers’ family members in Mexico.

In fact, all types of payroll cards are making inroads. Use of these cost-efficient, convenient wallet-size cards has grown from virtually nothing five years ago to the point where 2 to 3 million consumers will use them this year, according to the Pelorus Group, a marketing research firm.

Banks interested in seeking positive consideration under the Community Reinvestment Act (CRA) service test will need to demonstrate how their payroll card products qualify as community development (CD) services. For more information on this topic, see the Compliance Corner article in this issue of the newsletter.

With demand for payroll cards increasing, bank involvement in the market makes it more likely that consumers will get a fair shake. And a bank that reaches out to a previously unbanked customer though a payroll card program may find that the card opens the door to a lifelong banking relationship.