A September 2011 discussion paper issued by the Payment Cards Center at the Federal Reserve Bank of Philadelphia revealed that prepaid card businesses may be at increased financial risk because the prepaid card value chain includes players not part of either credit or debit card schemes.
The paper, Insolvency Risk in the Network-Branded Prepaid-Card Value Chain, which arose out of a March 2011 workshop at the Payment Cards Center, said a traditional bankcard value chain involves a card issuing bank, an issuer, a payment processor, a payment network, an acquiring processor and an acquiring bank. But a common scheme for an open-loop, network-branded prepaid card incorporates three more parties to the typical bankcard value chain: a program manager, a distributor and a seller.
Kirsten Trusko, President of the Network Branded Prepaid Card Association, said at the workshop that since independent businesses extend the prepaid value chain, each player along the chain could be exposed to losses if another player failed financially.
Two examples given at the workshop illustrated what could happen. One insolvency occurred at Silverton Bank N.A., which failed in May 2009. While the bank was not a prepaid card issuer, it operated prepaid card programs for other banks, the paper said. To alleviate concerns about the financial viability of those programs, the Federal Deposit Insurance Corp. interceded.
The other example concerned Springbok Services Inc. The program manager filed for Chapter 11 bankruptcy protection in June 2010. The paper said initial reports that cardholders were unable to access funds in Springbok managed programs were allayed when Springbok's issuing banks guaranteed cardholders would have access to those funds.
To protect players from financial troubles along the value chain, card networks implemented rules that govern how systems function. At the workshop, Ted Martinez, who heads the North America credit settlement risk team at Visa Inc., said the card brand protects its member banks against insolvency risks through the Visa Third-Party Agent Registration Program and the USA Prepaid Issuer Risk Program.
By identifying players, mandating compliance with procedures and monitoring that entities are meeting standards, the programs help to mitigate insolvency risks to banks, Martinez said.
As for consumer protections, NBPCA General Counsel Terry Maher outlined three bulwarks against insolvency along the prepaid value chain – FDIC insurance, state money-transmitter licensing laws and individual contracts between various players. These protections limit the risks to cardholders, Maher said.
Despite increased insolvency risk inherent in prepaid card networks because of the involvement of additional players, the industry has implemented best practices and other controls to manage risks and, in case of insolvency, limit damages to consumers and players along the value chain, the paper said. However, for a rapidly evolving market, vigilance is necessary at the network level down to the individual institution to mitigate against future risks.
The paper, written by Philip Keitel, Senior Attorney at the Federal Reserve Bank of Philadelphia and Industry Specialist at the Payment Cards Center, is free for download at www.phil.frb.org/payment-cards-center/publications/discussion-papers/2011/D-2011-September-NBPCA-Keitel.pdf. 
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