Are Stored Value Cards the Same as Cash?
Card Transaction 1: You go to the ATM, swipe your card, leave with your cash.
Card Transaction 2: You go to the ATM, swipe your card, leave with your Stored Value Card which holds a balance of monetary value.
What's the difference between the two payment scenarios? Are both transactions simply accessing your funds in exchange for cash? Our answer may surprise you.
In the second scenario, with the Stored Value Card no money has actually left the bank, even though it has left your account, but a promise to pay at a later point has been secured. For the purpose of this discussion let us call this "Charging the Card."
In some sense those who advance the direction of Smart Card technology believe that leaving with cash and leaving with a "charged card" are the same. At your ATM, the money in your pocket has left your account and the bank, but that cash has intrinsic value, backed by the U.S. Government. Who or what backs the Stored Value card?
While we admit that the transactions look a lot alike, when a transaction occurs using currency settlement occurs on the spot, since it is legal tender. With a Stored Value card, the bank has moved the purchase amount from a cardholder's account into its own account and will settle the transaction at a later date. So, the bank rather than the cardholder earns interest on the cash reserve.
You may have noticed the "at a later date" above. Contrary to popular opinion, transactions processed with a Stored Value card do not happen immediately because the payment has not been made in legal tender. What is actually happening is the bank (or other third party) informs the merchant that the bank has the funds to pay for the transaction. No money is transferred. Rather, the right to claim the funds has been transferred. The settlement occurs later.
Confusion comes about because Stored Value Cards are marketed as "same as cash," only more convenient. (As we know, you can't get much more convenient than cash, but we'll let that slide.) Similar to cash, Stored Value cards are susceptible to theft. But, unlike cash, when a card is stolen the funds may be stolen from the customer but they are still in its account at the card issuing institution. Even though this is true, the consumer may still lose the money since it is difficult to tell exactly how much money is left on a card at a given time due to the "float" and anonymity of the cards.
The ABCs
Let's get very basic for a moment and look at the ABCs of funds movement from a Demand Deposit Account (DDA). Bank account holder A writes a check and gives it to consumer B. Bank C is not involved in the transaction until consumer B cashes the check, at which time Bank C will give account holder A's money to consumer B. Should consumer B lose the check and another consumer attempts to cash the check, the bank will confirm that account holder A authorized the payment (signed the check) before they give account holder A's cash to anyone. In one sense the loss or theft issue is much akin to losing a personal check. The obvious difference is that in the case of the lost or stolen check the bank doesn't end up with lost or stolen funds. Account holder A might be the beneficiary of the theft, consumer B might also get the funds replaced, or even the thief could benefit, but never the bank. In addition, the bank is not giving money to anyone who wishes to draw on the combined funds of all account holders, but rather on a transaction-by-transaction basis.
The biggest difference between Stored Value Cards and other payment mechanisms such as ATM, credit, and debit is that the Stored Value card transaction is an off-line transaction. "Off-line" means that instead of going through a central computer, the transaction goes through a chip on the card. There is no account to verify, the funds are stored in the bank's interest bearing account, which we talked about above. The consumer's account is not accessed and funds are not verified at the point-of-sale.
Issuing
Additionally, there is the question of who issues the Stored Value cards. The assumption is that banks will issue the cards but, as most of us know, non-depository institutions will issue the cards as well. As we've discussed in many an article, while these entities may act like banks they are not governed by banking regulations.
Therein lies the problem: Stored Value balances at depository banks are subject to reserve requirements. But, the Fed doesn't have the ability to impose these same regulations on cards issued by non-depository institutions. Since they aren't regulated, a slew of questions arise such as:
1. What if the non-depository institutions invests the funds in risky assets to make a profit, and they subsequently go bankrupt or out of business?
2. Will the FDIC insure Stored Value Cards? If so, will they insure all cards or only those issued by banks?
3. Will Stored Value Cards have a secure enough reputation to always be settled at par?
4. Will the cost of Smart Card technology out weigh the benefits of eliminating small cash purchases?
When these questions are eventually answered in a positive way, some believe cash will be obsolete, replaced by Stored Value cards. But, as is the case with so many other technologies we have discussed in the pages of The Green Sheet (EDI and The Internet; ATM and Checks; Debit and Credit) no payment mechanism has as yet been eliminated. We believe consumers will continue to use a variety of payment methods and while the percentage of use of each type may vary, we are a long way from cash disappearing.
