The Regional Economist April 1996 “We’re about to see another revolution similar to the Industrial Revolution.” James G. Cosgrove, vice president, AT&T “Do not get caught up in the PR hype in the press.” Scott Cook, chairman, Intuit Inc. by Adam M. Zaretsky he quotes above represent A New Wrinkle on in-house merchants to settle just two of the many diver- an Old Idea transactions. Although these Tgent views about electronic prepaid cards can usually be currency. Using “money” stored Transit systems and universities reloaded with additional value, electronically on a microchip have used prepaid cards for years. their use is limited to specific embedded in an ATM-like card is More recently, telephone and regions or merchants. supposed to change the way con- telecommunication companies The emerging smart cards with sumers and merchants carry out have been selling them, too. stored value (hereafter, stored- transactions. No longer will a per- Single-purpose prepaid cards, like value cards) will act like multi- son have to fumble for change at those used for telephone calls and purpose prepaid cards, but be the bottom of a purse or find that mass transit fares, can be used even broader in scope because a dollar bill is too ratty for a vend- only at specific locations for cer- they will not be limited to specific ing machine to accept it. The new tain products. The consumer regions or merchants. This antici- “smart cards,” as they are known, exchanges cash for a card that has pated widespread acceptance by will purportedly replace cash and an equivalent value stored on a merchants and consumers is why coins for small transactions, while magnetic stripe. This value can pundits place these cards on par offering more security than cash.1 then be used to purchase the ser- with cash. One card can act as a credit card, vices for which the card is debit card, ATM card and “cash.” designed. When the value has The multi-function convenience is been depleted, the card is usually A Cash Equivalent? the advantage of this technology, discarded. In some instances, Are stored-value cards really a smart card proponents report. though, the value on the card can form of cash? No, they are not, There are many questions, be replenished. and this is a fundamental differ- however, that these proponents Multi-purpose prepaid cards are ence between the two. Yet, poten- do not address. What happens if more commonly found at univer- tial issuers of these cards argue the card is lost? How and when sities and corporate offices. In that they are.2 does settlement of the transaction these cases, the university or The confusion centers on the occur? Is the transaction anony- employer collects cash from stu- perceived similarities in the way mous like using cash? Who will dents or employees and issues ATM and stored-value cards work. issue the cards? Are the cards real- them cards with stored value. The Today, a consumer inserts an auto- ly different from the forms of cards can then be used to make mated teller card into an ATM and payment used today? These are purchases at a variety of sites on can withdraw cash, which the questions most potential card campus—for example, the book- machine dispenses, from his bank users are likely to want answered store, cafeteria or other food out- account. The withdrawal either is before deciding whether this tech- let. University or corporate immediately posted to the account nology is really a useful innova- merchants accept the value from if the ATM belongs to the bank tion or just a marketing gimmick. the card as payment, knowing with the account, or is posted a day that the university or corporation or two later if the ATM belongs to a will convert these balances back different bank. Cash has moved into cash. Thus, the university or from the bank to the consumer. corporation acts like a bank With a stored-value card, a sim- because it collects funds and then ilar transaction occurs. The con- disburses them to the various sumer inserts the stored-value card 5 into an ATM-like machine and makes microchip does not actually transfer a withdrawal from his bank account. “funds” from the card to the mer- “It really is no different than if [the chant, but only gives the merchant ATM] had dispensed cash,” said David the right to claim these funds from Van Lear, president of Electronic the bank. In other words, the stored- Payment Services Inc., to Congress.3 value card verifies that the funds to But there is a difference. The con- honor the liability are available from sumer might believe he has received the card-issuing institution. Settle- “cash,” but he has instead received ment takes place afterward, when the only a balance of monetary value customer’s bank transfers the funds to from the bank. This monetary value the merchant’s bank. is in the form of a promise the bank makes to pay the debts the consumer incurs by using the stored-value card Uh-oh, the Card’s Gone! up to its available balance. Thus, the customer has “funds” on the card Like cash, the risks from loss, dam- with which to conduct transactions, age or theft also exist with stored- re but, in fact, no cash has left the bank. value cards. But unlike cash, the AAre “funds” on a stored-value card cannot The bank actually moves the with- drawn funds from the customer’s actually be “lost” because they are still account into its own account, from at the card-issuing institution in its sstororeed-d- which it will settle transactions its account. Thus, whether a lost, dam- t customers make with stored-value aged or stolen card will mean the cards. These funds, which could have stored balances are gone for good— been earning interest for the cus- like losing a $20 bill—is still unclear. valuvaluee tomer, can now earn interest for the Even the use of personal identification bank while awaiting a payment order.4 numbers (PINs), like those used with In addition, float—the balance that ATM cards, will not guarantee the remains in an account while a check consumer reimbursement. They can, cardscards aa or other debit instrument is in process however, prevent others from access- of collection—has been transferred ing the value stored on the card. from the consumer to the bank. That individuals would be reim- bursed for losses seems unlikely, formform ofof though, because—like trying to pay Settling a Transaction interest—determining the exact bal- ance on any card at any given time When a purchase is made using would be costly and impractical. cashcash?? currency, final settlement occurs on Moreover, if the issuer wants to make the spot because currency is legal ten- this determination, it would also need der. No third-party involvement is to match individuals to particular No, they necessary. If the purchase is made cards, which would require tracking No, they using a stored-value card, however, consumers’ purchases through mer- final settlement does not occur at the chants, thus destroying anonymity. point of sale because payment Merchants, on the other are not. has not been made in legal hand, might benefit because are not. tender. In fact, all the accepting stored-value stored-value card does is card balances could pre- inform the merchant sumably reduce the that the bank that security costs associated issued the card has the with safeguarding cash funds to pay the mer- in the store until it is chant upon presenta- deposited. The risk of tion of the liability. employee embezzle- Thus, a third party, like a ment and the costs of bank, must be involved in secured storage and trans- discharging the debt. A similar portation could be reduced or process—a wire transfer—illustrates eliminated if the volume of cash at the point. an establishment were to drop drama- For years, Western Union has been tically. The additional costs incurred wiring money around the country to install and operate the technology and world. Western Union, of course, necessary to accept stored-value cards, does not actually send money to the however, will probably offset many of designated destinations. Instead, the these potential savings, at least in the company sends only an authorization short run. to the office at the receiving end to issue funds to a particular party. Final settlement of the debt occurs a day or Off-Line Convenience two later, when the issuing office’s bank transfers the funds into the One major convenience of stored- receiving office’s bank account. value cards is that their transactions The same is true for the stored- occur off-line. This means that no value card transaction. The card’s real-time contact with a central com- 6 Regional Economist April 1996 puter for verification of identity or A potential problem, however, is that funds is necessary. The off-line capa- these firms might then begin acting bility is a fundamental difference like banks, while not being subject to between stored-value card payments banking regulations. Former Federal and credit, debit or ATM card pay- Reserve Board Vice Chairman Alan ments. Essentially, the “computer” Blinder and others have expressed on the stored-value card serves as its the concern that in this situation own balance verification mechanism. banks and nonbanks would be trea t e d Rather than the merchant confirming differently.5 According to Blinder, identity and availability of funds under current regulations, “Stored- through a central computer, the chip value balances issued by depository on the stored-value card verifies this institutions would be treated as trans- information instead.