Virtual gift card provider CashStar Inc. will be introducing an app next year that lets consumers use their banking credit card reward points to buy digital gift cards at participating merchants.

MobileGiftRewards, the name of the app, will be rolled out by not-yet-disclosed financial institutions in early 2012.

“Consumers love and hate [gift cards],” David Stone, chief executive and co-founder, tells Bank Innovation. “Though they are mostly convenient, they also don’t feel very personal. The digital age changes all of this.”

MobileGiftRewards will use location-based technology, a “digital age” functionality, to improve the accessibility of collecting on the currency, Stone says. Say you’re walking in Columbus Circle in Manhattan. The mobile technology, he explains, will alert a consumer to which nearby merchants will allow him to burn his points.

The benefit for banks is twofold. Creating easier ways for consumers to spend their unredeemed points is important for banks as they use reward programs as a loyalty tool. As it stands today, there’s approximately $16 billion in unredeemed reward points each year, Stone estimates. In other words, banks need an outlet for their booked rewards liability. Stone further argues that loyalty programs, like the one he is offering banks, amplify a consumer’s stickiness, which is a much better approach to gaining more revenue than “fee-ing consumers to death.”

Two challenges ahead for CashStar include: increasing consumers’ awareness of digital gifting, and getting banks to think beyond regulation burdens.

“They are consumed by Durbin and other challenges,” Stone says. “But they shouldn’t lose sight of their customers and not lose their spirit of innovation. …[Consumers] need to do more than check account balances. They need to buy real stuff, transact real stuff, and use their points… [Otherwise, banks] will lose consumers to PayPal and Square.”

CashStar demoed its offering at Finovate in September. Below is an image of MobileGiftRewards: