Prepaid is a great business for card issuers — but it’s one regulators are looking at with growing interest.

For bankers, those are scary words.

Prepaid card usage is growing steadily– 23% of consumers used a prepaid product at the end of 2013, according to research from Aite Group. This is up from 19% in 2010 and 15% in 2008.

But the recent FDIC consent order handed to major prepaid issuer The Bancorp Monday threatens to send a chill through the industry. The Wilmington, Del.-based bank was barred from issuing new prepaid products or acquiring new customers until it complies with some very specific requests from regulators relating to fraud protection in its prepaid products.

“This underlines the extent to which this business is being tightly watched and regulated,” said Jim Shanahan, CEO of Prepaidian, a prepaid industry vendor.

It’s clear how interested regulators are, Shanahan said, “when an industry leader like The Bancorp gets rapped across the knuckles.
This is going to make it more difficult for new guys to enter the market.”

Stifling innovation will be the major consequence of this action, Shanahan said. “This will slow down the creation of new programs. Ironically, it’s good for the people who are already in.” The higher the bar set by regulators, Shanahan said, the more the advantage swings to players with established compliance programs.

Of course, The Bancorp had an established compliance program, too.

“I’m surprised,” said Madeline Aufseeser, senior analyst with Aite Group, the consultancy. “The Bancorp had done a good job managing business and compliance and adhering to the regulatory rules.”

Aufseeser sees the consent order as a challenge to program managers and marketers rather than to issuers such The Bancorp. Prepaid has a notoriously complex value chain, and Aufseeser said industry participants “that don’t bring value to the space, will not survive.” Prom management businesses, in particular, she said, will face difficult times.

Among other factors, the pricing in prepaid in recent years has become highly competitive and margins have been squeezed. Still, Aufseeser said, banks will come through this fine. Prepaid has become a mainstream product, and banks have a built-in channel — the branch network — through which to sell cards.

“There is a continuum between checking products and prepaid products,” Aufseeser said, rather than a wall. Consumers will choose the mix of products that suits them going forward. “This business is still huge and very viable,” she said. “Issuers will find a way to make it work.”

Shanahan agrees that established players will weather the storm, but worries that companies with smaller compliance teams may be scared away from offering the product.

“The bigger players that have been through this [facing regulatory action] and are already up to speed will benefit,” Shanahan said. “But the smaller players will become cautious. The first thing [community bankers with prepaid products will] do is pick up the phone and call the head of the [prepaid] program or the head of compliance and say, ‘Are we OK?’ and ask for a review. Because if it can happen to The Bancorp, it can happen to us.”