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Financial institutions have been on the defensive since their balance sheets melted down during the housing bust. Government bailouts have turned public opinion completely against them. Yet while many banks have responded by grabbing for more profits, one company is taking a longer-term view with a product that actually makes sense for some customers.

The prepaid card you shouldn't leave home without
This week, American Express (NYSE: AXP  ) announced that it would offer a prepaid card to consumers. The move represents a significant strategic initiative for the company, as AmEx has long lacked exposure to the debit-card market that Visa (NYSE: V  ) and MasterCard (NYSE: MA  ) have used as a growth vehicle. With the debit-card market representing $1.85 trillion in sales for Visa and MasterCard last year, AmEx couldn't afford to leave it untouched.

The AmEx offering is far from the first available to customers. Small companies including Green Dot (Nasdaq: GDOT  ) and NetSpend Holdings (Nasdaq: NTSP  ) are the biggest prepaid processors and have been hugely profitable, thanks in large part to activation and maintenance fees. One of the most egregious examples of prepaid cards was the short-lived Kardashian Kard, with its $100 annual membership fee and numerous additional charges for everything from paying bills to using ATMs.

What makes the AmEx card stand out is that it charges very few fees. Fund the card from a checking account, and you won't pay a reload fee. You get one free ATM transaction every month. The card never expires, and it lacks foreign currency conversion fees. Even more impressively, AmEx will offer credit-card-style perks like purchase protection and roadside assistance.

Hitting competitors where it hurts
Hearing these customer benefits, you might figure that the idea behind the AmEx card is to hammer home fees on retailers who accept their cards. After all, high debit-card fees have made plenty of money for issuers like JPMorgan Chase (NYSE: JPM  ) and Wells Fargo (NYSE: WFC  ) , and they've led to Congressional scrutiny and a proposed cap on those fees. In fact, some banks are hoping to use prepaid cards as a way to circumvent debit-card legislation.

But AmEx is cutting merchants some slack with its offering, too. Although actual fees weren't disclosed, AmEx said that a lower rate structure will apply to its prepaid cards than merchants pay for AmEx credit cards.

Good news for customers?
I've long wondered what the big deal is about debit and prepaid cards. Call me old-fashioned, but the benefits of using credit cards -- including the best rewards programs and the ability to float expenses for a month or longer -- are just too good for responsible cardholders to pass up.

But with fees disappearing, there are definitely some legitimate uses for prepaid cards. First and foremost, using the cards as budgeting tools or methods to help children learn how to handle money makes a lot of sense. Moreover, for those who don't have access to banking services and would otherwise carry substantial amounts of cash around, a prepaid card is a definite improvement from the standpoint of personal security.

Where's the money?
The key question is whether prepaid cards will ever offer the same levels of rewards that many credit cards do. Given that prepaid cards aren't going to be subject to the same limits on transaction fees as debit cards -- or at least not yet -- companies like AmEx should be able to earn enough profit from card use to justify giving customers cash back or some other perk for using their prepaid cards.

I don't see that happening anytime soon. With many people impressed enough at the fact that AmEx isn't gumming up the works with extra fees, the company doesn't have any incentive to reward cardholders further.

Financial institutions clearly want new payment methods to replace old, reliable ones. If you want to get the most out of whichever method you use to pay, you need to stay vigilant to ensure you don't end up losing money in the name of progress.

As banks start boosting their profits, they're going to pay higher dividends to shareholders. But you don't have to wait to get strong dividends now. Read the Fool's special free report and find out about 13 high-yielding dividend stocks that could be everything you're looking for.

Fool contributor Dan Caplinger thinks like an economist. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of JPMorgan Chase. Motley Fool newsletter services have recommended buying shares of Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy won't rip you off.

Read/Post Comments (2) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 27, 2011, at 12:23 PM, BankFreedomDebit wrote:

    American Express Debit Card will cost much more to use then reasonably fee based prepaid debit cards and here is why. The majority of Prepaid Debit Card users don’t have bank accounts but do receive a payroll or benefit check. They take their checks to check cashing facilities and pay 1-5% of the face value of the check (depending on the amount of check ) this can range from $15- $60 a month. American Express doesn’t allow for direct deposit. So for a person without a bank account (unbanked) they will then have to pay another $4.95 each time they load cash. In my opinion American Express either doesn’t get it or they are not trying to help the poor with this card just people who don’t need a debit card in the first place.

  • Report this Comment On June 27, 2011, at 10:18 PM, gstanski wrote:

    It is very interesting that AmEx is pushing into prepaid cards. They have their own reasons, but the card is actually very good, especially for consumers with no access to credit cards and bank accounts.

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