That's because the cards present opportunities for money laundering, especially when card holders can reload them at non-bank locations, said the paper's author, an employee at the Fed bank.

Banks should perform due diligence similar to the "know your customer" checks used for new banking clients.

Issuers of prepaid cards should also limit the "velocity" of cash loading and reloading, restrict the acquisition of multiple cards for the same account, and limit the number of ATM withdrawals per card. Monitoring systems should also be used to track cash loading, card acquisition, and ATM withdrawals.