Financial Inclusion

Is being “unbanked” really so bad?

Financial inclusion is an economic topic that’s been on the radar of policymakers for years. In an international context, it has been newsworthy  for a while. I think particularly all the buzz about M-PESA a few years ago and how mobile money was enabling economic growth thanks to greater financial  interconnectedness brought this issue into the spotlight. The World Bank even has a plan to achieve universal financial access by 2020. Even in the context of large developed nation like the United States though, this is still an issue.

Before I dive in further, I’m going to answer my own question and say – yes, being unbanked isn’t great. The unbanked, or people who don’t have bank accounts, are at an extreme disadvantage when it comes to their options for household financial management. The problems that come with not having a bank account are pretty apparent; these individuals have limited access to payment methods, credit, and loans.  This often leads to the use of what policy makers see as sub-optimal choices like using check cashing stores, payday lenders, or any other method deemed by the FDIC as “alternative financial services (ASF)” in order to get liquidity and/or credit.  AFS providers typically charge higher interest rates and fees than traditional financial providers, so use of these services contributes to the issue of it being expensive to be poor. As a result, this issue has been cited by several U.S. governing bodies including the Council of Economic Advisors, the FDIC, and the Federal Reserve as an area for improvement.

According to the FDIC National Survey of Unbanked and Underbanked Households, about 8% of U.S. households are unbanked as of 2013. An additional 20% are “underbanked,” meaning they have a bank account but they also use some form of AFS. This is no small number of people and it has serious implications for these individuals. The issue that I really want to address is that the default solution to provide better options for these groups is to get them into the mainstream banking system. The FDIC says that it “is committed to increasing the participation of unbanked and underbanked households in the financial mainstream.”

The debate needs to acknowledge that this is both a supply-side and a demand-side issue. The concern from policy makers about people using AFS rather than traditional banking services implicitly assumes that consumers are making a sub-optimal choice. However, I would argue that there are cases when using something besides a traditional bank is actually the rational choice. Take for example the case of an overdraft fee. If somebody has to wait three days for his/her paycheck to hit the bank account, he/she may face paying a $25 (or more) overdraft fee if bills are due and a payment hits before the balance has been updated. Alternatively, he/she can go to Walmart and have that check cashed for $3 and pay for things with cash. In this case, the overdraft fee is the irrational option as it is, in effect, a high interest loan.

It goes beyond rationality though, there’s a huge component here that has a lot to do with something that economists tend to ignore: feelings. People don’t trust banks. According to a recent report from the Federal Reserve Bank of Boston, 40% of consumers with no checking account cited their reason for not having one as “I don’t like dealing with banks.” 10% said it was because the fees are too high. So that’s half of the unbanked population CHOOSING not to have a bank account either because of perceptions about cost (which may or may not be accurate) or because of their feelings about the institutions. Only 10% claimed that their reason was that a bank wouldn’t give them an account.

So, for many of the unbanked and underbanked, using options outside of the mainstream financial system is preferable. We need to stop assuming that they are making this choice because they aren’t financially literate or because they have no other options. This fascinating piece discusses in more depth some of the reasoning behind these choices.  There are three main issues:

  • Speed – Low and moderate income people often need their money ASAP. Many of these households may be living hand-to-mouth and don’t have time for transfers to clear or to wait long enough to avoid an overdraft or a check bouncing.
  • Transparency – The median number of pages of disclosure for a checking account is 111. That seems a lot more complicated than walking into a payday lender where all of the services and their prices are posted up on the wall for all to see.
  • Trust – This goes along with transparency, but the unbanked and underbanked are skeptical of banks in general, and quite frankly, they should be. Banks don’t really want to do business with low and moderate income people and they make that clear with account minimums, high fees, and a lack of approachability.

All that to say, being unbanked might not so bad, given the current setup. It is unfortunate that there aren’t other options outside of the mainstream that are truly competitive with the prices and treatment that fully-banked people get with mainstream banks. We are seeing more and more that this could be possible as technology improves and innovation leads to more financial options, but as of now, people living on tight budgets have a choice only between the lesser of two expensive tools.  At least when they go with the AFS, they feel that they are choosing something that they can understand and trust.

In the past few years, great efforts have been made to make mainstream financial services more transparent and less predatory via reforms such as Dodd-Frank and governing bodies like the CFPB. I applaud those efforts, but there’s still much to be desired. Even though regulations have made it more difficult for institutions to intentionally pray upon lower income people, the fact of the matter is that they still don’t trust banks. So, it’s not necessarily that these people are locked out of traditional financial markets – it’s a choice that they’re making for (sometimes) non-economic reasons. We’ve got to get people to trust the banks. Or rather, make the banks worthy of the people’s trust. This will require transparency. I think it will also require redefining what “banking” really means, but that’s for another day.

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