Bankless America

The FDIC recently released a study that finds that 60 million Americans, a quarter of all U.S. households, are either “unbanked or underbanked.”  Unbanked is defined as lacking a checking or savings account, while underbanked means relying heavily on alternative means of finance such as payday loans, rent-to-own agreements, and pawn shops.

http://www.prnewswire.com/news-releases/new-fdic-study-shows-one-in-four-us-households-currently-unbanked-or-underbanked-state-by-state-data-available-78311312.html

http://www.washingtonpost.com/wp-dyn/content/article/2009/12/02/AR2009120201016.html?hpid=topnews

As both of the above articles point out, racial and ethnic minorities and lower income groups are the most likely to be in this non-banking demographic.   According to the report, the percentages of African-American families who are unbanked and underbanked are 21.7% and 31.6%, respectively.  Hispanics and American Indians are also disproportionally represented in both the un- and underbanked populations.  Meanwhile, 71% of households without a bank account make less than $30,000 annually, and those making less than $50,000 are far more unlikely to use banks for financing purposes.

What is the cause of these startling trends?

While the Chairman of the FDIC believes it is based in rational economic decision making, it seems more likely that non-banking means of financing, i.e. the predatory means, are the only alternatives to a banking system which has been historically discriminatory towards poor people and people of color, especially when it comes to lending.  Of course payday loans are a necessary choice when they are the only choice.  It is a valid assessment that there is rational economic decision making occurring when a poor person chooses not to open up a savings account because they do not have enough money and the liquidity costs are too great.  However, to say the same of a poor person borrowing from a payday lender because the location is more convenient is ludicrous. To say that the poor seek non-banking lenders because they are “less likely” to qualify for a bank loan, is a gross understatement.  Payday loans and other forms of non-bank lending are often the only way a low-income person can raise capital to meet some need.   This is a tragedy due to the predatory nature of these non-banking institutions.

WashPo does well to point out that commercial banks lack viable options that low-income people can qualify for.  No current lending option is really affordable to low-income families. Payday loan rates are outrageously high, between 300% and 400% APR, and banks require money down and an interest rate that reflects levels of risk and uncertainty.  Either way, the cost of capital is quite high. It is really the qualifications, credit scores and collateral, which bars low-income families from financing through a commercial institution.  This quickly turns into a financial trap that is not easily escapable.  If a family has no credit or a low credit score, they are barred from the institutions that will improve their credit situation, which would in turn improve their chances of receiving a loan or better terms.  With no options, families turn to predatory lenders, and face steeper fees or worse.  It is time that policy makers look to enable lending practices which will bring low-income families and minority groups back into banking.

There are many ways this can be done, including federal insurance or guarantees to existing banks, but I think this is a call for a strong micro-lending sector in the U.S.  Low-income families need a way to get hold of small short-term loans at a lower cost of capital and at lower qualifications.  As done in some global micro-finance institutions, loans could be made available only for emergency situations or for productive activities such as housing or education.  Loans could then be pulled into group cooperatives, which would allow families to support one another while hedging risk for the institutions.  Micro-finance can also help with the building of savings.  As consumers build up credit and capital, they can begin borrowing for discretionary items and finally make a full transition into the mainstream banking system.

Aside from unmet needs in the U.S. banking system, these articles and this report may have brought up another major underlying social issue, and that is lack of trust that may exist between low-income and minority groups and commercial banks.   Historically, commercial banks in this country, especially in the South, have artificially inflated interest rates on loans as a discriminatory measure against African-Americans and other ethnic minorities.  Furthermore, the sub-prime mortgage crisis showed us that in the recent past financial institutions would entice low-income people into loans that they simply could not afford, with measures such as No-Doc, Low-Doc home loans, no money down, etc.  Until the system came crashing down, Wall Street was profiting off the backs of the poor while ultimately setting them up for failure.  There is no wonder why we see drastic numbers of these demographic groups outside of the banking system.   It may be to the point where some may trust dealing with loan shark at a shady “Express Loans” more than entering an agreement with a loan officer at a commercial bank.  Policy makers should keep this lack of trust when addressing this gap in banking.  Any policy considered should redefine the relationship, considering the needs and concerns of the target population.  This involves an open dialogue between all parties involved and customer feedback and oversight mechanisms that deter the historic trends of exploitation and discrimination.