In the first article in our series on financial inclusion and how traditional institutions can better serve underbanked and unbanked populations in the US, we broke down the three reasons more than 40 million people are underserved by traditional banking institutions: the high cost of services, inaccessible services, and a growing lack of trust in the banking industry.
Here, we turn to a deeper analysis of how these populations are increasingly burdened by alternate financial services, and how fintech aims to close the gaps in services left by today’s banks and credit unions.
Banking in the US today is actually a tale of two financial services landscapes. One is dominated by large financial institutions such as JP Morgan Chase, Wells Fargo, Citibank, and Bank of America. The other is composed of a network of alternate financial services, including payday loans, paycheck advances, pawnshops, auto-title loans, and advances on tax refunds—none of which provides consumers with a secure, stable, equitable way to manage their money.
And while the underbanked and unbanked populations reached their lowest levels in nearly a decade in 2019, the COVID-19 pandemic and the ongoing economic volatility point to an expected increase in the number of people who don’t have full access to the nation’s traditional banking system.
The most recent data from the Federal Reserve System’s Board of Governors clearly outlines how this lack of financial inclusion predominantly affects BIPOC communities, low-wage workers, and the unemployed—three groups of people who have also been adversely affected by the pandemic.
Family income
Families with a household income below $40,000 are seven times more likely to be unbanked than those with household incomes between $40,000 and $100,000.
Black demographic
Black people are more than three times as likely to be unbanked or underbanked as white people.
Hispanic demographic
Hispanic people are more than twice as likely to be unbanked or underbanked as white people.
Racial disparity
Only 50% of Black people and 66% of Hispanic people are classified as “fully banked,” compared to 85% of white people.
In addition, the federal reserve report on economic wellbeing shows that 16% of adults in the US are underbanked. Historically, traditional financial institutions have failed to meet the needs of the underbanked and unbanked with affordable, accessible products that pave the way toward becoming fully banked. That’s resulted in more people needing to pursue alternate financial services, which often pass along exorbitant costs these consumers can’t afford.
The costs of being unbanked
Those who are unbanked face numerous direct costs related to even the most basic banking services like check cashing and bill payment. A check-cashing operation will charge upwards of five percent to cash a check, for example, resulting in thousands of dollars in annual fees for individuals already stretching the value of every dollar they earn. Equally burdensome are the high-interest loans traditional lenders offer, which can easily balloon out of control and oftentimes become more costly than even their initial value.
Then there are the indirect costs. Not having a formal banking relationship means the unbanked lack the resources to save money or build a credit history. And while having a bank account doesn’t mean an individual will save, many experts in the space—as well as unbanked individuals themselves—say it’s an important means for facilitating savings.
That’s because individuals who collect their savings in a dedicated savings account are much more likely to open other types of financial accounts—such as certificates of deposit (CODs) and insurance contracts—more likely to own homes and cars, and more likely to use formal sources of credit.
Unbanked individuals, however, are forced to use other methods if they wish to save. Keeping cash or jewelry at home is one example, but such methods offer no interest, not to mention leaving individuals much more susceptible to theft. Additionally, unbanked consumers miss out on the benefits of maintaining a bank account offers for building a credit history—a critical piece of an applicant’s profile when it comes to decisions regarding a host of basic needs, including employment, housing, and personal loans to cover medical or emergency expenses.
Fintech looks to redefine notions of creditworthiness
Recognizing that traditional financial institutions are failing to address the pain points of the underbanked and unbanked, the fintech space is disrupting long-held notions of what it means to be “creditworthy”—thereby opening new avenues for financial inclusion to connect with millions of consumers with thin or non-existent credit histories.
To do that, fintech organizations are looking at the proliferation of new sources of consumer data that provide insight into a borrower’s financial standing. Such alternative credit data can include utility and phone payments, as well as rental records and even changes of address—all of which are easily accessible to lenders and provide a bigger picture regarding an applicant’s ability to pay.
And business is booming for the emerging industry. Personal loans underwritten by fintech alternative-lending platforms have grown rapidly since the 2008 global financial crisis. In fact, a 2020 study by TransUnion found that outstanding unsecured personal loan balances showed 16% YOY growth between Q4 2016 and Q4 2019, representing $161 billion across more than 23 million loans. And much of that growth comes from loans originated by fintech companies.
So what can banks, credit unions, and traditional finance organizations do to promote financial inclusion, ensure they don’t cede additional market share to fintech, and better address the needs of today’s underbanked and unbanked communities? The answers lie at the intersection of technology, adaptability, and education. In the final article in this series, we’ll unpack these in detail.