Introduction

An astonishing number of American families lack a basic financial asset -- a bank account. The Federal Reserve estimates that about 13.2 percent of American households don't own a checking account and that about 9.5 percent of American households hold no bank account at all.

The demographics of the "unbanked" are striking:

• The unbanked are disproportionately poor. Four out of five of these families make less than $25,000 a year, and two out of five families have annual incomes of less than $10,000.
• The unbanked are mostly minorities. More than half of all unbanked households are nonwhite or Hispanic, and studies estimate that as many as one-third of all nonwhite households are unbanked.
• Unbanked households are young. One out of three unbanked families is headed by someone under the age of 35, and more than half are headed by persons under 45.
• The unbanked are likely to be less educated than the general population. For example, one survey of federal benefits recipients found that of those recipients without a bank account, 59 percent had less than a high school education.

Conventional wisdom has held that many low-income consumers cannot afford a traditional bank account because of high maintenance fees. This assumption led to several state and federal initiatives that attempted to encourage banks to offer low-cost basic accounts to eligible participants. These initiatives have not proven successful, however, and mounting evidence indicates that affordability is not the principal reason low-income consumers avoid banks.

For many people, being unbanked is not a question of access, but of appeal. The banking products offered by mainstream banks do not fit the spending and savings needs of low-income consumers, and banks are failing to tailor their products to compete effectively in low-income markets. For example, many low-income consumers generally live paycheck to paycheck and cannot afford to wait for a deposited check to clear. Recent research into the attitudes of low-income consumers toward mainstream banks also indicates that many potential customers harbor either a distaste for or a distrust of traditional financial institutions. Moreover, recent studies have found that a significant percentage of low-income customers who do have bank accounts rely on fringe institutions for all or part of their day-to-day banking needs.

In fact, low-income workers are increasingly turning to "alternative" financial service providers such as check cashers and pawnshops to supply their banking needs. According to recent research, about 11,000 check-cashing stores are in business today -- or double the number five years ago. Moreover, pawnshops now outnumber credit unions and banks. "Payday lending," which was in its nascence as an industry less than a decade ago, is perhaps the fastest-growing fringe phenomenon. Prof. Michael Stegman of the University of North Carolina at Chapel Hill reports that the number of payday lenders has grown from about 300 stores seven years ago to more than 8,000 stores today.

Although these "fringe" institutions do offer the types of services that low-income consumers want -- that is, convenience and easy access to cash -- they do not offer the tools for savings and wealth creation that mainstream banks can. Moreover, because of lack of competition from mainstream banks, the prices charged by fringe institutions for their services can be extortionately high.

Mainstream banks can and should compete effectively -- and profitably -- in low-income markets. But doing so will require a radical rethinking of how banks do business with low-income consumers. Bringing banks to the unbanked will also require the full cooperation of government and community-based organizations to nurture the market and make it work for low-income consumers.

For low-income customers currently served by a lopsided market, more competition means lower prices and better services. For banks, low-income markets may hold tremendous untapped profit-making potential.

Conclusions

• Traditional banks must adapt to a nontraditional market, either by offering nontraditional services themselves or partnering with institutions that do.
• Government can promote competition in lower-income markets by providing judicious incentives to mainstream banks to enter the market.
• Community-based groups can work to educate consumers about the relative costs of financial services and the benefits of savings.