Services for people without bank accounts are expanding. Photo Credit: diaper/Flickr.com/CC-BY

There is a class of people called “unbanked” who do not get a lot of media attention. The unbanked are people who have no bank account of any kind. The number of services catering to them, such as the payment management system PayNearMe, is growing.

Payment system and convenience chain form partnership

There is a new payment management system called PayNearMe that has formed a strategic partnership with 7-Eleven convenience store chain, according to BusinessWeek, that aims to serve a group of people referred to as the “unbanked” in the economic literature. The unbanked are people with no transaction account, such as a checking or savings account or debit card. PayNearMe founder Danny Shader recognized a need for these people to be able to conduct transactions, which led to him starting the company. Customers feed cash into a kiosks located in 7-Eleven locations in order to complete electronic financial transactions.

Growing number of services

PayNearMe currently can be used for such functions as shopping online or paying bills, and it costs less than getting a money order through similar services such as Western Union. The unbanked are able to secure financial services a lot easier these days, as more companies are offering products for them. Prepaid debit cards, for instance, are easily obtainable and can be used in lieu of a traditional bank account. As of January of this year, Kmart was rolling out a retail banking program at its stores, according to the Los Angeles Times, that offers services like check cashing and bill paying. Walmart already has financial service centers in 40 percent of Walmart Supercenter stores that have similar services available for unbanked and underbanked consumers. Walmart financial service centers charge far less than traditional check cashers.

A quarter of Americans do not rely totally on banks

A sizeable minority of Americans don’t rely totally on banks or credit unions to handle their financial transactions or services. The unbanked, those with no transaction accounts at all, are estimated to make up nearly 8 percent of the population, according to Forbes, about 9 million people as of 2009. A further 21 million, or about 18 percent of Americans, are defined as “underbanked,” in that they have a bank account but have to rely on alternative financial service providers, or AFSPs, to make some of their transactions for them, according to the FDIC. Nearly 47 percent of unbanked households have never had a bank account and about 41 percent said in an FDIC survey that they never intended to do so. The most common reason among the unbanked for not having a bank account was not having enough money to warrant opening a bank account.

Sources

BusinessWeek

Los Angeles Times

Forbes

Federal Deposit Insurance Corporation

The IRS is offerng tax refund debit cards to save money and allow unbanked households to get their money faster. Image: CC Neil T/Flickr

The IRS will start sending tax refunds to unbanked taxpayers on debit cards in 2011. Tax refund debit cards will cut the expense of mailing paper checks and allow unbanked taxpayers to get their money faster. The IRS will send a letter next week to taxpayers eligible for a pilot program testing the tax refund debit card program.

Debit card tax refund could help millions

Issuing debit cards for tax refunds is another step in the effort to eventually make the IRS a 100 percent digital agency. Filing tax returns electronically began in 1990. In 20 years the IRS has processed 892 million e-filed tax returns and expects to hit 1 billion in 2011. In 2010, 70 percent of taxpayers filed their tax returns electronically. About 63 percent had their tax refund deposited directly into their bank account electronically. According to the latest U.S. census, there are nearly 9 million unbanked households — 17 million adults who don’t have a savings or checking account.

Who is eligible for tax refund debit card?

A notice for the debit card tax refund pilot program will be sent out to 600,000 households next week by the Treasury Department. The tax refund debit cards will also be offered to more than 1.7 million workers in the U.S. who get their paycheck in the form of payroll cards. The Treasury Department will be offering different debit cards with different features and fees in an experiment to identify the best approaches when the pilot program is expanded. Debit cardholders won’t feel compelled to get a loan or be charged service fees if they withdraw fast cash from ATMs in the MoneyPass network. ATMs outside the MoneyPass network will charge regular service fees.

Paper checks don’t pencil out anymore

Last year the Treasury Department said $40 million was spent mailing about $45 million in tax refund checks. The fastest way to get a tax refund is with e-filing and direct deposit, which puts tax refunds in bank accounts in as little as 10 days. People who owe taxes can make payments to the IRS online as well.

Sources

Los Angeles Times

CBS News

Mybanktracker.com

IRS.gov

Check cashing and payday lending serve two different groups, but they are often lumped together. Image: Flickr / denverjeffery / CC-BY-ND

In Dallas, Arlington and Irving, Texas, a new program is trying to undercut payday lenders. Called Bank On Dallas, the program is trying to open traditional banking to new customers. Texas lawmakers are also considering new limits on payday loans.

The basics of Bank On Dallas initiative

Bank On Dallas is a bank and credit union program based in the Dallas area of Texas. It tries to encourage banks and credit unions to give “starter” bank accounts to residents of the area who do not have bank accounts. This group of people, called “unbanked,” is a group that often uses check-cashing storefronts. The “Bank On Dallas” initiative is supported by many groups that are also trying to pass new regulations on the payday loan industry in the Dallas and Irving, Texas, area.

Debating payday loan limits in Texas

A coalition of community groups are currently lobbying Dallas-area lawmakers for more regulations on payday loan stores. Dallas officials point out that car title and payday loan stores are more common in Dallas than Whataburger and McDonald’s stores. Currently in Dallas, payday lending is limited to “credit service organizations.” Dallas lawmakers want to limit the interest rates and terms that credit service organizations can use, claiming that they take advantage of their customers.

Differentiating between underbanked and unbanked

The Dallas organizations that are trying to open banking up to unbanked customers are claiming it will also reduce customers available to payday lenders. The problem is, however, that unbanked customers and underbanked customers are two different groups. Unbanked customers often use check cashing locations and other alternative banking locations. Underbanked customers, on the other hand, are the ones who tend to use payday lending and other options for short-term cash because most payday lenders require that customers have a bank account. The new regulations for payday lenders in Dallas have not yet been written, but the City Council is still considering changes to the regulations.

Sources

Dallas City Hall
Payday Lending Statistics report

Things like recent gains for financial services giant Dollar Financial prove that demand for services like payday loans isn't diminishing. Image from Wikimedia Commons.

Recent earnings gains for financial service giant Dollar Financial Group indicate demand for payday loans and other services hasn’t diminished. Alternative financial service providers, or AFSPs as they are called, have a long history in the U.S., and indeed, throughout the world. The company, which offers check cashing, money orders and pawn loans as well as cash advances, is having a banner year.

Dollar Financial among largest payday loan lenders

Dollar Financial Group is one of the largest among corporate payday loans lenders, although that isn’t the largest of the company’s offerings. Payday loans and cash advances only make up 50 percent of how the company makes a pay day, with the other half being from check cashing, pawn loans, military loans and other financial services. Out of the largest global alternative financial services firms that are publicly traded on the market, Dollar Financial realized the greatest gains this quarter. Profits were $28.7 million this quarter with only 15.2 percent of loan revenue being lost, though payday advance loans are only 9 percent of its business in the U.S., according to MSNBC.

Demand for services like payday lenders are constant

There will always be a demand for alternative financial services, like payday loans, short term loans and check cashing outlets. Granted, the demand isn’t as huge as one might think. People who don’t use banks for their every financial service need fall into two categories, according to the FDIC and the Federal Reserve. There are the “under banked,” who use alternative financial services but have bank accounts, and the “unbanked,” who have no bank account whatsoever. The underbanked amount to just under 18 percent of the U.S. population, and the unbanked make up around 10 percent.

The demand will remain

Alternative financial services have a long history. Pawn lenders and short term loan lenders, like payday lenders, have been around in some form since before the Roman Empire existed. Obviously, with evidence like the booming business in companies like Dollar Financial, demand is not going away. You can read more in the Payday Loan Fact and Statistics Report on Personal Money Market.

When the IRS ended debt indicators, refund anticipation loan facilitators like H&R Block raised objections as their stock price fell. jalefkowit/Flickr photo.

Debt indicators — IRS information about back taxes and other debts taxpayers owe — are going away. The IRS has sent debt indicators to tax preparers to let them know if their customer’s refund might be held to cover back taxes and other debt. Debt indicators are used by refund anticipation loan banks to decide whether to make short-term loans to customers backed by their tax refund.

Debt indicators gone starting with 2011 tax season

Saying they are no longer needed, the IRS announced Aug. 5 that it will stop providing debt indicators starting with the upcoming 2011 tax season. Electronic filing and direct deposit lets taxpayers get their refund in a matter of days. The IRS said that eliminates the necessity for refund anticipation loans. Companies that profit from refund anticipation loans say the elimination of debt indicators limits an essential service they offer to the unbanked and underbanked.

Debt indicators: singling out the delinquents

The debt indicator is a key underwriting tool refund anticipation loan banks use to determine whether they will loan, how much to loan and at what interest rate. Journal of Accountancy reports that until now, when a tax preparer e-filed a client’s tax return, the IRS included a debt indicator in the acknowledgment file if the taxpayer would have any portion of the tax refund offset for delinquent taxes or other debts, including unpaid child support or delinquent federally funded student loans.

IRS criticizes refund anticipation loans

Short-term refund anticipation loans have been criticized by consumer advocates for charging high interest rates and fees in exchange for providing cash just a few days before the tax refund arrives. In 2008, 8.4 million taxpayers paid more than $738 million in fees for refund anticipation loans, according to the National Consumer Law Center. IRS Commissioner Doug Shulman told the Associated Press that refund anticipation loans are often targeted at low-income taxpayers. He said with electronic filing and direct deposit it takes 10 days or less to get a tax refund. He also said:

“I think it’s unfortunate that there’s a lot of hardworking Americans that are in a financial situation where they have to pay a substantial fee to access their refunds a week or two before they can get it from the IRS.”

Refund anticipation lenders unhappy

Companies that facilitate refund anticipation loans argue that debt indicators let taxpayers who are strapped for cash get their money faster. MarketWatch reports that Alan Bennett, president and CEO of H&R Block, said the IRS decision to ax the debt indicator would hurt consumers with significantly lower refund anticipation loan approval rates and higher costs for the most vulnerable taxpayers. He said these consumers are often unbanked or under-banked and will be forced to seek more expensive and unregulated credit. H&R Block said the demise of debt indicators will dent 2011 profits 5 cents a share, sending its shares down 3 percent.

Mango Financial hopes to raise the standard of financial services provided to unbanked and underbanked consumers in the U.S. robert & fabienne/Flickr photo.

Mango Financial, also known as Mango Money, is a relatively new financial services company dedicated to serving the underbanked and unbanked population. Mango Finanacial provides its Mango Money with prepaid debit cards online, plus a full menu of bank-like services not typically available for unbanked and underbanked consumers. Mango Financial currently only has one physical location in Austin, Texas, but plans to expand to new locations.

Something extra for the unbanked and underbanked

Mango Financial was created on the basis of a prepaid debit card, but its Austin location is a preview of something extra. Mango founder Bertrand Sosa told My Bank Tracker that his company’s prepaid debit card is a gateway to a growing range of financial services unbanked and underbanked consumers can use to manage their money. Mango customers can earn 5.1 percent interest with a linked savings account. Mango cardholders in Austin can come to the Mango store to pay bills, send money internationally, load paychecks directly onto prepaid debit cards, withdraw the cash they need from the ATM, use the self-service kiosk to manage their accounts or use the prepaid debit card’s integrated mobile capabilities to send money via text message or check balances.

Mango money for an untapped market

By serving the unbanked and underbanked population, Mango Financial is going after a largely untapped market for financial services. A fact sheet provided by the Center for Financial Services Innovation (CFSI) said that 20 percent of U.S. households, about 22.2 million families, are unbanked, meaning they have no transaction account at a mainstream financial institution. An additional 22 million underbanked families use a mixture of mainstream and alternative providers such as check cashers and payday lenders to meet their financial service needs. Each year, Americans spend at least $13 billion on more than 340 million alternative financial services transactions.

Mango focuses on the customer experience

Mango Financial is raising the bar for unbanked and underbanked services. But Triplepundit said the company’s most ambitious innovation could be its first Mango Store in Austin. Mango hopes its Austin store is the first of a national chain. Jennifer Tescher, founder and director of the CFSI, said Mango should be applauded for paying attention to the customer experience for this under-served portion of the public. Tescher pointed out that Mango is thinking not only about what it offers, but how it’s offered. She said many young people are growing disenchanted with traditional banking, whether because of high fees or Wall Street greed. The look and feel of the Mango Store could resonate among these consumers.

In what universe does a one percent check cashing fee exceed a $35 overdraft fee for overdrawing a checking account by $.01? (Photo: flickr.com)

In the 1960s and 1970s, many of America’s largest banks decided to go “where the money is” by pulling their branches out of the inner cities and focusing more on affluent areas. It may be sheer coincidence that infamous bank robber John Dillinger once gave that response to the question of why he robbed banks, but I’ll leave that for you to decide. Only in recent years has that trend begun to reverse.

What this exodus created was a growing population of “unbanked” individuals and families, people who depended upon everything from shoe boxes and coffee cans to store their money to check cashers for paycheck services and payday lenders for emergency cash. The traditional view society took of such people who depended upon check cashing and payday lending was that they were the “unsophisticated poor.” However, re-examination of this idea is advisable, as the truth may be that the unbanked are more knowledge about what the banking establishment is foisting upon consumers that we’re willing to admit.

Avoiding the World of High Fees

A recent New York Times article explores the phenomenon of why so many people are resorting to alternative measures rather than depending upon traditional checking accounts. While the journalist fails to produce any conclusive reasons, it doesn’t take much to read between the lines – the cracks in society’s pavement, if you will: overdraft fees of $35 per infraction for a checking account mistake are exorbitantly more expensive than a check casher’s fee of a few percentage points to cash a paycheck.

Jose Abreau Says “No”

A 37-year-old native of the Dominican Republic, Abreau denies the bank representatives who come to his New York coffee shop to recruit him into the world of traditional banking. He doesn’t see the point, as what money he earns beyond his immediate needs is sent to his family back home. He does this in spite of the fact that banks are credit unions are within easy reach. However, so are check cashing businesses.

A recent Pew poll indicates that 86 percent of licensed check cashers in Manhattan are located closer than four blocks from a bank or credit union. People like Jose Abreau actually walk past the banks and credit unions to get to the check cashing businesses and payday loan stores. Perhaps this is because many immigrants come from countries where friends or relatives lost money due to bank collapses or corruption (where there was no FDIC to step in and insure the deposits), but in reality there are a wide variety of reasons. Language barriers can exist, but community outreach groups are available to assist. Financial education is available for those who may not understand how traditional banking works. However, the way many banks treat consumers stands at the top of the list as to why someone would not want to rely upon the banking monolith.

Not So Unsophisticated, Are They?

Millions of Americans live from paycheck to paycheck. That’s a fact that the current recession has made painfully clear. Yet this does not mean that these consumers who are just making it are unsophisticated. On the contrary, they’re educated enough to see that if a surprise expense or miscalculation dips their checking balance into the red, the resulting overdraft fees are unconscionable. Rather than having such an organization hold their money hostage, many people feel more comfortable with check cashing, where all the money they have is right there in their hands. Check cashing fees are much lower than any overdraft fee or minimum balance penalty.

How Much Lower?

Consider this. Many banks extend customers the “courtesy” to use ATM machines to withdraw more than they actually have in their accounts. This comes with a heavy – and damningly silent – penalty. We’re talking 200 percent on overdraft fees or more. How is this no legal fraud? How can this be advertised as a courtesy? Is it any wonder that check cashing customers don’t want anything to do with such institutional treachery? If banks would charge no overdraft fees and simply not allow purchases that would create overdraft to go through, they’d probably draw more of a customer base. But banks depend upon overdraft fees for much of their operating profit, so it’s clear that they have little incentive to stop.

Imagine this scenario if you don’t already understand just how disillusioned some are with banks. If a working poor family bounces a single check – let’s say it’s for a mere $3 – there’s an overdraft fee of $35 or more. That could be a weekend’s worth of food for hungry children, plus diapers and subway fare. If the family doesn’t keep their balance above a certain figure, they could be paying even more. Yes, if overdraft fee policies were different, I’d be telling a different tale. And some banks and credit unions do offer free checking. But not everyone meets the credit or documentation requirements, or their local bank many not offer the service. For the transportationally challenged, that means taking what’s closest to home.

What Carrot Could Banks Possibly Offer?

Banks are crying out for customers in this recession, aren’t they? What kinds of incentives could they offer to make people want to use their services? Aside from being able to receive direct deposit or develop a credit history, it seems that people would like to earn a decent amount on their money. But savings accounts that offer .0125 percent interest don’t cut the mustard, let alone the artificial buttery spread. It’s better than nothing, but not by much. Factor in the fees and penalties and traditional banking can feel as good as a sock in the eye.

Hiding from “The Man”

Those who avoid traditional bank accounts for the services of check cashers may be hiding, too. I mention this not to justify the practice, but it’s something of which we should be aware. Without a checking account, bill collections and courts have one less option for skimming cash in the event that the consumer owes money. Of course wage garnishment is still a possibility. And what about those people who avoid traditional banking because their income is under the table? Being able to cash in on certain welfare benefits is a powerful lure, which could explain why some consumers don’t feel the compulsion to put their money in the bank where it can be detected so easily.

Not Such a Rosy Picture for Most

One reader commented on the New York Times article in a manner both poetic and bitingly real:

O, these great unwashed masses, unwilling to strap themselves to our glorious consumer banking system where they can know the joys of ATM fees, NSF fees, account maintenance fees, account research fees, etc. , all while enriching themselves on the 1.8 percent interest rate! What is wrong with these people? Don’t they want to be part of the American Dream?

Avoiding traditional banking is second nature for many, but steering clear of it entirely can have its disadvantages. Check cashing is an attractive option for those who can ill-afford the predatory practice of overdraft fees. Unfortunately, that would include most people. Many who have money do not understand just how much the deck is stacked against those with so little. Bank presidents think in terms of profits; bank customers hope not to run afoul of bank policy, as they have become increasingly unprofitable for consumers with each passing year.

Pursuit of alternative financial services like payday loans is sometimes necessary. But do the costs break the budget? (Photo: flickr.com)

There are numerous entries in the volumes of study on payday loans which suggest that low- to middle-income (LMI) families are the most frequent users of the product. Where access to credit and liquid assets are limited – particularly in areas that are not well-served by the traditional banking industry – the need for short term credit is greatest. Yet payday loan industry critics continue to produce statistics which they claim are evidence that too much of LMI families’ income is being eaten up by the allegedly excessive fees that payday lending outlets charge for their services.

Not According to this University of Michigan/Federal Reserve Study

In an August 2009 paper entitled “And Banking for All?” by Michael Barr and Benjamin Keys of the University of Michigan and Jane Dokko of the Federal Reserve Board, we see the expense for alternative financial services like payday loans expressed in very different terms for LMI families. Contrary to your average slapdash media expose, their well-researched study found (using the Detroit area as a sample) that “for the vast majority of households, annual outlays on financial services for transactional and credit products are relatively small, around one percent of annual income.” Payday loans and similar alternative financial services make up only a fraction of that, as we’ll see.

The Nature of the Study

The authors derive their data from the Detroit Area Household Financial Services (DAHFS) study. The survey takes into account which alternative and mainstream financial services LMI households tend to use. Respondent demographics, socioeconomic patterns and full access to balance sheet information helped the authors to piece together an interesting portrait of nearly 1,000 Detroit LMI households. Mainstream financial sector fees like annual bank account fees, check fees, NSF fees, bank overdraft charges and annual credit card fees are significant, while alternative financial service costs like money orders, check cashing, payday loans and others are somewhat less so.

Banked vs. Underbanked (or Unbanked)

The authors found that LMI households with access to bank accounts were more financially active and had access to more forms of credit than those households with little or no traditional banking usage. In short, the banked households tended to spend more. Underbanked LMI households displayed less willingness to access credit, but their status did not entirely preclude them from mainstream bank services. Furthermore, the state of being unbanked was shown to be a far from permanent condition. Expanding bank policies which strive to extend services to the “invisible minority,” would account for this.

Who Chooses Payday Loans?

“The alternative financial services sector plays a significant role in the provision of financial services to LMI households,” write the authors. According to Federal Reserve studies like those conducted by Brian Bucks et al in 2006, 25 percent of such households nationwide tend to be unbanked. This creates the need for such products as payday loans and check cashing services to fill the gaps that traditional forms of credit might be used.

Do Payday Loans Burden Them Unnecessarily?

That is a widely held view, but the authors’ findings suggest that convenient, easy-to-use payday loans have a negative financial impact on only “a small fraction” of LMI households. On average, LMI households (banked and unbanked) have been shown nationally to pay between $400 and $600 on payday loans yearly, which only amounts to two to three percent of annual income. For the Detroit area, the median was much lower, ranging from $41 to $98 for various credit services.

Time and distance costs for LMI households to use alternative financial services were observed to be somewhat more significant. In most cases this appeared to be the time and cost of transportation to get to brick-and-mortar payday loan and checking cashing outlets. However, I would suggest that if more consumers were aware of online payday loan services like those found at PersonalMoneyStore.com, time and transport costs would be greatly reduced or cut to nothing, so long as a home Internet connection is available.

Conservative Spending

LMI households necessarily displayed low level spending in the study. Mainstream financial service usage was low, as was alternative service usage (like payday loans). Being banked and having access to direct deposit – both of which are generally necessary in order to receive payday loans – are two areas in which LMI Detroit households surveyed were behind national averages. What this means, of course, is that widespread abuse of payday loan products would be impossible, as the possessing both of the above criteria is generally required.

Staving Off Food Shortages and Eviction

These were two categories where use of payday loans were reported among LMI households in Detroit, which would appear to indicate that such credit is relied upon in emergency situations (rather than in superfluous spending, as the media would have people believe). Access to more credit options (following a transition into the traditional financial services sector) would perhaps assist such consumers in dealing with financial issues, but the fact remains that most traditional banks simply do not have programs for which LMI households can qualify, whether it is because their credit rating is insufficient or the entry cost is too great.

Payday Loans and Fees: a Minute Percentage of Annual Income

While it is true that LMI households may curtail spending due to their relative lack of financial means, the observed debt load from payday loans and similar products didn’t prove to be excessive when they were used. Some financial institutions are rushing to catch up with payday lenders by offering similar products, but since they draw so much of their operating income from more expensive services like overdraft protection, there is little incentive to face risk and greater loss potential that goes with payday lending.

Savings is Important

The savings factor is not included in the authors’ analysis, but they do mention that consumers who face credit restrictions and income shocks that threaten to destroy their budget could certainly benefit from such education. Sadly, such things as how to budget and maintain savings for a rainy day is still something that the American public school system tends to gloss over. Basic financial literacy is something everyone should be aware of, which is why a great deal of institutional reform is needed. To their credit, many payday loan outlets and traditional banks offer information on financial education, but the ideal time to learn is during childhood.

Why So Many Unbanked?

Recall earlier that I mentioned that payday loans aren’t terribly lucrative for banks, to the point that things like overdraft protection are more interesting for them. It is true that the costs of collecting small deposits are high in relation to potential earnings. The only way to make up for that on the institutional level is to charge a higher fee. Unfortunately, such fees even apply to maintaining bank accounts, particularly for LMI customers who banks might consider to be of greater risk. The fees make having a bank account less attractive to some of the more challenged LMI households. Costs for transactions, not maintaining a minimum balance and overdrafts are often excessive. And if a household has had difficulty maintaining a bank account in the past, systems like ChexSystems let banks know. It would appear that the traditional banking system itself is designed to oppose the entry of many LMI households.

Is it Any Wonder that Payday Loans are Popular?

They are popular, indeed. And the authors’ findings regarding payday loan fees in relation to total annual income clearly indicate that they are not an excessive burden. There is a need that payday loans fill. The aftermath for most borrowers is far from catastrophic. Only the slim catastrophically impacted minority make for juicy news, I suppose.