For most people, having a bank account and a good credit score is one of the most important things in life; it guarantees access to finances in loans and other credit facilities. However, some, known as the “unbanked” do not have bank accounts, automatically putting them in the category of low-credit scorers. The category means that while they do have access to credit facilities, such is only provided by a niche class of lenders (often online lenders) who charge extremely high-interest rates even as they offer longer repayment periods. By extending high-interest loans to the unbanked, companies such as Enova and Elevate Credit are taking advantage of this group and traditional financial institutions should introduce financial products specifically targeting low-credit unbanked customers.
Traditional banking, while expensive (especially to the poor) brings a lot of advantages to its customers. Eisenberg-Guyot et al. (2018) posit that traditional banks and financial institutions offer their customers the flexibility of cashing free checks, accessing loans at reasonable interest rates, and taking out money orders. However, traditional financial institutions such as banks and credit unions do not serve all customers, leaving the underserved population to fend for themselves. According to Rubin and Felt (2016), there have been calls from Consumer Financial Protection Bureau for the institutions to implement policies making it easier for consumers, especially the unbanked (people without bank accounts), to access small-dollar loans. The idea behind the call is to make these traditional institutions low-cost providers to small-dollar loans.
By neglecting the unbanked, traditional financial institution have forced these customers to look to other alternatives for their financial needs. Online lenders such as Elevate Credit Inc., Enova, and North Cash Inc., and fringe banking (includes payday lenders, pawnbrokers, car-title lenders, and check cashers) have grown to fill the gap left by the institutions (Eisenberg-Guyot et al., 2018; Rubin & Felt, 2016). While these alternatives offer financial solutions to the unbanked, they do so by exploiting their desperation and inaccessibility to the traditional financial institutions. Eisenberg-Guyot et al. (2018) point out that short-term fringe loans and online financiers carry annual percentage interest rates of between 400 to 500%. In comparison, banks charge an average of between 7% and 18% on personal loans, 5% on car loans, 3.75% on mortgages, and 18% on credit cards (Tankersley, 2019). The interest rates charged by online lenders in comparison with bank rates present stark evidence of exploitation by alternative solutions.
The high-interest rates are not the only evidence of exploitation of the unbanked. According to Eisenberg-Guyot et al. (2018), as an alternative source of credit, pawnbrokers customarily offer to buy customers’ property for the advancement of cash. They (pawnbrokers), however, allow the customers to purchase the goods but at a higher cost. Moreover, while the loans offer by the alternatives such as pawnbrokers, car-title lenders, and check cashers often presented as a one-off emergency alternative, most borrowers take multiple facilities throughout the year and rarely discharge the debt fast enough. On average, the unbanked remain in debt five months a year, paying an average of $520 in fees and loan interests averaging $375 (Eisenberg-Guyot et al., 2018). The alternative facilities, therefore, continue to exploit them with high interest, fees, and sometimes seize their property when they default.
Part of the reason for the bulk of the unbanked remaining without bank accounts is the regulations that banks have to comply with to remain operational. Government regulations require banks to comply with the regulations, some of which are not only burdensome to the banks but also limit their profitability, thus preventing them from reaching out to the unbanked (Rubin & Felt, 2016). Thus, the safety and soundness regulations that prevent bankers from the unbanked are the bottlenecks for banks.
Banks have an opportunity to not only widen their customer base but also make profits. Eisenberg-Guyot et al. (2018) posit that the payday lending industry grew from advancing just $10 billion in credit in the 1990s to $48 billion in 2011, pointing to a growing industry. To meet the needs of Low-credit score consumers, therefore, banks must be innovative in their approach to this group. One way of tapping into the potential market is to identify regulatory barriers limiting their ability to expand their customer offerings (Rubin & Felt, 2016). Banks and credit unions must, therefore, look for a workaround the safety and soundness regulations. Additionally, traditional lending institutions have an opportunity of working with innovative technology companies, thus enabling them to navigate regulatory barricades while expanding their services beyond their traditional markets.
Paying 400-500% percent on loans and credit is indeed exploitation that the unbanked have to undergo given their low credit scores. The inaccessibility of traditional credit facilities due to regulatory bottlenecks is the main reason for this suffering by the unbanked. It is important to have a new regulatory regime, which will allow the underserved population to access lower-rated credits. Beyond regulations, the institutions should also look to innovation in technology to enable them to tap and expand their customer base for both their profitability and benefit to the unbanked.
Eisenberg-Guyot, J. et al. (2018). From payday loans to pawnshops: Fringe banking, the unbanked, and health. Health Affairs, 37(3), 429-437.
Rubin, J. & Felt, D. (2016). Online lenders are answer to unbanked problem. American Banker. Retrieved from https://www.americanbanker.com/opinion/online-lenders-are-answer-to-unbanked-problem
Tankersley, J. (2019). The Fed just cut interest rates. Here’s what that means for you. The New York Times. Retrieved from https://www.nytimes.com/2019/07/31/your-money/fed-interest-rates.html