Expand Your Base By Serving the Unbanked and Underbanked

Nearly one-quarter of the country is unbanked or underbanked, according to FDIC research. As COVID-19 threatens to draw more into those consumer categories, what factors will influence product design among institutions that try to step up service to this segment?

Most of America’s 260 million adults have a bank account today, with access to credit from traditional financial services firms. However, the number of “unbanked” and “underbanked” adults remains numerically huge and represents a large potential opportunity. The reasons these people are not fully engaged in the traditional financial services industry vary and therein lies the challenge. The COVID-19 economic shutdown and the resulting slump have and will certainly exacerbate the situation.

Nearly 6% percent of adults do not have a checking or savings market account (the study’s definition of “unbanked”), according to 2019 FDIC research of this issue released in October 2020. Additionally, 16% of adults are “underbanked,” defined as having a bank account but also using alternative financial services products such as a money order, check cashing service, pawnshop loan, auto title loan, payday loan, paycheck advance or tax refund advance. Combined, these two groups represent 22% of US adults or 57 million people — about one in five. (Keep in mind these figures are pre-COVID-19.)

“Findings from multiple years of the survey suggest that the unbanked rate is likely to rise as the unemployment rate rose from its level prior to the pandemic,” said FDIC Chairman Jelena McWilliams in a speech. “Households without a paycheck tend to be banked at lower rates than those with a paycheck. The economic ramifications of the pandemic will likely have an outsize impact on households without an adequate savings cushion or without access to responsible, affordable credit.”

The study categorizes people as unbanked based on their use of “alternative financial services,” suggesting that a reliance on these financial products indicates a failure of the traditional financial services industry to completely fulfill their needs. Less than half of the truly unbanked use some of these products, leaving about 3-4% completely disengaged.

Outlook Is For Growth Among Ranks of Unbanked and Underbanked

During the pandemic shutdown, much press coverage has been given to the sharp spike in unemployment (currently at 14% when including those who have left the labor pool) and the number of people living paycheck-to-paycheck. The numbers on those folks are shocking, with estimates varying, depending upon the study you cite, between 40%-50% of U.S. adults. Most of us likely know someone working in the “gig economy” relying on two-to-three jobs, sometimes more, just to get by nowadays. Recent 2020 estimates project that about 36% of U.S. adults are gig workers (Sources: Small Business Labs; Gallup; International Labour Organization; Statista). It’s likely many of these workers fall into this world of unbanked and underbanked.

The unbanked and underbanked are more likely to have low incomes, according to FDIC’s research. Only 1-in-100 of those adults with incomes over $40,000 are unbanked, versus one-in-seven with incomes of under $40,000. Additionally, this population is more likely to be in a racial or ethnic minority group — representing 14% of blacks and 11% percent of Hispanics versus 4% of whites.

Among these unbanked/underbanked segments, most (89%) use transaction services such as purchasing a money order or cashing a check at a place other than a bank. Of this group, 28% borrowed money using an alternative financial services product, including payday loans or paycheck advances, pawnshop or auto title loans, and tax refund advances.

Their reasons for these behaviors vary. Some have been turned down for more traditional financial services ¬— or fear being turned down. Others have been ill-informed about the traditional system and believing they cannot “afford” traditional bank or credit union services.

The same FDIC study indicated that of those who applied for credit in 2018, one out of four were denied at least once in the prior year, and one out of three were either denied or offered less credit than they requested. When in need and turned down by traditional channels, people will pursue non-traditional channels, likely at higher costs.

COVID-19 has or will undoubtedly made all these numbers worse. What can traditional financial services providers do to better inform and engage the underserved?

Balancing Service and Growth Against Their Costs

The financial industry has always played a role in helping the less advantaged (sometimes in response to regulatory requirements), but perhaps not always as much as it could. Not-for-profit credit unions certainly have been involved in community development efforts. Many new fintechs are targeting this “underserved” population with narrow, low-cost entry into the financial services. Chime is a prime example and has captured a reported 8 million-plus customers, adding a million new customers every three-four months.

The challenge in serving this population is keeping costs low when revenue opportunities are limited. It’s not that these potential customers are unwilling to pay for services. Just the opposite, they are likely paying more today by using non-traditional services like paycheck loans or check-cashing services.

As with any target segment, firms need to evaluate why their current services are not attracting this one. Is it a product issue? Educational issue? Risk concern? All of these matters can be addressed and overcome with proper planning.

With so many retail financial firms seeking incremental growth, this could be a big opportunity, especially as the ongoing pandemic continues to sap activity. What are the considerations?

• A clear, simple offering with straightforward pricing that is less costly than the non-traditional offerings.

• Simple benefits for the customer. (Chime offers early paydays for some customers with direct deposit.)

• Low-cost operations.

• Access to credit.

While it’s not necessary to have a branch network to reach this market, having one is likely an advantage, as it gives people the opportunity for face-to-face conversations with a banker. However, traditional account opening procedures have typically proven too costly. That’s one of the reasons Capital One touts opening a savings account in less than five minutes on either mobile devices or in branches. They have figured out how to reduce account opening expenses.

For many firms, online account opening continues to be problematic as many traditional firms merely put their old processes online, instead of rethinking them from the ground up.

The key to profitability in serving the unbanked and underbanked is keeping onboarding and support costs low. The few largest banks still have an advantage in pursuing this segment, but I expect it is credit unions feel that have the moral imperative to pursue them.

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