Understanding the Underbanked Consumer

The second session at the recent Microfinance USA conference Banking on the Poor was asked to review concerned financial services for the underbanked consumer. The session was subtitled “…and the Future of Financial Services.” This was a bit of an over-reach and, frankly, I was a little disappointed at the depth of this session. Nevertheless, it is a critical subject for millions of American families and if anything, the session underscored how more needs to be done to serve this market segment.

Why would one pay a large fee to cash a government check or pay a bill? What induces some people to pay an effective annual interest rate of 400% for a short-term secured loan? Two studies, one by the Center for Financial Services Innovation (CFSI) and another by the Pew Charitable Trust (PCT) provide some answers to these questions and were the basis for the session concerning “Understanding the Underbanked Consumer and the Future of Financial Services.”

Rachel Schneider outlined the findings in the CFSI study which found an ethnically mixed population of 21 million American households with little or no bank relationships. According to the CFSI study these low-income consumers spend $29 billion per annum on financial services. While the study determined there was significant overlap between the unbanked and subprime borrowers, some 25% would be considered prime borrowers and 42% simply had too thin a credit profile to qualify for prime credit products.

The study also found that the banked and the un-banked borrow and save for essentially the same reasons. Roughly 40% of both populations borrow because they have trouble covering living costs from current income. And, the major reasons for savings for both groups are also similar—emergency fund, retirement, college savings, buying a home purchase and purchasing a car.

However, the un-banked must rely on so-called “alternative financial service providers” (AFS) who tailor their product offerings to be more appealing to the unbanked while those with access to banking services address their needs at lower costs and often with government subsidies. As a consequence, while both banked and under-banked low income consumers were hard hit by the economic downturn, those with access to standard banking products faired much better.

The PCT study, presented by Eleni Constantine, documented the interesting phenomenon that as many low income consumers seem to be exiting banking relationships as opening accounts. This suggests that as individuals circumstances change for better or worse, they gain or lose options in the financial services arena.

So why might rational consumers opt for products and services that are significantly more expensive? Both studies pointed to the greater simplicity of the AFS products and how AFS providers made greater efforts to make low-income consumers comfortable. The studies quoted participants as saying they felt more appreciated and respected by the AFS providers and that their products, such as pre-paid cards, kept them from bouncing checks and running up large credit card balances.

The PCT study forecast a growing need for low-income financial products and services—especially for credit—and noted the growing participation of retailers, such as Wal-Mart in catering to the needs of the underbanked. It recommended that credit products be integrated with savings products and credit repair services, and warned that the growth in financial services provided by non-banks risked the creation of a two-tier system for the banked and the unbanked.

Ms. Constantine concluded that recent regulatory efforts designed to protect consumers from high banking fees could actually push more low-income consumers out of the banking system and into the high cost environment of largely unregulated alternative financial service providers.

Shame Fame and Video Games

Banking on the Poor attended the Microfinance USA conference again this year. It was held in my old neighborhood in New York City which I help “gentrify” when I moved to New York to begin a corporate career more than 30 years ago. From the conference center I could look across the street and see our old apartment which now sprouts an urban forest on the roof where I had installed a hot tub. How ironic that I would return for a conference dedicated to finding solutions to poverty!

I think there is a good blog piece in that irony which I will work on for posting later. However, as with last year I was invited to blog on some of the conference sessions. Here is the first which dealt with new ways to engage the “wired generation” in financial literacy.

In the break-out session on “Designing Products that Promote Financial Capability” participants outlined efforts to use social networking technology and video games to change consumer behavior related to personal financial decisions. Rob Levy of the Center for Financial Services Innovation (CFSI) moderated the session which addressed the apparent ineffectiveness of traditional financial education programs to improve the “financial capability” of American consumers.

According to a recent study by the CFSI, 49% of U.S. households are unable to meet monthly expenses from current income despite years of financial literacy training. Furthermore, the CFSI study rated U.S. consumers deficient in other factors they define as key determinants of financial capability such as using a budget and having the ability to select and manage basic financial products and services.

The CFSI concludes that to be effective in promoting financial capability practitioners must “think beyond the classroom” and design programs that are relevant, timely, actionable and ongoing. Financial literacy education must be linked to access to financial services, leverage technology, incorporate the principals of behavioral economics and utilize cross-sector partnerships.

Innovations for Poverty Action (IPA) has been engaged in the international sector since 2002 and recently turned its attention to the issues of high debt, low financial resiliency and low savings in the United States. Brooke Berman explained that IPA sees the problem of low financial capability in a broader social context. That is, behavior considered rational for the individual (e.g. maintaining a reserve of savings) is not often viewed as optimal from a social perspective.

IPA solutions stress such techniques as commitment contracts and automated reminder messages that, in effect, shame consumers who spend rather than meet announced savings targets. This is a similar approach some weight-loss programs or anti-smoking campaigns work to get participants to change unhealthy behavior. Ms Berman described the “Borrow less Tomorrow” (BoLT) program in which participants identify debt they know they should pay down, commit to a repayment schedule and enlist their social network contacts to provide peer pressure to achieve their goals.

Doorways to Dreams (D2D) has developed a number of video games designed to teach adults about financial capability and help them change financial behavior. Tim Flacke said that D2D’s approach is predicated on their belief that poor financial behavior is a “demand side problem”—people are inherently resistant to changing behavior. D2D has produced what they describe as “financial entertainment” which differs from traditional financial literacy training by being engaging rather than earnest, targeted rather than comprehensive, interactive rather than static and accessible rather than restriced. Their games are available at www.financialentertainment.org.

Piggymojo, works at behavior change by making savers “heroes” to their partners. Designed to be used by couples, the program turns impulse saving into a better “feel good” experience than impulse spending. The founder of Piggymojo, Jayson Halladay, said that a family with an annual income of $45,000 typically spends 20% of their income, or $8,000 on impulse, inessential purchases. Piggymojo rewards people when they make a decision not to spend by sending a text to the other half say that he/she, rather than buying something, put the cost of the purchase into a joint savings account. The program tracks the respective “saves” of each partner and creates an image over time of the goal the couple has mutually agreed to save for.

These approaches to improving financial capability are clearly not your father’s kind of financial literacy training. Designed to appeal to the “wired” generation it will be fascinating to see if these innovations take hold and produce a more fiscally responsible generation.