Banks Seek Profits, and a Better Reputation, from Low-Income Customers
Regulators are taking a hard look at payday lending practices, and that could give banks an unprecedented edge over storefront operators.June 28
Poverty is the next big business in banking — but there are plenty of pitfalls before it becomes the next big success in banking.
Selling financial services to low-income customers has long appeared unprofitable at best, and a reputational risk at worst. From subprime mortgages to hidden credit card fees, banks have gotten a bad reputation for preying on poor people. Some banks always avoided those products, and the financial crisis and new regulations have restricted the industry's ability to sell many of them but the public image of the predatory banker has only grown stronger in the post-Occupy Wall Street era.
At the same time, high unemployment and the ongoing housing crisis have moved many Americans down the income ladder, out of the traditional bank branch and into the storefront check casher or the Wal-Mart (WMT). Now banks, starved for profits and nursing tattered reputations, are increasingly trying to serve those customers in new ways — as long as they can figure out how to do so profitably.
"There's tremendous enthusiasm about this market, both as people come to understand this market, and as it's gotten bigger in the wake of the financial crisis," said Jennifer Tescher, head of the nonprofit Center for Financial Services Innovation.
She was speaking on the sidelines of the crowded Underbanked Financial Services Forum last month, an annual conference sponsored by CFSI and American Banker, which this year drew about 750 bankers, microlenders, nonprofit staffers and executives from nonbank financial companies.
Many of those companies are developing products for customers who no longer qualify for traditional checking accounts, or who keep some of their finances outside of the traditional banking system. Some banks and an entire nonbank financial sector have sought to do business with these so-called underbanked customers for years, but in recent months their appeal has become more mainstream.
JPMorgan Chase (JPM), the country's biggest bank, this month started widely selling a prepaid debit card that customers can use in lieu of a checking account, joining competitors including American Express (AXP), U.S. Bank (USB) and, a few days ago, PNC (PNC). Wells Fargo has long offered remittances and other financial products that many people buy at Western Unions and MoneyGrams, and now it has competition from banks including Regions Financial (RF) and Fifth Third (FITB) to offer customers cheaper, if still controversial, variations on payday loans.
Bankers at those companies acknowledge that they see a new opportunity to earn revenue from the poor, but they also say that want to meet legitimate customer demand for financial services that go beyond the checking account and the credit card. In the process, they say, perhaps they can help repair the banking industry's reputation for exploiting poor people.
"As far as what we face as an economy, financial institutions have been the whipping boy across the board. This is an opportunity to try to show … what we want to do to support our consumers," Poppie Parish, a senior vice president of community development banking at KeyBank (KEY), said in an interview.
The Cleveland bank has broadened its services to compete with check cashers and payday lenders, and it has won tentative praise from consumer advocates, who call its short-term, small-dollar loans "much more affordable" than some bank-offered payday loan products.
The Federal Deposit Insurance Corp. estimates that about 9 million households do not have a bank account and another 21 million households rely on financial services beyond traditional banks. The term "underbanked" comprises more than just low-income customers; Tescher and other speakers at the conference repeatedly spoke about the diversity of people who opt not to participate in the traditional banking system, ranging from immigrants and people without established credit histories to young and tech-savvy consumers who prefer to use online services and prepaid cards instead of checking accounts.
Parish acknowledged the diversity of demand for Key's new services, but she also attributed some of the bank's interest in developing them to a broad loss of wealth among Americans since the financial crisis.
"With the negative financial events that have been occurring, we're seeing a lot more individuals that now you would consider underbanked and underserved. We're seeing credit scores lowering because people have lost their jobs, they've changed jobs and their income has gone down," she said.
But it is unclear how worthwhile it is for other banks to follow Key's lead, especially when it comes to products like short-term loans. Key says its version of the product is profitable, but it is unclear to what extent. That is a crucial question for banks that, while wanting to avoid regulatory run-ins or the whiff of predatory lending, are looking for ways to make up for lost fee income. Since the financial crisis, regulations of banks' credit cards, overdrafts and debit card interchange fees have cut into many sources of retail banking revenue.
Some of Key's competitors have opted to try to split the difference by selling their customers versions of payday loans called deposit advances. Executives from those banks have defended the advances, arguing that they offer a less-expensive version of a product their customers already buy from storefront lenders.
Those bankers are mindful of the Consumer Financial Protection Bureau and the new attention it is paying to the financial services that banks and nonbanks alike sell consumers. The agency is scrutinizing some of those products, including prepaid cards, remittances and payday loans; this month it showed its teeth by taking its first enforcement action, against Capital One (COF), for the bank's credit card marketing practices.
But the CFPB's officials also appear to recognize that banks and nonbanks need to experiment in order to offer better products to low-income customers.
"Achieving solutions that scale requires that we actively engage all the sectors — mainstream financial service providers, startups, nonprofits, governmental entities and community groups," David Silberman, the CFPB's acting associate director for research, markets and regulations, told the conference audience last month.
He added, "Listening to organizations in the field and learning from your experience are crucial to our work in addressing the financial challenges faced by low-income and economically vulnerable people. That learning has just begun and will continue."
Perhaps the biggest question for banks — and for their critics — is whether for-profit financial institutions can offer low-income customers better financial services than they can find elsewhere, while still making a profit. That was a criticism raised by some conference attendees, especially from nonprofit organizations that offer competing products.
"There is a genuine interest on the part of banks and formal financial institutions of wanting to do better and reach a low-income customer," but because nonprofits "are compelled by a social mission … we can absorb less of a profit," Caitlin McShane, a spokeswoman for the non-profit microlender Opportunity Fund, said this month.
Tescher, summing up the debate at the end of the conference, argued for a more inclusive view of companies that can profitably and reputably serve low-income customers.
"We don't pretend that financial services are the antidote to life's problems," she said. But "when people are financially challenged, it's in that moment that we need to think creatively about what kind of tools we need to bear."