In Selling Service to Poor, Banks Badly Lag Rivals

There is money to be made selling financial services to America's poor, but banks are only beginning to wake up to that fact.

Right now, an estimated 20 million U.S. households have no relationship with a bank. Yet as a group, these people spend billions of dollars on financial services each year. Who gets the profits? For the most part, a gaggle of often seedy outfits, including pawnbrokers, check-cashing services, and money-transfer agents.

But lately, the nation's "unbanked" underclass has caught the attention of giants like American Express Co. and Western Union Corp. American Express is inching into the money transfer business, helping millions of Hispanic workers in the U.S. send money home to their families in Central and South America. The company charges anywhere from 3% to 24% to transfer funds, depending on how much money is being sent.

Target for Western Union

Western Union is already well-entrenched in the money-transfer business and is now planning to launch a nationwide chain of check-cashing outlets. The target: mainly poor neighborhoods.

Pawnbrokers, meanwhile, have flourished to the point that several have raised money by issuing stock to the public. Shares of Cash America, the nation's largest pawnbroking chain, have more than tripled over the past five years.

Investors, it seems, like the fat profits that come from the pawnbrokers' high annual interest rates, which range to more than 200%.

Even as others are cashing in, though, the great majority of America's banks remain cautious. It seems that they are reluctant to do business with America's underclass -- and when they do, it is often because of pressure from regulators, politicians, and community groups.

Profits Are Possible

Once forced into the business, however, some bankers are beginning to realize that they can potentially make a modest profit by doing good.

"We look at basic banking as the lead end of our customer base," said Banc One chairman John McCoy, explaining that his strategy is to gradually expand his bank's relationships with each customer. "Our goal is to take a person from that [basic] account and open doors to other services."

In this series, American Banker will chronicle success stories and new initiatives by both banks and other companies who market their financial services to the underclass. It will also examine bankers' changing attitudes toward this segment of the business.

Competition from Nonbanks

Without doubt, one of the biggest players in the field is Western Union, based in Upper Saddle River, N.J. The company expects to operate a nationwide check-cashing chain within 10 years, and predicts profit margins of 30%. "We want to enter a growing business to serve people who don't like going to banks," said Warren Bechtel, a spokesman for Western Union.

In the $8 billion-a-year money-transfer market, Western Union netted $81 million last year for transmitting $6.9 billion for low-income consumers. Three years ago, American Express entered the money-transfer world -- shortly after Citibank backed out -- and now has 10% of the market.

Most bankers, already caught in the glare of public scrutiny over problem loans, seem wary of such markets. One reason: The idea of making big profits by serving the poor might not sit well with liberals in Congress or community activists who keep a close eye on the banks.

Many banks, in fact, are being forced to serve the poor through more prosaic products -- so-called "lifeline banking" services that provide low-fee checking and no minimum balances. Few banks make money on such products.

No Common Ground

It is no wonder that bankers and low-income customers share a mutual distrust of each other. The poor often feel unwanted or overwhelmed by the sophisticated men and women in pinstripes. Many bankers, equating low-cost transaction accounts with low profits, lose the drive to expand services to low-income customers.

There is some justification for such reasoning. A recent survey of 400 banks by the American Bankers Association found that three out of five institutions lost money or broke even on basic-banking products. Small banks, those with assets under $100 million, were the least successful; only 18% said such accounts were profitable, compared with 30% of banks with assets of more than $1 billion.

That means an overwhelming 70% of big banks and 82% of small ones lose money or just break even on the accounts. But looking at basic banking by itself may be short-sighted.

"We've always regarded basic banking as a breakeven business," said Banc One's Mr. McCoy. But, he adds, low-income customers often have hidden assets -- untapped equity and multiple deposit accounts -- that Banc One hopes to capture.

A Seasoned Program

The $33 billion-asset bank, based in Columbus, Ohio, has used this "foot-in-the-door" strategy since it began offering basic banking accounts two decades ago. The accounts were initially aimed at college students, on the theory that their income and financial needs would grow in tandem with their relationship with the bank. Similar strategies can be developed for low-income customers, Mr. McCoy suggested.

Gradually, bankers seem to be coming around to this viewpoint. Their reasoning: If banks have to serve the poor, they should work hard to make it profitable. "The real issue for banks is, what can we provide to low-income consumers, at least break even, and make a little profit on," said Carol Parry, senior vice president at Manufacturers Hanover Corp.

The company offers an account that gives customers eight checks each month and unlimited use of automatic teller machines. But with a monthly charge of only $5, this account is never going to be a big source of profits.

The only way to make money doing this is to do huge volume, cross-sell other products, and keep expenses to a minimum, several bankers said.

Building volume, however, remains a challenge. Bankers concede that a huge gulf exists between them and the poor.

"There is an opportunity and we need to work hard to change the image that we are cold, that we're only there for the well-to-do," said William E. McDonald, vice chairman of National City Bank in Cleveland. "Banks have to find a way to educate the [poor] and make them feel more comfortable coming into the branches."

Aversion to Risk

Mary Houghton, a cofounder of South Shore Bank, a pioneering for-profit community lender in Chicago, said most bankers don't get past appearances when considering lower income consumers. They mistake dress and demeanor for creditworthiness, she said.

Yet low-income consumers and minority-owned businesses "are very risk-averse," said Ms. Houghton, president of Shore Bank Corp., parent of South Shore.

One of South Shore's most profitable commercial lending relationships is with a group of entrepreneurs who redesign old buildings -- consumers that most traditional bankers might reject as borrowers.

"They walk in the door with their shirt sleeves rolled up, and do their cost projections in pen and pencil," she said. "They keep a lot of stuff in their heads."

Success and Failure

Even South Shore, often cited as the paragon of a profitable community lender, has had its false starts. Fifteen years ago, the bank offered a low-cost savings account with a $1 minimum balance and no transaction fees. Low-income depositors flocked to the account -- and the company lost money.

In an effort to break even, the bank has since had to increase the minimum to $250.

One sign of bankers' realizing that they must serve the poor and find efficient ways to do it is that they are beginning to criticize pawnbrokers, check cashers, and other players plying the financial fringe.

"We watched these businesses springing up and we wonder why consumers would choose to use them," says Joe Belew, president of the Consumer Bankers Association., referring to the high rates and fees being charged by pawnshops and other operations.

Adds Steven Ackerman, a vice president and product manager at CoreStates Financial Corp: "The fear is that they're taking advantage of people who could be better served by having a low-cost checking account."

The entrepreneurs and corporations that have been cashing checks and extending credit to the poor respond that they have for years been offering a vital service that banks refused to provide.

Maybe so. But that seems to be changing. BankAmerica Corp., for one, has been expanding the roster of products it markets to California's booming Spanish-language population. Last year, the West Coast giant originated $482 million of first mortgages in low-income neighborhoods, up from $232 million the year before. This summer, it introduced a money transfer business.

"If we are going to be competitive, we need to focus on these groups," said Ennio Quevedo-Garcia, vice president and manager of market segments at Bank of America.

Compensating for Declines

As a matter of sheer economics, banks may have to reach out to the low-income consumers in their communities, particularly as baby boomers near their retirement years and require less credit.

As James Johnson, chairman of the Federal National Mortgage Association, recently told a group of mortgage bankers, "If we're going to keep our volume potential at its maximum in the 1990s, we're going to have to reach a lot of people who we haven't reached in the past."

PHOTO : CASHING CHECKS in New York City. Who needs a bank?

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