Walmart’s launch of the Amex Bluebird prepaid debit card has rekindled the chatter about the supposed dangers of consumers using nonbank, non-FDIC-insured companies rather than banks and credit unions.
Invariably, critics of nonbank financial intermediaries, whether retailers or check cashers or payday lenders, contend that consumers use these dangerous, "high-cost" options because they are financially illiterate. They just don't understand how much better off they would be by dealing with banks or credit unions.
But, like most simplistic conclusions, this one is seldom accompanied by facts, and is as wrong as it is demeaning of the innate intelligence of these consumers.
The most recent iteration of the "banks are better than nonbanks" chorus reminded me of research I conducted several years ago into the possible reasons behind financial institution depositors' use of payday advances.
A review of 4,026 account statements from 757 banks, thrifts and credit unions in 11 states, collected from payday loan customers in 2005 and 2006, revealed that many depositors appeared to be seeking alternatives to inhospitable practices of their financial institutions.
The high incidence of Non-Sufficient Funds and overdraft charges was the most obvious practice impacting these depositors The average monthly statement showed 5.23 NSF items or 4.37 overdraft items, at an average cost of $26.73 or $24.67 each, respectively. The total value of NSF and overdraft fees contained on just over 4,000 statements was almost one million dollars.
In one example, 60 of 94 statements from the same institution showed an average of 3.3 NSF items per statement, costing depositors $40 for the month.
But, the cumulative number of NSF charges was staggering. One November statement showed a depositor had incurred 52 NSFs thus far for the year. A December statement showed 68 NSFs for the year; at least six per month.
Closer analysis of the statements revealed that many depositors appeared to be victims of a differential accounting treatment for debits and credits that increased the frequency of NSF items. It appeared that the financial institution applied deposits – even direct deposits of Social Security and payroll – on the day following "posting", while it debited checks drawn on the account on the day preceding "posting".
The practice created a two-day under-funded position between debit and credit items posted on the same day which cost depositors dearly and enriched the institution unfairly.
On one statement, checks as small as $5.35 and $9.90 were declined and assessed $12 NSF fees on the same day that over $1,300 was deposited electronically by Social Security.
The only exception to this differential accounting practice occurred when the financial institution debited that account $1,048 as a payment for its own mortgage loan on the same day a $1,438 direct payroll deposit was posted.
Had this process been used for the six checks posted on the same day as the Social Security deposit, the depositor would have saved $72 in NSF fees, plus whatever fees were assessed by the payees for returned checks. At that time, such fees averaged $25 each.
This type of differential accounting practice may help to explain why the check-cashing industry has maintained that roughly two-thirds of its customers have bank accounts. The implication is that these customers cash their checks so that they can deposit funds into their bank accounts to avoid such shenanigans.
In the previous example, if the depositor had received a paper check instead of direct deposit, it would have cost $39 to cash the $1,300 Social Security check at a check cashing location. Depositing the proceeds at the financial institution would have saved the depositor $72 in NSF fees and whatever additional fees might have been assessed by merchants.
Unquestionably, the account statements showed consumers who were living paycheck-to-paycheck and writing checks in anticipation of deposits. But they were estimating the timing fairly well. Their checks were hitting their accounts on the same day as the expected direct deposits.
However by manipulating the way debits and credits were applied to accounts, their financial institution aggravated their depositors' financial situations to create fee opportunities for itself.
Throughout the research sample, heavy fee burdens, inequitable accounting and confusing statements contradicted widely-held contentions about the benefits of using insured depositories over nonbank providers. Accounts at financial institutions were not less expensive than using nonbanks. Direct-deposit did not provide immediate funds availability. Funds clearing processes were not disclosed. And consumers' use of nonbanks did not evidence a lack of financial literacy.
In the face of such unfavorable treatment, over 4,000 customers appeared to be doing what any intelligent individuals would do. They looked for more advantageous options.
Admittedly, this research was unscientific. It was based solely on consumers who were seeking short-term credit from nonbank providers and agreed to provide statements. However, the commonality of the problems experienced by thousands of customers made it hard to believe that they were uncommon practices.
These experiences also suggest that those who characterize the use of nonbank financial service providers as a collective lack of financial literacy oversimplify and trivialize the situation.
In reality, the growing use of nonbank intermediaries may represent an educated response to the high-cost of using "mainstream" financial institutions.
Jim Wells is president of Wellspring Consulting International, which specializes in designing financial products and services for consumers seeking alternatives to traditional financial institutions. He can be reached at mailto:email@example.com.