A common pitfall among those trying to direct resources to the underbanked is almost everyone working on this issue has been focused on making existing products work rather than designing new ones.
Banks have tried to alter services to focus on the revenue challenges of catering to low- and moderate-income customers. Regulators and advocates have focused on lower prices, such as in the Federal Deposit Insurance Corp.'s Model Safe Account. But efforts to boost revenue and lower cost are in direct opposition. It's no surprise we're at an impasse.
We will succeed in improving access to healthy financial services only when we get to the core of what lower-income customers grapple with when juggling finances. Their biggest challenge is volatility. Rather than take steps to plan ahead or save, which they don't have time for, they tend to focus on their most immediate financial need and fulfill it any cost. That is why they pay so much for alternative financial services without complaint. They even intentionally pay late fees to buy short-term credit in the form of delaying a bill.
While banks lose money on low- and moderate-income customers, a healthy chunk of what these consumers spend to manage their finances — more than $1,100 on average annually — flows to alternative financial services providers. Other portions go to utilities, cable companies and cell phone companies in the form of late fees and reconnection fees. These payments are an opportunity for banks. Institutions could expandtheir businesses if they designed a product to help consumers manage volatility. In addition to the revenue opportunity, creating such a product would help solve a material public relations and regulatory challenge for banks.
Nearly a third of all Americans are considered unbanked or underbanked. To save these families from spending so much of their precious income just on financial management, consumer advocates, regulators, and others have been working hard to bring them into the financial mainstream — often by increasing pressure on banks to serve these households. A few banks have tried: American Express' prepaid card, Serve, and Regions Bank's Ready Advance are two examples.
But such initiatives are far from commonplace and progress on improving low- and moderate-income consumer financial health has been disappointing. The number of unbanked and underbanked consumers remains unchanged and low-income consumers using traditional banking services spend nearly three times as much on banking fees as their unbanked peers.
One hurdle to improving products for these consumers are the steps banks take to mitigate risk, such as delaying the availability of deposited funds or limiting credit availability. While these controls are legitimate, they make traditional banking products unsuitable for families who need to weather unpredictable and volatile cash flows.
Tackling these challenges involves understanding volatility from the consumer's perspective. New research in psychology and ideas42's work with low-income consumers reveal that the psychological effects of having to manage volatility hampers consumers' success at managing cash flow. Juggling scarce resources makes it harder to plan ahead and opens consumers up to potentially impulsive financial behavior.
Savings are another casualty of volatility. Consumers want to save, but they struggle to do so. One reason why is that consumers just trying to make it from one immediate obligation to the next don't necessarily have the time to compute when they have “extra” funds to save. But consumers who lack savings are spending money on fees for overdue bills and high-fee alternative financial products as desperate, last-minute solutions to avoidable problems.
If banks could offer a product to help consumers manage volatility, they could capture a healthy portion of the funds leaking to other providers. Such a product would need to accomplish three things: One, calculate excess funds and automatically transfer them to savings. Two, cover unexpected shortfalls with short-term credit that would get paid down automatically by temporarily redirecting excess funds from savings to repayment. And three, let consumers set aside funds for upcoming bills to reduce the risk that they would accidentally spend that money. Such a product could save consumers nearly half of the $1,100 they're spending every year, according to our analysis conducted with Oliver Wyman.
Those savings would, in turn, boost deposit balances, stabilize consumers, and ultimately, lower credit risk. Stable and bigger deposit balances would bring banks more profits. With the right product, we can turn a downward spiral into an upward one.
Piyush Tantia is executive director of ideas42, and a co-author of the newly published white paper 'Reimagining Financial Inclusion', produced in conjunction with Oliver Wyman.