Economy / Fiscal policy

Insufficient Funds: The Unbanked and Underbanked in America

Banking is based on a relationship of implicit trust in which consumers trust the bank to safeguard their money and provide instant access to funds while banks trust that consumers will retain a certain portion of their funds within the institution for use as lending capital. In order for a bank to retain solvency, it must have assets which exceed its debts, therefore a broad base of income in the form of consumer checking accounts is desirable.

According to the 2011 FDIC National Survey of Unbanked and Underbanked Households nearly 8.2 percent of the United States is unbanked and 20.1 percent is underbanked, compromised of a disproportionate amount of low income and minority households. Unbanked individuals or households do not have a checking or savings account while underbanked individuals or households have a checking and/or savings account, but still rely on Alternative Financial Services (AFS). AFS are divided into widely used transaction products which include check cashing, money orders, and pre-paid cards and the less prevalently used credit products which include cash advance, pawn shops, and rent to own stores.  One in four American households utilized a form of AFS in 2011.

Ten percent of unbanked households do not have a checking account, while 29.3 percent do not have a savings account. Hypotheses for abstention from mainstream banking often center the assumption that low income households are deterred by costs associated with maintaining a checking account and service fees such overdraft protection fees. The reality is that some individuals actually rely on overdraft fees as a means of short term lending and willingly pay the surcharge to ensure that rent checks are paid in full despite a lack of available checking account funds. The passage of Dodd-Frank in 2010 may have inadvertently pushed people out of the mainstream banking system by limiting or eliminating overdraft fees and other service fees in order to protect the average consumer, but thereby removing the backstop utilized by certain low income bank users.

Another contributing factor to non-participation in the formal banking system is mistrust due to past experience or language barriers. Families may feel that they do not earn enough to open an account or that they are not able to due to illegal resident status. Bank on San Francisco and Seattle programs have been successful in reducing the population of unbanked households in their respective cities by reducing identification barriers, accepting forms of ID other than social security cards. The success of these programs led to the creation of Bank on USA which extends the outreach efforts to a national scale and received $50 million as part of the 2011 federal budget.

In comparison to the fees associated with AFS, checking accounts may in fact be relatively cheaper. A family with an income of $20,000 may pay as much as $1,200 for AFS. Additionally, without a traditional bank account, individuals and households are less likely to save for retirement, have less access to credit, and may spend a large portion of their income on AFS to meet their financial needs.

Attracting the marginal bank user, an individual on the cusp of participation or nonparticipation, is beneficial for both the potential user and the recruiting institution. Users will benefit from theft protection, credit building services, automatic payroll, ability to write checks, and greater potential for savings while the bank will gain increased lending capital. With over one third of the unbanked users surveyed by the FDIC indicting they are “very likely” or “somewhat likely” to open an account, there is evidence that greater participation in the mainstream financial market can be achieved and marginal bank users should therefore be pursued.