The High Cost, for the Poor, of Using a Bank
Banks are often costlier for the poor than check cashers and other alternative financial services.
There have been a lot of reports lately on the growing numbers of people .. use alternative financial services such as payday loans. All this has convinced policy makers and many consumer advocates that low- and moderate-income people are victims of “financial exclusion.” They have therefore concentrated on moving these people to banks.
The numbers of “unbanked” and “underbanked” people are indeed growing. Seventeen million people nationwide are unbanked, up from 10 million in 2002; 43 million are underbanked. In very low-income areas like the South Bronx, where I worked, more than half of the residents have no bank account.
To understand why, consider loans of small amounts. People criticize payday loans for their high annual percentage rates (APR), which range from 300% – 600%. Payday lenders argue that APR is the wrong measure: the loans, they say, are designed to be repaid in as little as two weeks. Consumer advocates counter that borrowers typically take out nine of these loans each year, and end up indebted for more than half of each year.
It happens that banks offer a de-facto short-term, high-interest loan. It’s called an overdraft fee. An overdraft is essentially a short-term loan, and if it had a repayment period of seven days, the APR for a typical incident would be over 5000%.
To be sure, payday lending is a growing business, increasing from ten billion dollars in 2001 to nearly $30 billion in 2010. But Americans paid more than that on overdraft fees in 2011: a record $38 billion. (Banks are allowed to charge checking-account customers, on average, a hundred and forty dollars per day in overdraft fees.)
What’s more, many of the customers we interviewed told us that a lack of transparency at banks contributed to the costs they incurred; they found it difficult to predict when and what they would be charged. At RiteCheck and most other check cashers, in contrast, the fees for each transaction are typically displayed on large illuminated signs that span the row of teller windows, like the menu sign at a fast-food restaurant.
Joe Coleman, the president of RiteCheck, put it this way: “Banks want one customer with a million dollars. Check cashers want a million customers with one dollar.”
For low- and moderate-income people with few assets and some unpredictability in their income and expenses, banks simply don’t stack up well against check cashers and payday lenders. The number of people in a financially unstable position is rising. Yet policy makers continue to assert that banks are the answer.