Why the Unbanked Are a Goldmine for Retailers, Pawn Shops and Payday Lenders

From: GoBankingRates.com

By Tim Chen

The unbanked are finally getting noticed: From Walmart and Target, to check cashing services and pawn shops, NetSpend and Green Dot to American Express, banks and non-banks alike are scrambling to attract these low-risk, highly lucrative potential customers. Even as rising checking account fees drive some out of the traditional banking system altogether, alternative financial services providers clamor for those that banks reject.

For banks, a perfect storm of low interest rates, cautious lending and regulatory changes rubbed most of the luster off of checking accounts. Usually, a bank can defray the cost of a checking account — estimated at more than $200 a year — by lending out the deposited funds and earning revenue off the interest spread.

However, persistently low interest rates and a sclerotic lending climate have lowered the revenue per dollar deposited. Banks now struggle to recoup the fixed cost of a small-ticket checking account. In addition, recent legislation significantly lowered overdraft and interchange fee revenue on most debit cards. The customers who deposit a small amount without taking a loan are no longer profitable for banks.

One Bank’s Trash Is a Non-Bank’s Treasure

Yet the banks’ castaway customers represent a novel stream of revenue for some, and a tried-and-true one for others. Payday lenders, pawn shop owners and check cashing services have long charged exorbitant interest rates for their services, knowing that many of the unbanked will take their upfront (though higher) fees over the surprise charges of checking accounts.

But payday lenders have been around for millennia. A new development is the entry of Walmart, Target and similar retailers into financial services. Walmart issues a branded prepaid debit card and offers check cashing services, while Target offers its own debit card and any number of stores feature 0% financing or layaway programs.

A typical retailer can monetize services to the unbanked in myriad ways. Walmart, for example, directly makes revenue from its check cashing fees. But perhaps more importantly, they can increase sales: When unbanked customers cashes their paychecks, they’re surrounded by products to spend that money on.

0% financing and layaway programs can earn their providers fee or interest revenue, since the former often charges retroactive interest rates, and the latter, setup and cancellation fees. They also influence customers to buy products they otherwise wouldn’t, whether because they couldn’t afford to or because what they think they want in September isn’t want they want in December.

And finally, offering an in-store debit card can save the retailer millions on interchange fees. The bulk of the fee goes to the bank that issues the card, so the Target debit card keeps those hefty interchange fees in-house.

Oddly enough, some banks are now offering their own prepaid cards to capitalize on a loophole to the Durbin Amendment to the Dodd-Frank financial reform bill. A bank collected an average of 44 cents for what’s known as an interchange fee every time a customer swipes his debit card. The Durbin Amendment capped debit interchange fees to about 24 cents on the average transaction, but exempted prepaid cards. This loophole led traditional banks, from Regions to US Bank, to create or promote their own prepaid debit cards.

But What About the Unbanked Themselves?

These practices, old and new, can be incredibly lucrative for those who offer them. Often, though, they’re less advantageous for the unbanked themselves.

Payday lenders have drawn the scrutiny of the new Consumer Financial Protection Bureau for offering what amounts to APRs of 500% or more, among other practices. The cost of check cashing, which can be up to $3 per check, is similarly hard to justify when most checking accounts provide this service for free. Bank of America, not known for its low-cost services, offers a checking account for $9 a month that is almost certainly cheaper than a prepaid debit card and check casher.

0% financing programs contain a major pitfall: Retroactive interest rates. If someone has a 0% APR credit card, makes a $1,000 purchase and pays off only $900 by the time the regular interest rate kicks in, he pays interest only on the remaining $100. However, someone using the 0% financing program at Home Depot, for example, will be charged interest on the entire $1,000 balance if he can’t repay his debt in full within the 0% period.

And prepaid debit cards often come riddled with fees, from a charge for making a PIN purchase to ATM withdrawal fees to monthly maintenance charges. These costs are only compounded when a consumer uses more than one card at a time, churns through a number of cards in rapid succession, or incurs auxiliary fees for customer service, inactivity or a paper statement.

Lower-Cost Financial Products for the Unbanked

The cost of remaining unbanked goes beyond the fees paid to check cashing services, payday lenders or prepaid debit card issuers. Without a savings account, an unbanked household is far less likely to put money away for college, retirement or emergencies.

The unbanked have difficulty establishing the credit needed to get an auto loan or mortgage, and so are less likely to own a car or home. The ideal, then, is to find an affordable way to experience the safety and support of the traditional financial system.

One of the best options is a credit union. These not-for-profit institutions often provide completely free checking, higher-yield savings accounts, lower-interest loans and financial literacy programs. Some are low-income designated, charged with serving economically disadvantaged or rural populations. And if a member doesn’t have the credit or track record for a loan, a credit union is far more likely to work with that customer to build up his credit than a for-profit bank is.

One credit union is attempting to bridge the gap between mainstream financial institutions and the unbanked. Self-Help Federal Credit Union established a micro-branch with the aim of attracting those uncomfortable with traditional banks. It serves the largely Latino immigrant population of East San Jose, offering check cashing, remittance and money order services at a low cost with the aim of building trust in the community.

Such efforts to bring in unbanked households are laudable, as traditional services are one of the most sustainable ways to cut down costs on all financial products.

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