The data on racial disparity in financial services

The murder of George Floyd shocked the national psyche to its core, spotlighting the persistent, systemic racism that exists in many American institutions, which continues to disenfranchise those who live within the Black community.

The national and international outcry for reform has been strong. However, there is one institution that can take immediate action to make mainstream products accessible, life more affordable and the pursuit of a middle class dream attainable.

At the center of this institution resides the payments industry, supported by traditional banks, credit unions and credit card issuers, along with nontraditional firms such as pawn shops, payday lenders and check cashers.

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Typically, at the center of a consumer’s financial life, where a bi-weekly salary is directly deposited and monthly mortgage payments withdrawn, one would expect ownership of a bank account would be key, if not required. However, that’s really only the case among white and Asian Americans with about 97% of households owning a bank account.

According to data from the FDIC National Survey on Unbanked and Underbanked Households issued in October 2018, one-sixth of Black Americans do not own a bank account from a traditional bank or credit union. About 14% of Hispanic households do not own a bank account either.

Among all households surveyed, including all ethnicities, more than half (52.7%) of unbanked households cited “do not have enough money to keep in an account” as a reason for not having an account, and 34% said it was the sole main reason for not having one. By not having a bank account it creates a two-fold obstacle: first it limits a consumer’s ability to make transactional payments and second it negates an ability to save for larger purchases such as a car or house.

“To do anything in your life, you need money,” said Jon Schlossberg, co-founder and CEO of Even.com, an on-demand pay company. “Everything costs money and it’s always getting more expensive. You need a surplus and a way to build that surplus.”
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The data reveals that while many Americans do have a bank account, not all accounts are actively used to their full potential. This became apparent when the government was almost forced to send over 100 million stimulus checks by mail according to CNBC as many consumers didn’t link a bank account to their tax returns.

Based on data from the FDIC National Survey on Unbanked and Underbanked Households, more than 30% of Black households were considered underbanked, bringing the told unbanked and underbanked population to roughly half of all Black households in America. The FDIC defines a household as underbanked if it has a checking or savings account and has used an alternative financial services (AFS) provider such as a check casher, pawn shop, or payday lender in the last 12 months.

Not having a bank or credit union account, or not using one as a primary transactional payments partner, forces a consumer into using AFS providers such as check cashers. One reason often cited by consumers using AFS providers is the upfront transparency of fees.

While Walmart does offer consumer-friendly check cashing fees ranging between $4 (checks up to $1,000) and $8 (checks between $1,000 and $5,000), most Walmarts are not located in urban environments that tend to have larger minority communities.

PLS Check Cashers of New York, an AFS company with several locations throughout New York City, advertises a rate of 1.99%, below the state’s regulated market rate of 2.23%. Cashing a $2,000 check at one of PLS’ locations will cost a consumer $39.80 compared to Walmart’s $8.00.
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Traditionally, lower income neighborhoods tend to have lower densities of banks, and this is also true of Black and Hispanic majority neighborhoods regardless of income, leaving them all the more susceptible to price gouging.

According to the McKinsey report “The economic impact of closing the racial wealth gap,” white majority neighborhoods have a bank density of 41 financial institutions per 100,000 people while non-white majority neighborhoods only have a density of 27 financial institutions per 100,000 people.

The McKinsey report highlights the disparity of the cost of opening and maintaining a bank account in the different communities by citing research presented in the New America “The Racialized Cost of Banking” report, which stated that opening a bank account in a white majority neighborhood only required a $68.50 upfront deposit, while doing so in a Black majority neighborhood required an $80.60 deposit. When translated into a percent of medium income in each neighborhood, it came to 3% in the white neighborhood and 6% in the Black neighborhood.

More importantly was the cost of maintaining a bank account without incurring minimum monthly fees, as high monthly costs are often a driver of high attrition leading to underbanked and unbanked consumers. In the white majority neighborhood, the average minimum balance needed to avoid a monthly fee was only $625, representing 28% of the median community income. In comparison, in Black majority neighborhoods the minimum monthly balance was $870.50, or 60% of the median community income.
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The high cost of opening and maintaining a bank account from a mainstream financial institution in a community of color has forced many to seek financial service products from AFS providers.

According to the FDIC National Survey on Unbanked and Underbanked Households, almost 40% of Black households and 36% of Hispanic households reported using an AFS provider in the last 12 months. This is in comparison to just 15% of white households having used an AFS provider in the same time period.

McKinsey estimates that the costs of using AFS providers for basic payments and banking needs has a negative impact on the wealth accumulation of a household. The consulting firm claims that a full-time worker who cashes checks with an AFS provider could save over $40,000 over the course of their career by switching to a lower-cost checking account.
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The biggest use of AFS providers is for transactional payment services among the unbanked (all ethnicities) and not loans. The top two use cases of AFS providers by the unbanked in 2017 was for what would be considered typical activities for a checking account — obtaining money orders (checks) and check cashing (deposits).

Based on data from FDIC National Survey on Unbanked and Underbanked Households, banked households, in contrast, are more likely to use money orders and loans from AFS providers. In terms of loans taken from AFS providers, the biggest single category of use for the banked were tax refund anticipation loans.

The FDIC survey does show a direct correlation of when a community becomes more engaged with traditional banks and credit unions, their usage of AFS providers, particularly for check cashing and money orders, declines in lockstep.

The challenge for banks to engage with consumers, especially communities of color where minimum daily balances required is often higher, is the demand to balance the highly lucrative overdraft/non-sufficient fund fee revenues. According to the Center for Responsible Lending the top 20 U.S. banks earned $9.2 billion in OD/NSF fees and all banks over $1 billion in assets in $11.68 billion in OD/NSF fees.

The Pew Charitable Trusts surveyed consumers in 2018 and found that one-third (32%) used overdraft as a way to borrow when short on cash. This could be inferred to mean that banks are not adequately meeting consumer lending demands for small-dollar loans.
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Based on survey data from the Pew Research Center in 2018, before the coronavirus pandemic, over one-third (34%) of Black consumers reported that they used cash for all or almost all purchases — double the rate of Hispanic (17%) and white (15%) consumers. In the current environment where more and more consumers are eschewing cash in favor of contactless payments and e-commerce, it leaves the Black community at a greater degree of risk if cash ends up being found to be a transmitter of COVID-19.

One challenge for cash-heavy users has been the ongoing battle between merchants who have been increasingly going cashless and governments that are either trying to stop the trend or encourage it, such as Sweden.

While the reliance on cash can be used as a simple measure of budgeting, it can have a long-term, unsuspecting deleterious effect on a person’s credit rating. In other words, cash usage leaves no records for credit bureaus to report to banks to aid in their decisioning on a credit card application.

According to a paper published by the Consumer Financial Protection Bureau (CFPB), a large swath of Black Americans are “credit invisibles” and “unscoreable” due to a lack of data. The CFPB report estimated that 15% of Black consumers are invisible and roughly an additional 13% have insufficient or stale (too old) reports that are unscoreable. The unfortunate result is that 28% of Black applicants who apply for a credit card or loan are likely to be rejected outright because of their credit invisibility.
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As the U.S. economy increasingly goes cashless and more reliant on credit cards for e-commerce and contactless for in-store payments, it’s leaving several communities behind or completely cutting them out of the financial mainstream.

Based on data from the from FDIC National Survey on Unbanked and Underbanked Households, less than half of Black households own a general purpose credit card that can be used at any merchant and just over one-quarter own a store private label credit card. In comparison, three-quarters of white households own a general purpose credit and almost half have a store credit card in their wallets.

Usage of prepaid cards remains low for all households, partly due to the need to deposit upfront funds and pay high monthly fees. Additionally, some prepaid cards can also come with other add-on fees that make them even more costly. At a time where 40% of U.S. households can’t afford a $400 emergency expense without having to borrow from a relative or sell something, according to the Federal Reserve, prepaid cards are unable to fill the credit need.

More than one-third (36%) of Black households do not own any mainstream credit product – two and a half times higher than white households, according to the FDIC.

For social justice and racial equality to advance, the payments industry, as well as its supporting cast of traditional (banks) and nontraditional (AFS) partners, need to consider how it can be more inclusive of communities of color, especially as the economy increasingly goes cashless.