A check-cashing store in Chicago's Little Village neighborhood is one of the places that people without checking accounts do business.
Most Americans take easy access to financial services for granted: they maintain checking accounts to pay bills, use debit or credit card to handle purchases, and keep rainy-day money in savings accounts. But for the nation’s “unbanked” – an almost exclusively low-income group -- navigating the world of consumer finance is more complicated, and more costly.
To cash a check, they must go to a check-cashing outlet and pay a stiff fee. To pay a bill through the mail, the unbanked must hand over cash, and pay a fee, to obtain a money order. If their car breaks down or they face an unexpected medical bill -- the kind of situation most of us painlessly deal with a credit card – they must turn to a payday loan provider that will overlook their lack of a charges super-high interest rates.
It costs low-income people a lot of money, in other words, to be “unbanked.”
Historically, the banking industry was content to leave such customers to what is sometimes known as the “fringe banking” industry. Many of them, after all, have bad credit histories and few assets. But in recent years, banking institutions nationwide have been reconsidering that view. Why: it’s a sizeable potential market.
In the Chicago area, 8.6 percent of the households were unbanked, with no bank accounts; another 16.4 percent were “underbanked,” which means they have bank accounts but continue to rely on alternative nonbank financial services. And unbanked, according to the Federal Deposit Insurance Corp.’s last national survey released in 2012 are households that have bank.
Looking for more growth, many local banking institutions have tried to lure the unbanked with services such as check accounts and small loans. Such moves open up a potentially big market but, as some banks acknowledge, carry risks.
ABC Bank Inc., on Chicago’s West Side, can vouch for that, after six years of trying to develop this niche market.
ABC customer loan officer Reginald Little is in charge of ABC’s Ready Cash, a product that offers small loans to the unbanked and underbanked population. Ready Cash offers a credit line ranging from $1,000 to $10,000 and it carries a relatively cheap 12 percent annual percentage rate with a maximum of one-year term.
So far, “It’s not a money maker for the bank at all,” said, Reginald Little, customer loan officer with ABC Bank Inc. Sitting by his cubicle in an office in the Austin neighborhood, West Garfield, the 48-year-old banker was explaining how the company serves this community he has lived in since 1971.
Little said the bank offers a much better interest rate and much better repayment, compared with other nonbank firms. Picking up application form from a local payday loan lender, he pointed at the 403 percentage rate they typically carry on the contract and asked “Don’t you think that’s a bit abusive?”
Most payday loans are packaged as short-term loans for temporary needs with 15 percent annual percentage rate for two weeks. However, if the borrowers fail to pay back the money and renew the repayment term for a year, they can end up being charged as much as 400 percent annual percentage rate.
Even though it offers more affordable terms, Ready Cash has not been a big seller. Since the launch six years ago, only about 200 customers have applied, including about 40 new customers last year.
At ABC Bank, the loans are small but the overhead costs remain substantial, and that yields very small profits for the lender, explains Little.
In addition, some customers aren’t comfortable with bank lenders’ questions, which can include a borrower’s credit score, debt-to-income ratio and history of unpaid collections.
“A lot of people using payday loans know it’s expensive.” said Kant Desai, chief of policy of the city’s Treasurer's Office who is in charge of “Bank On Chicago” initiative that aims to bring the major banks and unbanked people under one umbrella.
In comparison with the bank lenders, payday loan centers “don’t ask questions. You just go and get the money,” he said.
However, some banks still have concerns over the potential risk from micro-lending. Urban Partnership Bank, an active lender in the South Side that boasts of its investment in community development, does not offer small-dollar loan products.
“The key,” said Levoi Brown, chief banking officer with Urban Partnership Bank, is having a “responsible product. I think we have questions about the responsibility about some of the products,” small-dollar lenders provide.
“A lot of these people are already in debt. So what you are doing is continuing to feed that cycle of debt with $500 loans.” He would want to see customers to get to the point where they can budget, save and manage their money before applying for loans.
Past efforts to bring the unbanked to mainstream banking have fallen short. In 2008, the FDIC carried out a two-year pilot project to encourage small-dollar loans, but many banks showed little interest.
“We would argue that just small-dollar loans … (are) not the answer,” said Lucy Mullany, senior policy associate for Heartland Alliance, a non-profit organization committed to poverty relief. “If you are taking out small-dollar loans, it still means you’re not able to make ends meet. What we need to be asking is ‘Why is that?’” What’s needed, she argues, is a way to improve low-income clients’ borrowing power. “Building your credit has ripple effect on a lot of things, especially when it comes to financial security,” Mullany said.
Some local credit unions say they’ve come up with a solution: credit builder loans.
“We ran into the situations where we might not be able to help people to get a line of credit because of their debt or the credit,” said Roman Ruiz, branch manager with the Second Federal Credit Union. “But we tell people ‘Let’s give you the opportunity to build your credit.’”
In a typical credit builder loan, instead of getting the money upfront, the borrower makes payments on the loan over a period of time. Credit unions put the money in an interest-bearing savings account. Over time, they report the borrower’s payment record to credit bureau. By the date the loan is paid off, proponents say, the borrower can have two things: access to the money and a better credit.
Since Second Federal rolled out Fresh Start Loan in November, 37 members have signed up for the loans. Each can borrow $500 to $3,000 with terms up to 24 month.
“One day, individuals who start with Fresh Start Loans may be able to get a car loan,” said Ruiz. Over time, he said, these borrowers will be able to improve their credit histories and move to other loan products.
“After that, they may come back and say ‘I want to apply for my first home loan. We can help people get the tools they need so that they will be able to get to that point.’”