Conventional wisdom has been that low-income people are better served by mainstream financial institutions than by check cashing storefronts, payday lenders and other providers of fringe financial products. But now, that wisdom is getting turned on its head as fee-starved banks start peddling these expensive “subprime” products to their poorest customers directly.
Major national and regional banks including U.S. Bank, Regions Financial and Wells Fargo are rolling out or building on their “nontraditional” offerings, according to the New York Times. They’re offering things like small, short-term loans, check-cashing and bill-pay services, money transfers and prepaid debit cards.
Since the recession, banks have been avidly pursuing the wealthiest Americans, wooing them with reward programs and other perks on credit cards, checking accounts, investments and the like. Doing a 180 to focus on the opposite end of the economic spectrum might not seem consistent with that approach — or wise. But a look at the numbers reveals a surprising truth: There’s gold is those clients. The New York Times cites a consultant who says unbanked and underbanked Americans are a $45 billion market.
A big part of the reason lower-income customers are so lucrative is that the fees banks charge them are so high. A recent study found that average monthly use of a prepaid debit card can be as high as $27. One bank customer profiled by the paper paid $100 in fees for a $1,000 he had to take out to pay for medication.
The other reason banks stand to make so much money is the potential pool of new customers is vast. Nearly 20% of American households are classified as “underbanked,” meaning they use some mainstream financial products but also rely on payday lenders or pawn shops, check cashers and other fringe providers. Around 9 million households have no relationship to a mainstream banking institution.
One reason so many people are unplugging from banks is the fees. Pew Research Center focus groups found that customers are even opting for prepaid debit cards because they believe bank fees are higher and less predictable. Another Pew focus group found that the top reason people leave mainstream banking is because of hidden or unexpected fees. J.D. Power and Associates’ 2012 Retail Banking Satisfaction Study reflects bank customers’ increasing frustration with fees. Overall satisfaction squeaked up by a single point to 753 (out of 1,000), but satisfaction with fees was only 609, a drop of 47 points in just two years.
But dumping a checking account for these alternative products is often equally or even more expensive. One prepaid card cited by the Times that is offered by U.S. Bank costs $3 upfront, $3 a month in maintenance and another $3 if the user wants to get service from a bank teller.
In addition to these fees, some prepaid cards incorporate small lines of credit, often at extremely high rates. Banks also earn money from stores when customers use their cards to buy things. While bank-linked debit cards are subject to a cap on how much banks can charge, prepaid cards aren’t — so guess which kind of card banks are pushing?
Banks say it’s riskier to provide financial services, particularly loans, to lower-income customers, so they have to charge more. Consumer advocates say banks push poor customers into more expensive products they know will trap these people into a lengthy cycle of paying interest and fees. These new products create a two-tiered system for financial services, they say, and people who can least afford it are getting the short end of the stick.