The paycheck to paycheck economy is changing what it means to be underbanked. In the past, the definition of an underbanked person was much simpler, meaning that the individual didn’t have basic deposit or checking accounts housed within a bank or credit union.
However, that definition now includes those who aren’t getting what they need from their banks and credit unions. As i2c President Jim McCarthy told Karen Webster in a recent On the Agenda conversation, “the underbanked population is much bigger than people realize.”
In the 21st century, underbanked consumers aren’t able to navigate their daily financial lives to the fullest, particularly if their primary accounts are accessed through digital channels.
As McCarthy noted, “The classic demographic definition of ‘underbanked’ gets thrown out the window. There’s clearly demand out there for alternatives to the classic financial services model as defined in the United States.”
McCarthy joined BrightFi Founder and CEO Michael Coghlan and Credit Sesame CEO Adrian Nazari in describing how the rise of neobanks and FinTechs is spurring a re-imagination of the relationship between the consumer and financial services providers.
The Federal Reserve has estimated that about 22% of U.S. adults are either unbanked or underbanked. Roughly 7 million households do not have credit cards, debit cards or other financial instruments at hand. Additionally, about 33 million households have bank accounts, but no established credit histories.
Those who live paycheck to paycheck need to be included to truly account for the underbanked population. PYMNTS’ own research has shown that more than half of the U.S. population fits within that demographic, which runs the gamut from individuals with no credit file or blemished credit histories all the way to people with six-figure incomes.
It’s a challenging financial existence, where an emergency or unanticipated expense can cause financial distress; however, the vagaries of living paycheck to paycheck are not solely confined to lower-income individuals and households. More than one-third of high earners live paycheck-to-paycheck, and 12% struggle to pay their bills.
As to why so many individuals are underbanked, according to McCarthy, “We’d all agree that one of the challenges has been that money is not really taught in school — payments and home economics are simply not taught.”
As Nazari noted, 78% of Credit Sesame’s population lives paycheck to paycheck, has $500 in savings on hand, and faces at least two financial emergencies a year that can derail opportunities to save money for future expenses.
The Chicken and the Egg — And the Initial Access
Chicken and egg problems dominate traditional finance and create vicious cycles that perpetuate the paycheck to paycheck cycle.
At a most basic level, individuals need cash to establish a traditional, transactional account. But cash use — and even acceptance, depending on where you look — has dwindled amid the pandemic, and banks have shuttered physical locations worldwide, making it harder to walk in with cash and open up an account.
Nazari said the chicken and egg issue complicates credit, too, which is often an entry point to the financial system at large.
“In order to get a loan you have to have credit,” Nazari said. “It’s difficult for many individuals to enter into the ‘system’ and be recognized.”
Consumers who have been forced to reside at the margins of traditional finance, without access to the financial system and traditional products had to rely on cash, check cashing or prepaid cards – all of which keeps them, well, marginalized.
See also: USPS Debuts Paycheck Cashing Services
As evidence of how FinTechs are plugging the gaps in conducting financial life, Nazari noted that 72% of Credit Sesame’s users, prior to signing up with the firm, did not use traditional financial products, including standard checking accounts, savings accounts and credit cards.
That initial lack of access, he said — without the aid of firms like Credit Sesame and other alternative providers — “puts these individuals at a huge disadvantage to conduct even the most basic and simple transactions.”
Coghlan’s own experience speaks volumes about the long path to establishing an identity and presence within the regulated banking system. He recounted coming to the United States from Australia and Ireland with decades of banking experience under his belt, and his years-long struggle to establish a credit profile here in the States.
There’s a chicken and egg problem with the banks themselves, noted the panelists. Traditional providers face both technical and funding hurdles when it comes to broadening their consumer bases. It can cost as much as $400 annually to support a typical retail customer.
The bank has to make about $600 on those accounts, Coghlan said, which they often can’t make on the underbanked populations. Thus, they exclude those would-be customers from marketing campaigns.
Because of this, a broad range of innovators are seeking to plug the gaps, offering individuals a way to live beyond cash and check-cashing outlets.
Companies like BrightFi serve banks, and non-banks, by helping launch consumer and commercial banking apps, lowering the cost and time to market. Coghlan noted that “a whole new group of people can come into the regulated banking system,” if the cost of establishing and maintaining an account was, say, $100.
This is not to say that the digital-first players, or even the banks that are moving into new online offerings, aren’t also navigating their own issues. If being underbanked used to be a question solely of access, it’s now a question of giving consumers what they want, when and where, along the continuum of an individual’s financial life.
Consider the fact that, as Webster noted, only a small number of consumers actually have accounts with digital banks. Forty-one percent of consumers say that mobile apps are their primary means of banking. As PYMNTS has noted, the transaction account is not enough — they want more services associated with those digital conduits, at the ready when they need them.
But the core offerings are critical, said Credit Sesame’s Nazari.
“We see consumers as people that are new to credit or new to the financial system — they just want to establish the basics and they want to be quick and fast,” Nazari said. “They don’t want a lot of bells and whistles.” Starting with debit and building credit, for example, lets consumers “graduate” to homeownership, family planning and retirement planning.
The Trust Factor
Trust is critical to leverage the primary account, or where the paycheck flows in, as a springboard to embrace other services. It is the trust factor where digital players have to redouble their efforts, the panelists said.
Coghlan noted that, “It would be foolhardy to think that the traditional banks are better than us at security.” After all, it’s fairly easy to create false documents, bring them to a branch and open an account. It’s much harder to “fool” the various safeguards and authentication protocols that are inherent in a remote, onboarding process tied to digital banking.
Nazari noted that FinTech firms are better at adopting, testing and using those technologies than much larger financial firms, who are still grappling with legacy systems.
Coghlan contended that there are still existing mechanisms within traditional banking firms that seek to engage with, and improve the online experience of, the underbanked population. Smaller banks and credit unions do not have the same financial resources as their larger brethren, Coghlan said — the big banks spent $10 billion on digital initiatives alone last year.
Those smaller financial institutions (FIs) benefit from the partnership model, where working with BrightFi helps build digital services and literacy tools for existing and new customers.
Looking ahead, the panelists noted that the industry is at least some distance from a “super app” serving the unbanked, where all of these financial activities are managed and offered by one neobank or traditional bank provider. For one thing, the traditional players are loath to give up too much data on consumers without proper security safeguards in place, but Open Banking is helping to streamline the joint efforts between FinTechs and FIs.
“The good news for the consumers is these days, you can have multiple apps on the phone and with a click of a button, you can go from one app to another app and be able to do your transactions and check [other] things,” Nazari said. “I suspect that as we go forward, that digitalization will help solve that [fragmentation] problem.”
The Outcomes-Based Approach
To reach beyond those basic transactions and embrace new use cases, panelists advocated that digital providers adopt outcome-based approaches that specifically targets the needs of the underbanked population. Remittances represent a key use case, said Coghlan, citing one example. In another example, BrightFi can help consumers “earmark” funds using savings pots tied to their primary transaction accounts.
In the move towards an outcomes-based approach, panelists said that regulation — in particular, excessive regulation — might be a fly in the ointment. As Coghlan noted of the innovations underway in the market, “we should be accelerating it, rather than slowing it down.”
At a higher level, and as a broader strategy to get consumers to choose digital banks as their primary relationships, Coghlan said, “You’ve got to have a compelling offering … and to get to a compelling offering, you have to be talking to consumers in the place and the way that they want.
“The nuance for un-banked and under-banked is the level of trust that they have for the banks and the banking system,” Coghlan continued. “They need to understand their money is safe and they can access their money in the way that they need to.”