Ensuring racial equity in banking starts with busting the myths, says BCG.
Among the inequities many Black and Latinx consumers in the US face, one of the most concerning is the lack of access to necessary financial products and services. Making up just 32% of the US population, Black and Latinx households represent 64% of the country’s unbanked and 47% of its underbanked households. While this problem is widely acknowledged, misconceptions about its causes and its effects on families make it difficult for banks to meet the challenge.
First, a bank account may often be regarded as a simple convenience, but in many Black and Latinx communities, check cashers and payday lenders are more common than bank branches and more likely to be open after hours. People in these communities often turn to alternative financial institutions, but such non-bank services come with high transaction costs. More importantly, without bank accounts, families cannot generate the data that helps establish creditworthiness. This makes it difficult to access the credit needed to fund wealth-creating activities such as investing in education or a business venture. In the short term, for those with low and volatile income, lack of credit can make it impossible to pay for an unexpected immediate expense such as a flat tire or medical bill.
Myths about the barriers to banking persist. For example, while it is often thought that lack of financial education prevents people from using mainstream financial services, many who turn to non-bank services for transactions such as cashing checks or “bill pay” services do so for a logical reason: to make it easier to cope with income volatility. Not having the luxury to wait for a mainstream bank to clear a paycheck, they must pay high fees to check cashers for immediate access to the money they need for food, gas, and other necessities.
A greater understanding of what motivates the behavior of unbanked and underbanked individuals can help financial institutions design services that better meet the needs of these populations. Achieving full financial inclusion and economic opportunity for Black and Latinx populations is not just a moral or altruistic goal—greater participation of these communities in banking will create greater economic value for financial institutions as well as for consumers.
Current options take a heavy toll
A look at financial services in the US reveals an uncomfortable truth: being poor is expensive. Reliance on alternative financial services (AFS)—including check cashers, cash transactions, prepaid cards, money orders, payday lending, pawnshop loans, and title loans—to receive income, make purchases, and pay bills come at a heavy cost. AFS lenders charge exorbitant interest and other fees, far higher than those charged by banks.
Further compounding the issue, those taking out payday loans are often unable to settle them in the next earnings cycle, which means they must roll the principal into a new loan. As a result, annualized interest rates on these loans can be as high as 300% to 600% APR. Yet people agree to the costs because they need immediate cash, clear terms and conditions, or convenient hours.
In some situations, families must choose between accepting highly unfavorable terms or being unable to pay for groceries or medical care.
Along with these crippling short-term expenses, being unbanked or underbanked imposes longer-term costs on individuals, families, and communities. Relying on transaction AFS products means missing out on the opportunities to access credit presented by mainstream financial services. A critical benefit of these services is the transaction data they generate, which makes it easier to secure affordable terms. Increasingly, consumers with strong payment history on rent, utilities, and healthy bank account activity can use this data to supplement their credit score when credit agencies and lenders make underwriting decisions.
Access to affordable credit not only helps families to weather immediate storms and take advantage of short-term liquidity but is also a gateway to wealth-building investments that provide long-term financial stability. For families to achieve economic security and break free from the pull of cyclical poverty, they need to be able to invest in assets that grow or facilitate wealth like homes, education, businesses, etc. Creditworthiness is critical to accessing these opportunities, but without mainstream financial tools and services, it can be difficult to achieve.