December’s release of early findings from the U.S. Financial Diaries Project should change our thinking on how to expand financial access.
The financial lives of lower-income families are mostly a closed book, poorly understood by both financial companies and policy-makers seeking to meet their needs. Since generalized consumer data mask vast complexity in how underserved households operate, the Diaries project was launched to dig deeper. Led by the Center for Financial Services Innovation (disclosure -- I serve on CFSI’s board of directors) and NYU Wagner’s Financial Access Initiative, the work is supported by the Citi Foundation, Ford Foundation, and Omidyar Network. NYU’s Jonathan Morduch and CFSI’s Rachel Schneider organized a unique research team that intimately observed and chronicled the real financial lives of 200 families for a year.
The results explode much of the conventional thinking about financial health and access.
Volatility is the key
Amidst many rich findings, one key insight stands out: For many struggling families, the problem is not insufficient income. It’s insufficient stability – volatility and unpredictability, in both income and expenses.
Even in households whose annual income exceeds their annual bills, unmanageable dynamism in both inflows and outflows leaves many people in periodic deficit. Since they lack a savings cushion and good options in today’s financial services market, these shortfalls create huge and lasting damage.
This means that addressing instability, itself, is critical. Unfortunately, that focus is largely absent from traditional thinking. For decades, public policy has assumed that these consumers mainly need more availability or affordability of standard bank products. Even our terminology reflects this – we call people “underserved,” or “under-banked” and define the solution as easier “access” to banks. Efforts ranging from the Community Reinvestment Act to regulatory jawboning urge banks to offer more products like basic checking accounts and especially credit – mortgage credit in particular. While these measures have yielded benefits and remain important, they have settled into a fairly stale policy debate over a narrow set of options. The Diaries research should catalyze new thinking.
The researchers found widely varied consumer situations, most of which elude conventional stereotypes. Many participants work full-time, and more. Some own their homes. Some have college educations. Some clearly are upwardly mobile, budgeting, building credit scores, and even saving. They range from two-parent families to single mothers and mature single men, and include new immigrants and urban and rural households from coast to coast. Some participants rely on seasonal income (one in the tax advice industry) and on sporadic sources like caring for foster children or renting out rooms. Some have bank accounts, mortgages, and credit cards. All, though, live at the financial edge, vulnerable to – and often in unsustainable debt because of – unexpected shortfalls.
The Diaries participants use an array of financial strategies that weave together the formal and informal economy. Many rely on family for emergency loans and/or in-kind help, often in reciprocal arrangements that can work well for all. Some have both bank accounts and payday loans. A high percentage have at least one serious health problem and manage that cost by adjusting medications (medicalexpense is a key source of volatility). Nearly half don’t have credit cards; of those who do, about a third are maxed out. Many are very savvy about their financial lives, managing income and outflows with precision timing to cover their bills (see my 6/30 blog post “Underserved and Underestimated"). Many use the Earned Income Tax Credit essentially as a forced saving mechanism. One person “saves through Mom” as the spending gate-keeper. Many save “in a sprint” when needed, or “save for soon” to meet upcoming needs but not long goals like education, retirement, or accumulating a financial shock absorber.
The Diaries’ December kickoff featured Vox.com’s Danielle Kurtzleben and a panel of Professor Morduch; the Urban Institute’s Ellen Seidman; former CFPB official Raj Date; and Bill Bynum of Hope Credit Union in Mississippi, who also chairs the CFPB’s Consumer Advisory Board. The panel and invitation-only audience voiced optimism that the financial system can actually solve much of this problem. Raj Date noted that people either borrow at 0% from friends and family or at 300% in payday loans, arguing for something in between (his company, FenwaySummer, offers a subprime credit card). Ellen Seidman cited the need for more community-focused institutions like the Hope Credit Union run by Bill Bynum, who pointed out that over 90% of post-recession branch closings have been in low- and moderate-income census tracts.
The session left me pondering the mismatch between the current system and financially-marginal families. American Express estimates 70 million Americans live at the edge of the formal financial system, spending a lifetime average of $40,000 in unnecessary fees -- $89 billion in fees and interest in 2012. This is a huge market with clear financial capacity. These consumers can’t readily access mainstream products partly due to the volatility problem, which clearly limits creditworthiness by traditional standards. Still, they can and do pay for financial services, at high prices, mainly at non-banks and in the informal economy. Could new insights like the Diaries findings, combined with new technology and fresh thinking, bring them better options?
Here are some thoughts:
- Payday Lending and Bank Overdrafts:
CFPB is considering how best to regulate these two financial products that aim to cover emergency cash shortfalls. The Bureau should study the Diaries’ sharp distinction between consumers whose problems are inadequate income versus volatility. Aaron Klein of the Bipartisan Policy Center has framed this as differentiating insolvency from illiquidity (see link here). Insolvent consumers are inevitably harmed by getting credit. Illiquid consumers, in contrast, can benefit from emergency credit if it doesn’t trap them. This argues for practical regulatory standards on ability-to-pay and more broadly, rules that enable banks and non-banks to offer fair, profitable, and innovative products.
As Bill Bynum noted at the Diaries event, most people experience financial volatility, but affluent people weather it through savings (and access to well-priced credit). Maybe it’s time for both policy-makers and industry to emphasize savings options and incentives, and deemphasize credit. Ideas include more focus on automatic and opt-out savings arrangements and innovative savings rewards programs, including ones styled on sweepstakes and lottery models that foster wide engagement.
The classic financial tool for covering unpredictable events is insurance. Advocates have long critiqued traditional credit insurance as a high-cost add-on that sometimes overstates coverage and/or is sold too aggressively -- not to mention that it only pays off the related loan. Innovators have begun talking about broader, affordable insurance for people who live within their means but face timing shortfalls. Solutions should, again, distinguish between illiquidity and insolvency, and regulators should prevent abusive designs and sales practices. Meanwhile, the continuing policy debate on health insurance reform should include focus on the outsized impact of unexpected medical expenses on financial system access, upward mobility, and government dependency, regardless of what the ultimate outcomes may be.
- Alternative structures:
Another promising approach lies in linking successful nontraditional and informal financial arrangements into the mainstream system. One example is Jose Qunonez’ Mission Asset Fund in San Francisco, which tracks repayment records of people borrowing within Latin American-style lending circles and creates data usable by mainstream credit bureaus, helping borrowers build formal credit scores. There’s also growing exploration of how to use big data to develop nontraditional but predictive metrics on creditworthiness.
- Mobile PFM:
Lower-income people are disproportionately high users of smart phones, including for financial tasks (see my 10/12/14 blog post The Benefits of Bitcoin). This is a game-changer, potentially opening whole new ways for people to improve their financial lives. Over time, PFM – personal financial management – in smart phones will permit effortless savings, budgeting, warnings against dangerous product terms, and much more. Think about BBVA’s Simple.com account, which takes the “simple” but powerful step of displaying the customer’s “safe to spend” number more prominently than the account balance. Such services won’t help all consumers but as PFM tools evolve and converge, they could revolutionize consumers’ options and behaviors.
- Regulatory clarity:
As I argued in Forbes last fall, a major barrier to widened financial access is the industry’s fear of enforcement and reputation risk in areas where regulatory standards are subjective and evolving, such as in defining discriminatory lending and “unfair and deceptive” practices. The more regulators can reduce this uncertainty, the more financial companies, especially banks, will do in underserved markets.
- Community Reinvestment Act:
It’s time to revisit CRA, which dates from 1977 when banks were local, banking was branched-based, and policy concerns focused overwhelmingly on access to credit, especially mortgages. The bank supervisory agencies are gradually updating CRA policy through new question-and-answer guidance. Their thinking should incorporate the Diaries insights and consider giving banks CRA credit for innovations of the kinds outlined above.
Speaking of innovation, both startups and the innovation labs at big financial companies are busily leveraging technology to reach traditionally underserved consumers affordably and in ways that offer better choices, better information, and more control. Regulators should encourage these efforts, and carefully not stifle them, while also watching for signs of emerging abuse.
- More research:
We need more research like the unique but costly Diaries project, deepening the insights, identifying high-impact solutions, and also looking at the longer-term patterns of these consumers.
If fewer people struggled with financial volatility, vulnerability, and damage, the larger economy and society would benefit. So would financial companies serving them profitably as an “emerging” market, much like today’s expanding markets the developing world.
Please also think about fresh ideas, for industry, regulators, innovators, advocates, or academics. Send me your thoughts, and please share the blog with colleagues and others who might be interested!