Americans across the economic spectrum struggle to manage their money. We spend too much, save too little, and wait too long to invest. While we could all be more fiscally responsible, access to services that facilitate sound financial decision-making is often concentrated at the top of the economic ladder. Each rung down, those resources get a little harder to come by, with those at the very bottom often locked out of the financial mainstream.
Historically, poor and minority families have gotten caught between the rock of discriminatory practices like redlining and high-risk lending and the hard place of debt traps. Without access to banks, they often find themselves subject to exorbitant fees and charges by providers of alternative financial services, including check cashers and payday lenders. Policymakers should take steps to ensure that all Americans - regardless of race or income - have access to secure, functional, and affordable financial services, as these commodities are crucial to financial wellbeing and social mobility. But in absence of policy action, the market has moved to fill this need.
Financial technology companies (known collectively as FinTech) are broadening access to a range of services that they claim can help us manage our spending, save more money, and make investments in our long-term financial security.
FinTech offers users an array of financial services -- from transactions to underwriting -- that were once almost exclusively the business of banks. Personal finance apps like Acorns, Digit, and Mint help users track their spending and stay on budget without the assistance of a financial advisor. Personal lending innovators like Lending Club and Prosper enable users to bypass traditional intermediaries with a peer-to-peer lending platform. Companies like Betterment and Wealthfront that facilitate investments, financial planning, and portfolio management have emerged as popular alternatives to traditional wealth managers.
Investors have responded favorably to FinTech companies. Just six months into 2015, FinTech startups have raised nearly $12.4 billion from venture investments and are on track to double their backing over the previous year. While FinTech is unlikely to replace banks altogether, and many FinTech companies actually rely on existing bank accounts, it could sap away some the banking sector’s profitability. This has raised concerns among traditional banks about their capacity to maintain low-margin services in a rapidly changing marketplace without being relegated to utility status. But altering some of these services could disrupt the financial lives of lower-income households that rely on inexpensive financial products.
Generally, banks follow a loss leader pricing strategy: they provide certain products (checking accounts) at a cost below their market value to stimulate the sales of more profitable products (loans) and to attract new customers. Now FinTech companies are beginning to extract the most profitable portions of the customer-facing banking model, leaving banks with high overhead and less profitable products. To recoup their resulting market losses and mitigate the threat of FinTech insurgents, traditional banks and other legacy players in the financial sector are discussing a range of strategies, including charging more for low-margin services, closing bank branches to cut costs, and acquiring FinTech companies.
The worst-case scenario for low-income families is that FinTech’s drain on their profitability over the long-term prompts banks to abandon their loss leader strategies. For people at the margins of the financial mainstream, the loss leader strategy is a financial lifeline that enables them to maintain checking and savings accounts. If banks compensate for lost revenue by raising fees and charges on current accounts, account ownership is likely to decline. Currently, over a quarter of American households are un- or underbanked. According to the Federal Deposit Insurance Corporation, one in three unbanked households reported high or unpredictable account fees as a reason for not owning an account and approximately 13 percent reported this to be the main reason. Raising the cost of owning a bank account could drive even more people away from the banking system entirely.
While life with banks can be rough, life without banks can be brutal. Without access to a transaction account, households often turn to alternative financial products that charge exorbitant fees. The average underbanked household spends a staggering $2,412 each year on interest and fees alone. For many households, access comes down to proximity to a brick-and-mortar branch. But as banks look to slash costs, branches are closing in droves (nearly 2,599 in 2014). Low-income and minority neighborhoods are often the first areas targeted. Since late 2008, an astounding 93 percent of the bank branch closings have been in ZIP Codes with below-national median household income levels. And the rise of digital banking may contribute further to this trend as regulators consider a new proposal that would give banks more latitude to decide where they have physical branches.
If the threat to their business grows, banks could opt to use their superior resources to buy up FinTech companies. With the five biggest banks controlling nearly $15 trillion in assets, FinTech’s $12.4 billion in venture investments this year look like peanuts. Acquisition was the approach Capital One took earlier this year when it bought Level Money, an app that helps users track their spending. If proven profitable, it’s likely that other banks will start buying up the competition.
While usurping the threat of FinTech by co-opting it may relieve immediate pressure on the banks, it won’t necessarily stop them from trying to cut costs in other ways that disproportionately impact those at the bottom rung on the income ladder. With the last 50 years of history at our backs (or even just the last 10), do we really want banks annexing every potential rival?
Competition is good, as is innovation, especially if they create inroads for new and currently underserved consumers to access and use traditional financial services. And for all their disruption, some FinTech startups have vision that traditional banks have lacked. They see underserved consumers as an emerging market, especially in developing countries where technological advances like mobile banking have been a key driver of financial inclusion.
The rise of FinTech gives policymakers a good opportunity to take stock of where we have been and where we should be going when it comes to providing the means for low and medium-income Americans to save for the future. As these market forces unfold, policymakers should be designing and supporting ideas that promote more financial inclusion, whether that means more community credit unions, subsidies and tax credits for financial services, or a government-run option like postal banking. Regardless of the provider, legislators need to make access to secure, functional, and affordable financial services for all Americans a bigger priority—and FinTech’s impact on the banking industry is bringing that need into sharper relief by the day.