Thinner margins and increased competition could provide a catalyst for more banks to make inroads with the nation's unbanked and underbanked.
Roughly 8.4 million U.S. households were unbanked in 2017, while 24.2 million were underbanked, according to the Federal Deposit Insurance Corp.'s latest study. While the ranks of the unbanked and underbanked have fallen steadily since 2011, they still comprise nearly a quarter of American households.
A big hurdle has been reshaping lenders' perceptions of those segments, said Phillip Baldwin, CEO of Citizens Bank in Batesville, Ark.
"It's not a bunch of deadbeat people," Baldwin said. "It's a bunch of people who, in most cases, lived their lives doing everything exactly right, but then something bad happened."
Baldwin, who ran a nonprofit credit counseling agency before taking over at the $862 million-asset Citizens, said the vast majority of unbanked and underbanked consumers become that way as a result of a job loss, sickness or divorce. Those people often deserve a second chance, and banks can make money courting them, he said.
Financial institutions that ignore the unbanked and underbanked are missing an opportunity to fulfill an overarching mission to provide access to capital and credit in their communities, said Darrin Williams, CEO of Southern Bancorp in Arkadelphia, Ark. While it takes a lot of time, effort and patience to work with those customers, Williams said, there can be a great payoff.
Southern might serve as an example of what community banks stand to gain from focusing on underserved markets.
Noninterest income at the $1.4 billion-asset company increased by 5% in the second quarter from a year earlier, to $6.1 million, and total loans rose by 10%, to just over $1 billion. The company originated $281 million in loans in underserved communities in the first half of this year.
While based in Arkansas, much of Southern's operations are in Mississippi, where nearly 40% of households are unbanked and underbanked, the highest percentage in the U.S., according to the FDIC.
About a fifth of households in Arkansas are unbanked and underbanked.
To be sure, there are a number of hurdles to reaching underserved markets.
While the Community Reinvestment Act was designed to encourage credit extension in low-income areas, Baldwin says the 40-year-old law doesn't go far enough.
On one hand, banks are supposed to reinvest in the underserved, but such activity has greater inherent risk. And regulators tend to scrutinize programs that have the potential to incur losses and cut into capital, said Tim Scholten, president of the community bank consultant Visible Progress.
"Often, these goals conflict with goals related to serving segments of the population that carry greater risk," Scholten said.
Scholten added, however, that he believes banks can design products and programs to protect underbanked consumers from spending money they don’t have while covering the costs of operating accounts with a flat monthly fee.
"While this may not be a profit center for a bank, it could be a way for a well-capitalized and well-run bank to make services more convenient to this segment of their communities," he said.
People who have grown up with little or no access to credit or financial education often find the banking system daunting, Williams said. Confusion over policies including overdraft fees complicate matters even more.
"We've probably been our own worst nightmare by creating this environment," Williams added. "Banks can be intimidating."
That often drives underbanked consumers to payday lenders. Though the fees are often much steeper, the loan terms are easier to understand.
"People say, 'Yeah they're high, but I know they're going to charge me 50 bucks, and I don't know what you're going to charge me,' " Williams said.
Payday lenders are banned in 12 states, including Arkansas, but not in Mississippi.
Bank On Arkansas was recently created as part of a national initiative to make sure all consumers have access to safe, trusted and affordable banking. The program offers checking accounts with no overdraft fees, no minimum monthly balance and access to a debit card. It is being touted as a safe, simple account that can't be overdrawn, but gives customers access to mobile and online functions.
It's also a good way to begin building trust between a bank and consumer that can lead to deeper relationships over time.
"There is not a lot of trust on either side of the relationship," Scholten said.
As banks lose control of the U.S. payment system, they need to reinvent themselves by providing services people want and need. Working with the underbanked would be a huge step in that direction, Baldwin said.
"This is a model that banks have to embrace to stay relevant," he added.
