“One of the great ironies in modern America is that the less money you have, the more you pay to use it.” So writes Mehrsa Baradaran in How the Other Half Banks: Exclusion, Exploitation, and the Threat to Democracy, her study of how the American banking industry stopped serving the poor, and the “fringe banks” that arose to fill the void. With the unbanked paying as much as 10 percent of their income just on the financial services required to use their money, being poor has become very expensive indeed. In the conversation posted below, we spoke with Baradaran about how we got into this mess—and how we might get out.
Payday loans are typically taken out by people with a steady income who need a few hundred dollars to deal with an unexpected expense. It is a common misconception that people who borrow payday loans don’t know what they’re doing or are “financially stupid.” The truth is that these borrowers have no other credit options.
The more interesting question, to me, is: why are there no other options? The entire payday lending sector began in the 1980s when community banks and credit unions abandoned poor neighborhoods and the savings and loan industry imploded after its deregulation. These institutions today function much like banks and generally avoid small accounts. The fringe banking industry has grown exponentially since.
Q: Some observers have suggested that innovations such as microcredit and mobile banking might help serve the unbanked. What do these kinds of programs do, and what are their limitations?
Microcredit can help solve “microproblems.” For example, if you want to start a business and need a few hundred dollars of start-up capital, microcredit can do the trick. Microcredit has worked with some limited success (and not without controversy) in the third world, but it has not taken off in the United States in large part because it does not address the credit needs of the American population. Americans have a functioning banking and credit system and most businesses need more than a few hundred dollars to get started. Even if microcredit were widely needed and available in the United States, the interest rates rival that of payday lenders and pawn shops and therefore it serves as a loan of last resort.
Mobile banking as it is currently envisioned will make the lives of bank account holders much more efficient. For those who have access to the banking system, they can now make money transfers, deposit checks, and make payments on their mobile phones. This is all great news, but does very little to address the needs of the unbanked. No one in the United States has proposed that mobile phone providers replace banks; nor is that even possible given the complexity of the U.S. banking sector. In Kenya, the introduction of mobile banking through M-Pesa created access where little existed. However, this is because the mobile company had a practical monopoly and they worked with the central bank to increase access. This is not the situation in America. The good news is that once the population had access to banking, the economy boomed and trade became much more efficient—once again demonstrating that access to banking services has many small and large-scale benefits.
Financial and technological innovations certainly have the potential to increase ease and access for all of us and we should continue to foster and encourage them. But we shouldn’t rely solely on technological advances to meet the banking needs of the poor. The problem is much bigger in scope than any of the programs can address, and the source of the problem is rooted in an unequal banking system—it is not just a gap in services.