Published January 13, 2012
With the recent appointment of its new director, the Consumer Financial Protection Bureau launched its “nonbank” supervision program and appears eager to begin overseeing a range of financial service providers that consumers regularly turn to when banks’ offerings fall short. This has resulted in numerous excited reports in the media of the coming “crackdown” on nonbank financial service providers.
The bureau’s focus on ensuring transparency in financial products is a good one, but any hard-line approach to regulating nonbank entities like payday lenders could ultimately hurt the millions of consumers who rely on such services to help manage their personal finances.
Nonbank alternative financial service products like payday loans, check cashing, pawn and prepaid debit cards are now mainstream products broadly used by middle America. According to the FDIC, one in four American households are unbanked or underbanked and analysts at Jefferies recently concluded that the underbanked segment has likely doubled since 2009 as credit card lenders have backed away from the demographic. This is certainly evidence of the need to provide regulatory oversight for these products. However, it is also evidence of the important consumer value that they provide. With a quarter of the population looking beyond the traditional banking system, it should be clear that alternative financial services are a much needed part of our economy and for millions of Americans are the only realistic source of much-needed credit.
Despite the high level of demand, many still do not understand why so many consumers turn to payday loans, prepaid credit cards, pawn shops, check cashing services and other alternative services over traditional banking products. The fact is that for low balance and low credit score consumers, traditional bank products can be abusive financial products. According to the FDIC, over 20 million Americans will pay over $1,500 annually in overdraft fees and face a dizzying array of unexpected fees. Nonbank financial products are popular because underbanked consumers value their convenience, simplicity, and transparency of fees. That’s why numerous academic studies (including one by the New York Federal Reserve) clearly demonstrate that when products like payday loans are regulated out of existence consumers pay more overdraft fees and face higher levels of bankruptcy.
So what’s the answer? Let’s start by asking the right question. The question is not, “How do we persuade underbanked consumers to use today’s banking products?” Big banks haven’t invested in understanding the unique needs of underbanked consumers and show little interest in building products that meet their needs. The real question is, “How can we encourage companies to create new types of financial products to serve the unique needs of underbanked consumers in an affordable (yet profitable), convenient and responsible manner?”
Today, there are several pioneering companies developing innovative solutions for underbanked or unhappily banked consumers. These companies realize that consumers do not want the same old bank account that they’ve already rejected, but new types of financial services that meet their needs in a more convenient, less expensive and more transparent manner.
Our hope is that the CFPB recognizes that innovation – whether it be through new technologies or strategic partnerships between banks, nonbank service providers, credit unions, Native American tribes and other entities – is critical to the financial success of underbanked Americans and that regulations that stifle innovation will do consumers more harm than good.
If the government truly wants to help people whose financial needs fall beyond the scope of banks’ offerings, it should strive to strike a balance between ensuring consumers are protected and encouraging non-bank financial companies to continue generating innovative solutions in a market devoid of choices.
Ken Rees is the chief executive Officer of Think Finance, a developer of online alternative financial products for underbanked consumers.