Access to banking functions like checking and savings accounts, mortgage loans, and consumer credit are vital to building and maintaining wealth. Historically, people of color [POC] have been limited in their access to banking through discriminatory banking practices and de facto segregation which persists long after the Civil Rights movement. Advances in financial technology—aka fintech—are helping to close the banking gap and better service those who have been excluded and underserved in the past.
Brief History of Underserved Populations
Homeownership is a key driver of wealth. In 2016, primary residence accounted for about 25% of all assets held by households. But POC have historically experienced discrimination in the housing and mortgage markets, particularly through the process of redlining.
The term redlining comes from maps which were used by the HOLC, the FHA, and the VA to determine areas where it was “safe” to issue mortgages. Areas where POC lived or areas near where POC lived were color coded red to show that they were too risky to insure mortgages. Redlining led to reduced homeownership rates, lower home values, and reduced access to affordable credit in predominately Black and Brown neighborhoods.
The mortgage market was not the only banking function that excluded POC. Inside redlined communities, there was little access to traditional banking for functions like saving.
Members of redlined communities also paid higher prices and received less favorable credit terms for consumer credit. In 1968, the FTC released a report showing that retailers selling to low-income consumers used installment credit in 93% of sales. Many of these low-income consumers were POC living in predominately Black and Brown neighborhoods. The rate at which these consumers were issued installment credit was much higher than for the average consumer and provided less favorable credit terms.
Higher prices, more expensive credit, and lack of banking and mortgage opportunities in Black and Brown neighborhoods has resulted in lower savings and less generational wealth. The ramifications of these policies are still apparent today. In 2017, Black incomes were about 60% of white incomes but Black wealth was about 5% of white wealth.
Changes During the Civil Rights Movement
In April 1968, after the Rev. Dr. Martin Luther King, Jr. was assassinated, President Johnson “utilized this national tragedy” to push the federal Fair Housing Act which legislators had been considering since 1966. This act prohibited basing the sale, rental, or financing of housing on race, religion, national origin, sex, handicap, or family status.
In 1974, congress implemented the Equal Credit Opportunity Act. This act took things a step further and applied nondiscrimination rules to all creditors. These regulations outlawed overt racism and sexism in credit markets. However, as Mehrsa Baradaran notes, “Ending credit discrimination was not the same thing as providing credit.” Decades later, banking and credit opportunities are still unequally accessible for POC and those living in low-income communities.
The Banking Gap Today
In 2019, 7.1 million U.S. households were unbanked. POC were disproportionally likely to be unbanked. The data shows that 13.8% of Black households and 12.2% of Hispanic households were unbanked compared to just 2.5% of white households.
There are many possible reasons for this including a lack of trust in financial institutions, the fact that banking is more expensive in minority communities and there are fewer bank branches located in minority communities. For example, there are 41 banks per 100,000 people in white communities compared to 27 per 100,000 people in communities where the residents are predominately POC.
Check cashing and alternative financial services are more prevalent in communities made up of Black and Brown people. These services can be more expensive, and estimates show that the fees for these services can add up to $40,000 over a person’s lifetime.
The Modern Push for Financial Inclusion
In 2011, the Consumer Financial Protection Bureau [CFPB] was established. Among other protections, the CFPB helps enforce the ECOA and fair lending laws. The CFPB also monitors data collected under the Home Mortgage Disclosure Act [HMDA] to identify discriminatory lending practices and ensure that lenders are serving the housing needs of their communities.
Today, the FDIC is partnering with private businesses to support the establishment and scope of Minority Deposit Institutions [MDIs]. MDIs have traditionally operated in underserved communities. For example, between 1888 and 1934, 134 Black-owned banks were formed. However, most of them failed during Great Depression. After the Civil Rights movement, there was a resurgence of MDIs and there were 50 Black owned banks by 1976. Many banks, including MDIs, failed during the savings and loan crisis of the 1980s. Today, the FDIC and private businesses are attempting to increase the number and scope of MDIs which provide valuable credit and savings opportunities to communities which have been historically underserved.
How could fintech help create a more inclusive financial system?
While there are many efforts to reduce discrimination in banking and improve the number of banks in minority communities, fintech could also improve access to financial services in historically underserved communities. New technology can help improve financial inclusion by creating new methods for saving and protecting wealth while providing faster, less expensive, and more accessible alternatives to traditional banking functions.
According to a report by the Federal Reserve Board of San Francisco, there are four ways that fintech can help build an inclusive financial system. The areas where fintech can provide improvements are payments, credit, savings, and insurance.
Digital payments by consumers to businesses have become mainstream in recent years. In 2020, more than 300 million digital payment accounts were active. These types of payments are built on the premise of low-cost and quick turnaround. As digital payments grow, businesses could have access to their funds more quickly and with fewer fees and consumers can benefit from the low-cost infrastructure.
Payments can be extended beyond the purchasing of goods. For example, payments from businesses to their employees can become faster and more reliable. The U.K., China, and India have all eliminated the waiting period after a check is cashed. In the U.S., a faster payment system for employees to receive their wages could eliminate the need for check cashers, payday lenders, and reduce bank overdraft fees. According to the Federal Reserve Board’s research, this could help low-income Americans retain over $10 billion per year.
Today, the ability to qualify for credit is based on credit scores and reports from credit reporting agencies. These agencies rely on credit-use history to determine creditworthiness. Credit-use history has historically excluded things like utility payments, rent payments, and cash-flow data.
Many low-income individuals have little or no credit history, despite having a steady income and a history of paying bills on time. Having little credit history makes it substantially more difficult for these individuals to access credit like mortgages and auto loans. With the help of fintech, credit scoring systems are now being enhanced to include more data points. In the future, fintech could provide a completely new method of qualifying credit that is more comprehensive and inclusive.
Distrust of traditional banks and lack of access to banking functions have historically limited low-income Americans from growing and protecting their savings. With fintech, the Federal Reserve Board’s research concludes that, “[f]intechs can create inclusive products that work for a range of circumstances, allowing consumers to weave together a bank-like experience even if they are unable or unwilling to access an account at a traditional bank or credit union.” This technology-based banking alternative could remove barriers to saving and create new opportunities for low-income individuals to grow their wealth without using traditional banks.
By pooling risk, individuals and businesses can lower their exposure to financial losses. Under the current system, only certain groups can pool their risk, like employees who work for the same employer. With fintech, a more inclusive insurance system could be created which allows individuals to pool risk without the traditional link through an employer or group.
The Future of Fintech and Financial Inclusion
In addition to providing valuable services to underserved communities, improving financial inclusion can help strengthen the overall economy. If gaps in labor market opportunities and returns were eliminated, the U.S. economy could have had $2.6 trillion more in output in 2019.
Advances in fintech can help close the gaps in traditional banking functions and make the U.S. financial system more inclusive and accessible to all Americans. With a combination of public and private investments and new opportunities created by technology, all Americans could have access to the tools they need to protect and grow their wealth in the future.
Financial Inclusion Powered by ADM’s Fintech
Our company, the American Deposit Management Co. [ADM] has developed proprietary fintech that helps businesses and financial institutions meet their cash management needs. Banks, MDIs and CDFIs that partner with ADM have access to business customers across the country, and businesses that work with us have access to extended FDIC / NCUA protection and and nationally competitive returns. Contact us to learn more.