In today’s modern world, it is almost impossible to imagine life without digital banking or financial services. Without digital banking, it is quite difficult to operate day-to-day expenses and build financial stability. However, even in this generation, many people are underbanked or unbanked. Multiple reports have confirmed that almost 14.1% and 4.5% of adults in the U.S. are underbanked and unbanked, respectively. By banking the underbanked, people can experience a variety of financial services and build their financial stability.
Imagine a life where being able to access financial services and having a bank account is considered a luxury. Having a bank account and being able to access financial services is not a complex job; rather, it simplifies and develops a person's financial well-being. However, some people cannot access such financial services. People who are underbanked or unbanked face various disadvantages and losses, such as no interest on savings, no availability of loans, alternatively high-interest rates, and much more.
In this blog, we will explore the concepts of unbanked and underbanked. We will understand the disadvantages of being unbanked and how we can bank the unbanked.
Unbanked vs Underbanked
It refers to people who do not have access to traditional financial services. Unbanked people simply need access to banking services such as loans, savings accounts, deposit accounts, etc. Such people rely on other sources for their financial needs, like payday lenders, check cashing services, and pawnshop loans. These methods contain higher fees and high interest rates and are riskier than traditional banking methods. These alternatives to banking services only make the situation worse.
Unbanked people rely on cash to pay their bills. They only use physical currency. This includes receiving wages in cash and paying all the bills in cash. Almost 6% of U.S. adults were unbanked in 2021, up from 5% in 2020, according to the Federal Reserve Report.
The term underbanked is used for people who have partial access to traditional banking services but also significantly depend on other sources of financial services. Such people do have a bank account but are not fully dependent on it. They have a low credit score because the banks are hesitant to give them loans. Almost 13% of adults in the US were declared underbanked in 2021.
According to data, in the US:
- 14% of those making under $40,000 do not have a bank account. 1% of those making at least $40,000 a year do not have a bank account.
- Compared to 1% of graduates, 12% of people with only a high school diploma or less lack bank accounts.
Both unbanked and underbanked can be put in the same category, as they both rely on external banking sources rather than traditional ones.
Who are the unbanked or underbanked?
The unbanked and underbanked populations comprise people who either have little traditional banking access or not at all due to many different reasons.
1. People with low income
People with low incomes are mostly unbanked or underbanked, as they aren't able to achieve the minimal requirements and don't have enough money to associate with traditional banks.
According to the Federal Reserve Report, along with 2% of individuals with incomes over $50,000, 17% of those with incomes under $25,000 were unbanked.
Similarly, 12% of individuals with incomes between $50,000 and $99,999 and 20% of those with incomes under $25,000 were underbanked. Merely 5% of individuals earning more than $100,000 were classified as underbanked. Such statistics represent that unbanked or underbanked are the terms specifically assigned to low-income people.
2. Rural Communities
Rural communities are the most affected communities in the USA. The people living in rural areas do not have much access to banks, and many of them do not have the proper knowledge about banks. Hence, many of the rural people remain unbanked. Additionally, traditional banks prefer not to extend branches in rural areas due to the high expense of operating and low earnings.
Due to systemic injustices, historical circumstances, and restricted access to traditional financial institutions, racial and ethnic minorities—including black and Hispanic communities—may be disproportionately represented among the unbanked population.
According to the Federal Reserve Report, 3% of white adults, 2% of Asian adults, 6% of adults overall, 13% of black adults, and 9% of Hispanic adults lacked bank accounts.
4. Individuals with limited education
People with limited education and those who are not efficient in English may be unbanked or underbanked as they have low financial literacy and find it complex to indulge in banking services.
According to the Federal Reserve Report, 1% of individuals with a bachelor's degree or above were unbanked, compared to 34% of those with only a high school education.
Those with a bachelor's degree or above made up 7% of the underbanked population, compared to 38% of those with only a high school diploma.
Disadvantages of Being Unbanked
Being unbanked in today's world can be expensive and inconvenient, which has various drawbacks when compared to having full banking privileges. These are a few of the most notable drawbacks.
1. Alternative financial services are costly.
Exorbitant fees and interest rates are common features of alternative financial services. People without savings accounts may be able to apply for non-bank loan options such as payday and "buy here, pay here" loans, given they can show proof of income that satisfies the requirements set out by the specific loan provider.
But that convenience may come with a heavy price. Compared to bank auto loans, which typically have interest rates of less than 6%, "buy here, pay here" loans can have interest rates as high as 20%. Similarly, payday loans have the potential to charge interest rates as high as 400% over the initial loan amount. This implies that a borrower receiving a $100 payday loan may ultimately be required to repay $500.
In addition, people without a bank account can use money orders rather than checks for bill payment and check-cashing services in place of direct deposit.
2. Limitations on accessing credit
Almost all bank loans, including those for a new car, a home purchase, and other purchases, require credit. Unfortunately, if you don't have a bank account, it can be difficult to get a credit card. Building a credit history without a credit card is nearly impossible, which for some people can result in an endless cycle.
Prepaid cards are frequently used by unbanked people for purchases that require a debit card. For instance, when there are no physical payment options, they might load prepaid cards to make purchases online or pay bills. Prepaid cards seem to be the answer to the dilemma of not having a debit card, but they might have serious drawbacks. High loading and sometimes usage fees are associated with prepaid cards. Furthermore, these cards won't help establish a credit history or raise a credit score because they don't normally build credit like credit cards do. Thus, prepaid cards only pull out high-convenience fees without offering a credit score.
3. Having trouble putting up an emergency fund
Saving up funds for unforeseen expenses is crucial for sound financial management. In a report, it is recorded that, as of 2020, the average amount borrowed through a payday loan was 375 dollars. The main advantage of emergency funds is that they avoid the extreme fees and interest rates that payday lenders charge.
This is partly due to the expensive ways that households that are underbanked or unbanked can save money. You run the risk of being robbed if you carry cash around the house, and it will eventually lose value due to inflation. You can prevent theft by loading up a prepaid card with additional funds, but you will still be responsible for the card's fees. Furthermore, since the money is in easily spendable form in both of these savings options, you are more susceptible to temptation.
Banking the Unbanked
1. Cut down on obstacles.
The complexity of the banking system is one of the main causes of people's continued lack of access to banking. People think that owning a savings bank account is much more expensive and out of their reach, especially in the United States. While it is true that banks charge certain fees to open a savings account, they do not stop there and also require a minimum balance. It gets harder for those in the lower income bracket to keep their accounts at the minimum balance. Some of them do not even save that much.
More people, including those from lower-income groups, may switch to the traditional banking system if these obstacles are removed.
2. Put credit and loans first.
If there are promotions for credit cards and loans, people will be more inclined to choose traditional banking services. In the US, 10% of people have no credit history. Greater public awareness of these credits will increase awareness of the schemes. These programs may serve as a catalyst for more people to choose banks over other financial options.
3. Online Banking
You might still be eligible to open a checking or savings account through an online bank if you reside in a place that lacks physical banks. You can start accumulating wealth with these banks' high-yield savings accounts and low fees. For those without access to a computer, opening an account can typically be done via a smartphone. Online banking is the easiest and most convenient solution for the unbanked and underbanked.
4. Unions Credit
You might find it easier to access credit unions locally as an alternative to traditional banks. You may be eligible to join a credit union through your employer, town, church, or worker's union.
Credit unions are owned by their members, not by shareholders, in contrast to banks. They're nonprofits as well. They are frequently able to offer extremely competitive rates on loans and accounts as a result.
5. Secured credit cards
Using a secured credit card is another way to establish credit and go from being unbanked to being banked. With this kind of credit card, your credit limit is determined by the refundable security deposit you make, which keeps you from going over your means.
Because secured credit cards are typically easier to obtain, they are perfect for those with poor or limited credit. These cards typically have minimum deposit requirements and annual fees, and some even provide rewards for regular purchases. You might eventually be eligible for an unsecured, standard consumer credit card after using the card for some time and building your credit.
6. Prepaid debit cards
Prepaid debit cards are a popular option for people who are unable to open regular bank accounts to make cashless transactions online and elsewhere. It options that are popular are the Walmart MoneyCard, Netspend card, and Green Dot card.
These cards still have hefty fees associated with them, even though they are far superior to predatory payday loans and check-cashing services that charge exorbitant fees for each check they cash. They also don't assist you in establishing credit or getting loans. Prepaid debit cards are still inferior to full bank accounts with minimal or no fees.
7. Knowledge of Finances
The majority of those who lack or have insufficient bank accounts are either from lower socioeconomic classes or lack sufficient education. Consequently, for people to comprehend the operation and organization of the banking system, they must have a solid foundation in finance. Social awareness could also help build financial knowledge. Apart from that, special policies for the low-income level groups can attract their interest in the financial world.
To sum up, having access to financial services and banks is a crucial element in everyone's life. Unbanked and underbanked people have many disadvantages, which not only affect their financials but also their overall life growth.
A proper financial system and bank services not only help individuals but also the whole economy to prosper. Unbanked people must get banked and start their financial journey.
Frequently Asked Questions (FAQs)
Underbanked and unbanked are similar terms with a slight change. Underbank refers to a household that has a savings account in a bank but chooses to take financial services from alternate institutions. On the other side, Unbanked refers to people who do not have access to banking services and do not have a savings account.
To cope with the growing unbanked population, Fintech is the only solution. Thanks to technological advancements, there are numerous fintech solutions for the unbanked. Some of the popular game changers are Banking applications, mobile wallets, blockchain cryptocurrency, microfinance, peer-to-peer lending, and credit scoring.
Unbanked is a term used for people who don’t have a savings account with a bank or credit union. In that case, they are exempt from availing the banking services such as regular interest, security, easy transfer, and more. This makes it hard for them to manage their finance and financial goals