Happy Payday: How Banks Drive the Poor to “Alternative Financial Services”

As the Pennsylvania legislature considers legalizing “micro-loans,” bank databases kick more low-income Philadelphians to the curb .

A story on the front page of Wednesday’s New York Times details the precarious situation many low-income and working-class consumers are finding themselves in when they go to the bank in the hopes of opening a new account.

According to the report, financial institutions like Bank of America, Citibank and Wells Fargo are using proprietary database software to scan applicants’ banking history, and flag and blacklist those considered to be “high risk.” Applicants are reportedly being denied accounts for as little as a single overdraft or bounced check.

The practice appears to be blowback from the financial crisis – which has made banking institutions considerably more risk averse; and it has left low-income and working-class consumers to suffer for the foibles and malfeasance of an industry that has historically ignored them (at least, when they’re not plying them with high-interest, subprime debt).

While comprehensive in scope, the Times story was based on surveys of consumers in just five states, and Pennsylvania wasn’t one of them. So I reached out to a source at Community Legal Services of Philadelphia — which represents poor and working-class citizens in consumer-related legal disputes — who confirmed what I already new to be true:

“I can tell you that we definitely have heard clients reporting that they have been unable to get a bank account because of prior problems that they’ve had at other banks involving overdrafts and bounced checks,” said Kerry Smith, a CLS staff attorney.  “This problem highlights the need for more effective reform of banks’ abusive overdraft programs, which are one of the major reasons consumers lose their bank accounts.”

Indeed, the overdraft policies at many large American banks would have earned the respect of the James Gang. Since the financial reforms of 2009 placed new restrictions on the industry, banks have developed all sorts of new tricks for milking extra dollars from consumers – like changing the chronological order of payments to put large transactions ahead of smaller ones, which are less likely to invoke a fee. Consumers paid $32 billion in overdraft fees last year, according to one tally.

By refusing to provide otherwise qualified individuals with a simple checking account for a mistake they made years ago, banks are amplifying what is already a critical problem facing low-income — and to a large extent minority — communities: A lack of access to safe, reliable financial services. One in every 12 households, or roughly 17 million Americans, have no bank account at all, according to a September 2012 report from the Federal Deposit Insurance Corporation (FDIC).

That’s up from the last time the agency checked, in 2009. More than one in four households — and 54 percent of all African-American families — are either unbanked or “underbanked,” which the agency defines as a household that has a checking account or a savings account but is still forced to rely on “alternative financial services.”

These alternative services — which include nonbank check-cashing outfits, payday lenders and, from January through April, advance tax-refund services — prey on the poor and financially marginalized. According to the Financial Service Centers of America, the industry’s trade association, alternative financiers process 350 million transactions each year, including more than $58.3 billion in check cashing transactions.

Costs for these check-cashing services vary and often include a membership fee in addition to a charge based on a certain percentage of the check. Only about half will cash a personal check, according to the Consumer Federation of America, and those that do charge the payee a percentage of the check’s face value that sometimes reaches into the double digits.

A banking industry blogger calculated the average annual cost of nonbank check cashing for a U.S. family earning $50,000 a year to be about $1,506.63 – more than an entire month’s rent for most working-class families.

But cashing checks is not how most AFS providers butter their bread; the real money is in usurious “payday” loans. Payday loans are very short-term loans, typically ranging from $100 to $1,000, with extremely high annual percentage rates — often exceeding 10 times that of a typical credit card. A report last year by the Pew Charitable Trusts determined that Americans spend about $7.4 billion a year in fees to payday lenders, or an average of $520 per borrower in interest. And contrary to the way they are marketed, the loans are often anything but short-term.

“Payday loans are marketed as two-week credit products for temporary needs. In truth, average consumers are in debt for five months and are using the funds for ongoing, ordinary expenses — not for unexpected emergencies,” said Nick Bourke, project director for Pew’s Safe Small-Dollar Loan Research Project.

As it happens, Pennsylvania currently has some of the strictest laws governing payday lending in the nation, and bans outright the storefront provision of such services. But according to Kerry Smith at the CLS, the industry has been lobbying hard to chip away at those restrictions, and it looks like they may be succeeding.  In June, the state Senate advanced a bill that consumer advocates say is a thinly veiled attempt to legalize payday lending at annual percentage rates as high as 332% for a two-week loan. Senate Bill 975 is sponsored by Republican Sen. Pat Browne of Lehigh County, and proposes to establish a “micro-loan” program that includes a pathway for borrowers to transition to more traditional lower-rate loans. But critics say that pathway is littered with hurdles and is more likely to keep low-income consumers trapped in the cycle of short-term, high-interest borrowing. A similar bill failed to pass last year.

The mere existence of SB 975 is evidence that lobbyists for the alternative finance industry will stop at nothing to get their hands into the pockets of people who have no other choice but to patronize their services.  And with bank policies now designed to shut out low-income and working class Americans, there are likely to be many more people who fall into that category.