Why are people with less income paying more for financial services?

It’s a question we at the Federal Reserve Bank of Boston ask all the time about the “underbanked.”

The underbanked (as opposed to the “unbanked”) have an account of some kind with a financial institution – usually checking or savings. But they still use often expensive nonbank “alternative financial services,” or AFS.

One example is payday loans, which are high-interest loans usually due the day of the borrower’s next paycheck. Another popular AFS is retail bill pay, when people go to a retail outlet like a supermarket or pharmacy to pay utility, credit card, and other bills for a fee.

The underbanked tend to have lower income levels and an incentive to pay less. So, what’s steering them toward more expensive financial products?

We know some of the answers. In a survey we conducted with the nonprofit Commonwealth, AFS users cited speed, trust, and confirmation that their funds were sent or received as their top reasons for using those services.

The good news here is that there’s a wide-open opportunity for financial institutions to create services that deliver those same benefits at a lower cost. And the Inclusive Payments Resource Center we recently released on the Boston Fed website offers a data tool and the survey findings to help them get started.

The data tool pinpoints where underbanked populations are located nationwide and which AFS services they are using within a given location. And the survey provides details on why the underbanked seek alternative financial services.

The resource center also features links to reports, research, and information on practical, real-world examples of current payments solutions and uses.

Nobody, including the underbanked, wants to pay more for financial services. And if they have better options, they won’t.

Instant payments technology opens path for improved financial services

We’ve all experienced payments that aren’t really instant: The money you deposited in your checking account isn’t available just yet. Or the amount you paid on your credit card yesterday still hasn’t been deducted from your balance.

Instant payments services, including the Federal Reserve’s FedNow Service, eliminate these lags, and that can open paths to better services that save people money.

How? Earned wage access is a great example. This gives workers access to money they’ve already earned before their traditional payday. It’s a popular AFS, according to our survey: More than a third of underbanked respondents say they use earned wage access.

When people get their money in their accounts earlier, it can help them avoid overdraft fees (55% of underbanked survey respondents say they paid an overdraft fee in the last year). Users also might not need to take out a payday loan.

We need more research about earned wage access to determine if it is truly beneficial to the user. But in cases when an employer offers earned wage access to its employees, the initial results look good, and it’s a promising area for financial institutions to explore.

Bill-pay services are another opportunity for financial institutions looking to better compete. In our survey, 46% of underbanked respondents say they use retailers to pay bills last minute, and they cite the confirmation they receive that their funds have arrived as the reason why.

Some banks already offer bill pay, but the experience can be slower, less transparent, or harder to use than AFS. If financial institutions modernize and streamline their bill pay offerings while keeping fees low, it would clearly be a major draw to the underbanked.

New data tool locates underbanked by state and area

Figuring out which services might draw underbanked customers is huge, but knowing where this potential pool of customers is located – and how big it is – is also essential. The data tool on our website tells users exactly that.

Users can enter a state or metropolitan district area and find out how many underbanked or unbanked households have used which AFS products there in the last 12 months. That can help financial institutions assess the size of the opportunity and determine which products to prioritize.

Just a quick check of the tool in some regions in the Boston Fed’s First District shows that in the Boston-Cambridge area, money orders are the most used AFS, followed by online payment services. In Portland, Maine, 20% of underbanked households make between $15,000 and $30,000 annually, and more than 28% use check-cashing services.

Links in our resource center can also equip financial institutions considering new or expanded offerings aimed at the underbanked.

For instance, they highlight reports that detail how faster payments can support better financial inclusion. They provide access to tools and templates that can be used to help build out new solutions. And there’s a “use case library” that includes instant payments applications that are up-and-running and helping financial institutions better serve their customers.

The need for affordable alternatives to AFS is clearly out there. And thanks to advances in instant payments technology, so is the opportunity for those ready to provide them.