grounds for competition: the basic financial service infrastructure in low-income … ·...

THE BROOKINGS INSTITUTION METROPOLITAN POLICY PROGRAM

Metropolitan Policy ProgramMatt Fellowes, Senior Research Associate

The Brookings Institution

Grounds for Competition: The Basic Financial Service Infrastructure in Low-Income NeighborhoodsThe High Cost of a Low Income: Financial Services in Underserved MarketsLouis L. Redding Public Policy Forum, University of Delaware


Why are we asking these questions?

Grounds for Competition: The Basic Financial Service Infrastructure in Low-Income Neighborhoods

I

What are the major findings?II

How is the market and public policy responding? III


We’re in the middle of a multi-year study that is evaluating how prices for basic goods and services vary by income

Food

Housing

Utilities

Furniture/Appliances

Transportation

Insurance

Other (e.g., fin. services)

Why?


Low-wage families pay higher prices than higher income households for nearly every basic necessity

Fixed Price

PricePremium forLow-IncomeFamilies


The implication is that lowering prices for low-income families is a powerful, and widely underutilized tool to fight poverty

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$2,000

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Income & BenefitSupplements

Lower theHigher Prices

Traditional anti-poverty strategies

Emerging anti-poverty strategies

Annual Income


In July ‘06 we will publish our second report in this project, an analysis of prices for necessities within 12 markets

Today, I want to give you a preview of our findings, by presenting some evidence related to the higher prices low-income consumers tend to pay for: short term loans and cashing checks

This forthcoming report will provide extensive evidence of these higher prices, along with an agenda for policy and market-based reforms to lower these higher prices


Over the past decade, policy, social, and economic trends triggered massive growth in the demand among low-income families for these basic financial services

Welfare reform spurred millions of low-income adults into the workforce

Immigration is at a recent high, many of whom have lower incomes than the national average

Wages have not kept pace with inflation through much of this period, particularly among low-income workers

DEMAND


Market entrepreneurs responded to this surging demand with new establishments, market products, and business models.

SUPPLY

Much of this entrepreneurship and innovation was spawned by new businesses rather than traditional, mainstream financial institutions.

The result is that low-income neighborhoods have a very unique infrastructure of financial services


As has been well documented, the outcome of these changes is that low-income consumers tend to utilize higher-priced providers of short-term loans

$23300%0%11.5%$200Auto-title Lender

$1.2012%1%0%$200

NCSECUCredit Union(Payday Loan)

$20120%0%$20$200OverdrawnChecking Account

$30390%0%15%$200Payday Lender$31403%15%$1$200Pawnshop

$791%1.5%2%$200Credit Card Cash Advance

$318%1.5%0%$200Credit Card

TotalMonthlyChargeAPR

Monthly Interest RateFee

MonthlyAdvance

Examples of Sources

Note: All estimates based on published analyses, but APRs widely vary across both places and companies; the credit union pay day loan is based off of the North Carolina State Employees Credit Union program Also, all sources are assumed to be utilized once per-month.


It is also widely known that low-income consumers are now more likely than other consumers to utilize check cashing services

Unlike most banks and credit unions, check cashing services charge a fee (usually 2-5% of the face value) to cash checks

Using this service makes sense for households who would frequently overdraw a checking account, but most researchers assume this is a small part of the population


Among the numerous causes, many have pointed to problems associated with access to mainstream products

Alternative providers (e.g., check cashers, pawnshops, payday lenders, & auto-title lenders) target low-income consumers

Mainstream providers (e.g., banks, credit unions, credit cards) dissuade low-income consumers


But, much of the data that speaks to these issues is out-of-date because this market is rapidly growing. For instance:

7,000

300

14,000

25,000

Number of Pawnshops Number of Payday Lenders

1980s Early1990s

Today Today

Note: Estimates are from John Caskey (Fringe Lending) and Sheila Blair (Low-Cost Payday Loans: Opportunities and Obstacles)


This leaves important questions unanswered..

Where is all of this growth happening?

What implications do these trends raise for public policy and the market?




I




Across the 12 metropolitan areas in our sample, there are approximately 5,243 alternative providers of check cashing and short term loan services, collectively earning about $3.2 billion in annual revenue.

DEMAND

SUPPLY

+ =LARGE MARKET OPPORTUNITY


The highest per-capita number of alternative check cashing and short term loan providers tends to be in the lowest income neighborhoods of metropolitan areas. For instance:

0 10,000 20,000 30,000 40,000 50,000 60,000 70,000

$120,000+

90,000 – 119,999

$60,000 – 89,999

$30,000 – 59,999

$0 – 29,999

Median Neighborhood Income

Population Per Establishment

For every one alternative provider in an Atlanta neighborhood with this median income, there are 7,030 residents


The same trend is found if we look at only the central cities ofthese metropolitan areas. For instance:



For every one alternative provider in a LA neighborhood with this median income, there are 6,882 residents

0 10000 20000 30000 40000 50000 60000 70000

$120,000+

90,000 – 119,999

$60,000 – 89,999

$30,000 – 59,999

$0 – 29,999


This evidence suggests that alternative check cashing and short-term loan providers tend to be more densely concentrated in low-income neighborhoods


But, the majority of these alternative financial service providers in metropolitan areas tend to be located in more moderate income neighborhoods. For instance:


Proportion of the Core Providers of Alternative Checking and Short-Term Lending Services

0% 20% 40% 60% 80% 100%

$120,000+

90,000 – 119,999

$60,000 – 89,999

$30,000 – 59,999

$0 – 29,999

In Seattle, 77 percent of these alternative providers are located in neighborhoods with a median income in this range


The same trend is reflected in 9 of the central cities within these 12 metro areas. For instance:


0% 10% 20% 30% 40% 50%

$120,000+

90,000 – 119,999

$60,000 – 89,999

$30,000 – 59,999

$0 – 29,999

Proportion of the Core Providers of Alternative Checking and Short-Term Lending Services

In New York city, 58 percent of these alternative providers are located in neighborhoods with a median income above $30,000.


This evidence suggests that most alternative check cashing and short-term loan providers tend to be located in moderate income neighborhoods.


The natural market competitor to these alternative financial service providers are mainstream financial institutions. Do they have the infrastructure to compete?

In our sample of 12 metropolitan areas, there are about 14,423 banks and credit unions.


In all but two of the 12 metro areas, mainstream financial institutions are more densely concentrated in low-income neighborhoods than alternative providers of check cashing and short term loan services. For instance:

0

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8000

10000

12000

14000

16000

18000

20000

Chicago MetroArea

Seattle MetroArea

New YorkMetro Area

IndianapolisMetro Area

Los Angeles-Long BeachMetro Area

Hartford MetroArea

Atlanta MetroArea

Banks and Credit UnionsAlternative Providers


in Neighborhoods with a Median Income Less Than $30,000


The same trend is found if we look at only the central cities ofthese metropolitan areas. For instance:


in Neighborhoods with a Median Income Less Than $30,000

0

5000

10000

15000

20000

25000

Chicago Seattle New York Indianapolis Los Angeles Hartford Atlanta

Banks and Credit Unions

Alternative Providers


This evidence suggests there actually is more of a “product desert” than a “retail desert” in most low-income neighborhoods


All of this adds up to a few central conclusions:

1. There is a very large market for alternative check cashing and short term loan services – over $3.2 billion in our sample.

2. This revenue is being generated in a diverse set of neighborhoods.

3. Mainstream financial service companies have a substantial infrastructure in place to compete with these alternative providers




I




The massive expansion in the alternative check cashing and short-term loan market has caught the attention of state policymakers

Source: Matt Fellowes (Laboratories of Capitalism)

0

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ber o

f Bills

in S

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Payday LoansPawnshopsAuto-title loans


It has also caught the attention of mainstream providers of financial services

Credit unions are entering the payday loan market

Banks are exploring new, competitively-priced short-term loan products, and are increasingly competing for checking account customers


Going forward, this means that the alternative lending market may actually become a victim of its own success

Policymakers can encourage this by:

1. Continuing to challenge the business model of alternative providers of these basic services

2. Curbing market demand for high-priced, short-term loans from mainstream providers

3. Fostering incentives for market innovation and competition in this market


www.brookings.edu/metro

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