University of Michigan Law School University of Michigan Law School Scholarship Repository Articles Faculty Scholarship 2004 Banking the Poor Michael S. Barr University of Michigan Law School, [email protected] Available at: https://repository.law.umich.edu/articles/62 Follow this and additional works at: https://repository.law.umich.edu/articles Part of the Banking and Finance Law Commons, Law and Society Commons, and the Social Welfare Law Commons Recommended Citation Barr, Michael S. "Banking the Poor." Yale J. on Regulation 21, no. 1 (2004): 121-237. This Article is brought to you for free and open access by the Faculty Scholarship at University of Michigan Law School Scholarship Repository. It has been accepted for inclusion in Articles by an authorized administrator of University of Michigan Law School Scholarship Repository. For more information, please contact [email protected]. Banking the Poor t Michael S. Barr Low-income households often lack access to banking accounts and face high costs for transacting basic financial services through check cashers and other alternativefinancial service providers. These families find it more difficult to save and plan financially for the future. Living paycheck to paycheck leaves them vulnerable to medical or job emergencies that may endanger their financial stability, and lack of longer-term savings undermines their ability to improve skills, purchase a home, or send their children to college. Additionally, high cost financial services and inadequate access to bank accounts may undermine widely sharedsocietal goals of reducingpoverty, moving families from welfare to work, and rewarding work through incentives such as the EarnedIncome Tax Credit. This Article calls for the transformationof financial services for the poor. The Article first explores the dualfinancial services market in which insured depository institutions largely serve middle- and upper- income persons, and check cashers and other alternative service providers largely serve low- and moderate-income households. The Article argues that the social benefits of breaking down barriers between these markets exceed the costs of doing so. The Article also contends that network externalities in electronic payment systems help explain why some technologies that would help low-income consumers have not been as rapidly adopted as would be socially beneficial. In response to this problem, the Article recommends governmental incentives for private sector financial and technological innovation to help lower banking and savings barriersfor the poor. Better access to financial services is critical for low-income persons seeking to enter the economic mainstream. t Assistant Professor of Law, University of Michigan Law School. B.A. Yale College 1987, M. Phil., Magdalen College, Oxford 1989, J.D. Yale Law School 1992. I would like to thank Alan Berube, Stephanie Dorn, and Kevin Smith for their research assistance. This Article builds on work conducted while I served as deputy assistant secretary of the U.S. Treasury from 1997 to 2001. 1 am indebted to my colleagues at the Department for their work on the unbanked, including Alan Berube, Natasha Bilimoria, Don Graves, Clifton Kellogg, and Melissa Koide in the office of community development policy and Fiscal Assistant Secretary Donald Hammond, Roger Bezdeck, and the professional team at the Financial Management Service. I would also like to thank Michele Kahane and the Ford Foundation for generous support for the research for this Article, and Bruce Katz and the Brookings Institution's Center on Metropolitan and Urban Policy, where I am a nonresident Senior Fellow, for their ongoing assistance. Research for this Article was also supported by the Cook Endowment of the University of Michigan Law School. For comments on earlier drafts, I would like to thank Reuven Aviyonah, Greg Baer, Omri Ben-Shahar, Rebecca Blank, Mike Bylsma, John Caskey, Marsha Courchane, Steve Croley, Cathy Donchatz, Peter Edelman, Richard Friedman, Jonathan Gruber, Don Herzog, Janet Holtzblatt, Jill Horwitz, Elena Kagan, Andrea Kane, Robert Litan, Kyle Logue, Karl Scholz, Ellen Seidman, Dan Sokolov, J.J. White, and the participants in the Law & Economics Workshop at the University of Michigan Law School. Copyright D 2004 by Yale Journal on Regulation HeinOnline -- 21 Yale J. on Reg 121 2004 Yale Journal on Regulation Vol. 21:121, 2004 Introduction ............................................................................................. 123 1. The Unbanked .................................................................................. 128 A . Patterns of Account Ownership............................................... 128 B. The Costs of Being Unbanked.................................................. 128 II. The A lternative Financial Sector ..................................................... 128 A . Check Cashers......................................................................... 128 1. Industry Overview ............................................................ 128 2. Custom ers ........................................................................ 128 3. Costs ................................................................................. 128 4. Regulation ........................................................................ 128 5. Reform s ............................................................................ 128 B. Payday Lending ....................................................................... 128 1. Industry Overview ............................................................ 128 2. Custom ers ........................................................................ 128 3. Costs ................................................................................. 128 4. Regulation ........................................................................ 128 5. Reform s ............................................................................ 128 C. Title Lenders ............................................................................ 128 D. Tax Preparersand Refund Anticipation Lenders .................... 128 1. Industry Overview ............................................................ 128 2. Regulation ........................................................................ 128 3. Reform s ............................................................................ 128 III. The Banking Sector ......................................................................... 128 A . Barriers to Banking the Poor................................................... 128 B. Governmental Policy and PrivateSector Innovation ................................................................................ 128 1. Electronic Funds Transfer '99 and Electronic Transfer A ccounts ............................................................ 128 2. Electronic Benefits Transfer ............................................ 128 3. Private Sector Innovation in Banking Products ............................................................................ 128 4. Rem ittances and the Hispanic M arket .............................. 128 5. International Experience .................................................. 128 IV . Paym ents System s and Distribution N etw orks ................................ 128 A . Network Externalities .............................................................. 128 B. Checks and Debit Cards .......................................................... 128 C. ATM s ........................................................................................ 128 D . Direct Deposit and Bill Payment ............................................. 128 V . Transform ing Financial Services for the Poor ................................. 128 122 HeinOnline -- 21 Yale J. on Reg 122 2004 Banking the Poor A . B ank A ccounts.......................................................................... 128 1. First Accounts Tax Credit ................................................ 128 2. The Community Reinvestment Act .................................. 128 3. State Policies and Welfare Reform .................................. 128 B . FinancialEducation ................................................................ 128 V I. C onclusion ....................................................................................... 128 Introduction Access to financial services is critical to success in the modern American economy. Most households can take access to a bank account for granted. Yet 22% of low-income families-over 8.4 million families earning under $25,000 per yqar-lack the most basic financial tool, a bank account.' These "unbanked" households and other "underbanked" low- and moderate-income individuals face high costs, relative to their income, for basic financial services. For example, a worker earning $12,000 a year would pay approximately $250 annually just to cash payroll checks at a check cashing outlet.2 Low-income workers often turn to tax preparation services and costly refund loans to access their government tax refund check under the Earned Income Tax Credit (EITC). The costs of these basic financial transactions can undermine public initiatives that help families move from welfare to work, and can diminish the effectiveness of the EITC in lifting families out of poverty and encouraging workforce participation. Low-income families, particularly those without bank accounts, often lack any regular means to save. These families, often lacking alternative forms of financial