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Serving the underbanked with short term loans


Financial institutions are primarily focused on meeting the needs of Americans that fit into certain demographics. The rest of the population ends up as the underbanked – consumers with needs viewed as too costly, too risky or too difficult to serve. According to the FDIC, the collective population of underbanked Americans is approximately 34.4 million households, more than a quarter of the total.

By ignoring the underbanked, banks and credit unions are in danger of missing out on an important trend in consumer demand: the expectations that businesses provide value both to the individual and the broader community. Additionally, they are giving up revenue to non-bank competitors. Here are some likely misconceptions that keep them away:

It isn’t profitable to work with the underbanked. This ignores the fact that the underbanked have an enormous demand for short-term loans. Payday lenders have found ways to make working with this segment profitable. Traditional financial institutions have the ability to offer similar products at a lower cost. The reason: banks have a preexisting relationship with many of these customers and access to their transaction data. They can offer these loans cheaply and quickly if they use systems that base loan approval on past transaction history, instead adding the additional step of ordering a credit check.

Reputational risk, or the fear that offering short-term loans would brand the bank as a peer of payday lenders, with all the accompanying negative connotations. Bankers may also be concerned that consumer activists will criticize them. However, by ignoring the needs of a quarter of the population, banks forego significant profits and the opportunity to build strong relationships with this significant group. Ignoring and alienating such a large demographic is harmful for banks’ health in the future, as many of the underbanked population will eventually transition to more traditional bank products. Disregarding this segment is also dangerous because banks are then allowing other non-bank competitors to remain dominant in this space. Banks of all sizes are created to support people and communities.

Instead, financial institutions should position themselves as providing better services at lower costs and taking a strong stand to meet all consumers’ needs at their institution instead of driving some out the door to non-bank competitors, where they will receive less favorable products and services.

Working with the underbanked will make compliance more challenging and increase the risk of audits. However, the rise of automation in the financial industry now enables lenders to more easily manage compliance risk without jeopardizing earnings. Especially because of recent proposed Consumer Financial Protection Bureau (CFPB) regulations related to payday lending practices, banks have been hesitant to become involved with product offerings that are subject to these strict regulations, which include offering loans at rates lower than 36% and extending the length of short-term loans to at least 30 days. However, if banks offer short-term loans compliant with these CFPB standards, they can do so more cheaply than payday lenders for the reasons mentioned above.

Ideally, short-term loans from a financial institution are products that help consumers stabilize their finances enough to be eligible for the firm’s more traditional products. Products such as short-term loans are key to building relationships with the underbanked and broadening a base of loyal customers. Financial institutions should be concerned with the prospect of missing out on interactions with a quarter of the American population and adjust traditional banking practices to meet the needs of these consumers.

Mr. Morales is the CEO of Olympia, Wash.-based Q-Cash Financial, a provider of an automated, cloud-based, mobile lending platform for financial institutions. He can be reached at [email protected]