Brookings Institution On The Benefits Of Real-Time Payments For Underbanked Americans

Underbanked households are often forced to tap predatory lending options when they fall behind on everyday payments, but access to real-time payments can help, says the Brookings Institution’s Aaron Klein. In the latest Real-Time Payments Tracker, Klein discusses how access to faster payment rails can help underbanked consumers settle bills on time and avoid falling into a black hole of late fees and unpaid debts.

Bank accounts are considered a staple of everyday life among the vast majority of U.S. consumers, yet more than 7 million households lack access to this basic financial service. This represents approximately five percent of the U.S. population, but this cross-section is not representative of Americans as a whole: 14 percent of Black households and 12 percent of Hispanic households are considered unbanked or underbanked, as opposed to nearly 3 percent of white households.

It has been more challenging than ever to be underbanked over the past 18 months as the ongoing pandemic and economic downturn disproportionately affected those who lacked access to financial services. The absence of a bank account makes all financial decisions slower, and delayed payments can have a ripple effect on the well-being of families as fines are levied and services are denied due to untimely payments.

“Slow payments are a tax on society,” said Aaron Klein, senior fellow of economics at the Brookings Institution, a Washington, D.C.-based economic think tank. “They provide no value for society, but tremendous cost. That cost is borne mostly by those with the least amount of money and those that are living closest to the edge of financial solvency, whether it’s people or businesses.”

Accelerating these transactions in the form of real-time payments can be massively beneficial for underbanked Americans, said Klein, and alleviate many of the downstream effects of delayed payments that can perpetuate a cycle of poverty.

The Challenges Faced By Unbanked And Underbanked Americans

A common adage among economic equality advocates is that it is more expensive to be poor than rich, and in few areas does this present itself as starkly as among the underbanked. Those without traditional lending options are often forced to turn to predatory lenders like payday loan companies, for example. This is even the case for many bank account holders, as the fees at check cashers are often less than bank overdraft fees.

“If somebody gave you a check this afternoon, and you tried to deposit that in your bank tomorrow, it might not be available for four or five days until after the weekend,” Klein explained. “If you’re one of the half of all Americans who live paycheck to paycheck, what are you supposed to eat for the weekend? How are you supposed to pay your bills? This helps explain why more than half of the checks cashed at check-cashing places are from customers with bank accounts. Cashing a check at a check casher might cost $20, but that’s a lot cheaper than a $35 overdraft fee.”

Costs like these quickly add up, hampering underbanked households’ abilities to build up savings and put themselves on the road to financial security. While approximately 5 percent of American households can be considered unbanked, far more pay excessive overdraft fees due to a lack of effective payment options.

“Eight percent of Americans pay more than $350 a year in overdraft fees, so if you’re a family earning $35,000 a year, you could be paying 1 percent of every dollar you earn in bank fees,” said Klein. “If you ask the 5 percent of Americans who are unbanked why [they are] unbanked, the main reason cited by about half of them has to do with the cost of basic banking.”

Ensuring that these unbanked individuals have access to proper banking services is a systemic, industry-wide issue that banks have been addressing, but a short-term method to help underbanked households receive payments instantly, which relieves financial uncertainty and anxiety, already exists in the form of real-time payments.

How Real-Time Payments Can Alleviate Underbanked Individuals’ Troubles

Real-time payments’ greatest impact when it comes to helping underbanked consumers, according to Klein, is that it can cut off the ripple effect of delayed payments and their attached fees at the source. Late payments tend to beget late payments and all the added fees that come with them — the earlier one can end this negative feedback loop, the better.

“Say July 2 is payday Friday, but your rent is due Thursday, July 1 — what do you do?” Klein noted. “If payday lending is a $30 billion a year industry and America had adopted real-time payments, that would alleviate 20 percent of the demand for payday loans. You could have $6 billion a year returned to underbanked families had the Federal Reserve adopted real-time payments 13 years ago, when the Bank of England did. That’s almost $100 billion of wealth put back in the hands of underbanked families out of the profits of payday lenders.”

Real-time payments could also significantly aid day-to-day expenses in addition to the systemic issues caused by the costs of poverty and being underbanked. Klein identified two main areas where real-time payments could help underbanked households.

“The first is child support, where it can be caught in multiple layers of delay: One spouse has to wait for their paycheck to come through, then the next spouse has to wait for the transfer from one account to the other and, meanwhile, this kid needs diapers now,” he said. “The second is household expenses, which are very lumpy. You pay rent once a month, you pay your car payment once a month as well as your student loan. We don’t each get paid a little bit every day and then pay out a little bit every day — we need to wait for the paycheck.”

Being underbanked in the U.S. is a systemic issue with multiple causes, compounding aftereffects and issues that financial institutions need to address to reduce the problem. Real-time payments may not be a silver bullet, but it can provide ample aid for underbanked households in the meantime.