Munich Personal RePEc Archive
Targeting the unbanked-financial literacy’s magic bullet?
Tatom, Jojn and Godsted, David
Networks Financial Institute at Indiana State University
14 November 2006
Online at https://mpra.ub.uni-muenchen.de/4266/
MPRA Paper No. 4266, posted 28 Jul 2007 UTC
NFI Report
2006- NFI - 02 November 2006
Targeting the Unbanked – Financial Literacy’s Magic Bullet?
D a vi d Godst e d a n d Joh n A. Ta t om Ab ou t t h e Au t h or :
John A. Tatom is the Director of Research at Networks Financial I nstitute, part of I ndiana State University, and Associate Professor of Finance at I ndiana State University. He has published widely on international and domestic monetary and fiscal policy issues, especially inflation, capital formation, productivity and growth; the macroeconomics of supply, especially oil and energy price shocks; the relationship of exchange rate movements to international competitiveness, capital flows, trade, and international economic policy; and on financial innovations and their effects on monetary policy and the economy, among other areas.
David Godsted is Networks Financial I nstitute’s director of outreach. He is charged with connecting I ndiana State University’s financial, business and educational expertise and resources with educational needs in the marketplace, specifically addressing financial services industry needs and functional educational needs focused on financial knowledge, skills and processes. Godsted formerly was executive director of New Mexico Coalition for Literacy. Prior to that, Godsted spent 10 years in the Middle East first teaching English as a Second Language and then directing a US Embassy English language school, and he was the training director for LVA – Elgin Area Affiliate in Elgin, I llinois.
The views expressed are those of the individual author(s) and do not necessarily reflect official posit ions of Net works Financial I nstit ute. Please address quest ions regarding cont ent t o John A. Tatom at john.tatom@isunet works.org. Any errors or omissions are the responsibility of the author(s).
NFI working papers and ot her publicat ions are available on NFI ’s website (www.networksfinancialinst itut e.org). Click
“ Research” and then “ Publications/ Papers.”
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Targeting the Unbanked – Financial Literacy’s Magic Bullet?
D a vi d Godst e d a n d Joh n A. Ta t om
Adult financial illit eracy is a m aj or problem in t he US and elsewhere. Financial fraud and poor perform ance in m anaging personal finances go hand in hand.1 The nat ion’s bankrupt cy and hom e m ort gage foreclosure rat es rat e have
cont inued t o clim b2 despit e im proving em ploym ent opport unit ies, rapid growt h in t he nat ion’s incom e and bankrupt cy reform aim ed at m aking bankrupt cy filing less necessary and m ore difficult . Am erica’s personal savings rat e hovers in negat ive t errit ory.3 As new financial services and t echnologies proliferat e, m any low incom e persons are being left in t he dust , oft en unable t o part icipat e in cost saving or high- ret urn opport unit ies, or t hey are offered new services only on very unfavorable t erm s. At t he sam e t im e, lack of financial and t echnological safeguards has m ade it easier t o exploit all individuals t hrough ident it y t heft , m ort gage fraud, or legal, but financially dubious, new product s. I n som e cases, new t echnology is being forced on low- incom e individuals by a coordinat ed federal push for elect ronic paym ent of benefit s. While an im posit ion on t he ot herwise unbanked, increasing access t o financial inst it ut ions m ay provide a useful int roduct ion t o a higher level of financial inform at ion and lit eracy, as w ell as enhancing t heir confidence and abilit y in financial m anagem ent .
Recent ly, H&R Block developed an innovat ive schem e for providing cash advance loans against incom e t ax refunds t hat were used t o fund new I RA bank account s for t he t ax payers. These program s offered new opport unit ies for saving and invest m ent , especially for low- incom e individuals. They connect ed unbanked individuals t o t he paym ent s syst em and organized saving program s, in m any cases, for t he first t im e. Nonet heless, precisely because low- incom e people were t he biggest beneficiaries of t he plan, t he plans cam e under st rong scrut iny by
1Fight ing Financial Fraud: How t o Shield Yourself from Swindles. 2003. FDI C Con su m er New s, Spring, 1- 2. The Spring 2003 issue of t he FDI C Con su m er New s det ails st rat egies for becom ing a defensive consum er t o prot ect against ident it y t heft and decept ions involving credit cards, ATMs, ot her bank product s and t he int ernet .
2 Nationally, foreclosures in the first quarter of 2006 increased 38% over the fourth quarter of 2006. See Roger, R
“Foreclosures drop locally, rise elsewhere.” (2006, June 9). Bradenton Herald. Bankruptcy rates in 2006 have declined slightly from the inflated levels in the first half of 2005, prior to new bankruptcy laws taking effect. For the 12-month period ending June 30, 2005, a total of 1,637,254 bankruptcies were filed, while in the 12-month period ending June 30, 2006, 1,484,570 bankruptcies were filed. See http://www.uscourts.gov/bnkrpctystats/bankruptcystats.htm.
3 The savings rat e has been in negat ive t errain since t he second quart er of 2005. See U.S.
Depart m ent of Com m erce, Bureau of Econom ic Analysis, Nat ional I ncom e and Product Account s Table, Table 5.1, Saving and I nvest m ent .
regulat ors for t heir prom ised low rat es of ret urn and high cost s t hat are t ypical of sm all deposit account s. As a result , t heir developm ent was slowed. I n
Sept em ber 2006, however, t he com pany announced a program t o open low- cost bank account s for free t o one m illion client s and t o reduce t he cost of ant icipat ion refund loans for t he 2007 t ax season.4
Congress has also begun t o address t he perceived m arket for at t aching t he unbanked and ot her low incom e- individuals t o t he financial syst em in order t o develop bet t er spending and saving habit s and provide access t o lower cost m eans of paym ent . Such effort s are crit ical for addressing t he growing problem of financial illit eracy. I n part icular, Senat e Bill 1321, as recent ly am ended, includes provisions t o im prove financial educat ion t hrough t ax preparat ion help and t o increase t he availabilit y of saving and checking account s for individuals.
Equally not ewort hy, financial educat ion and assist ance wit h access t o financial services would be facilit at ed by upgrading and ext ending t he work of com m unit y assist ance inst it ut ions, broadening t heir port folios t o include personal financial planning and m anagem ent services.
Large num bers of people do not have bank account s. According t o Professor Robert Lerm an, t here are 25 t o 56 m illion adult s who do not have access t o a checking or saving account .5 A recent Federal Reserve st udy says t hat 10.2 percent of fam ilies did not have a checking account in 2004, t he lat est dat a available, down from 12.7 percent in 2001. The form er figure is about 11.4 m illion fam ilies or, based on t he populat ion averages of 2.57 people per
household, about 29.3 m illion people, closer t o t he low end of t he range cit ed by Lerm an.6 Michael Barr claim s t hat som e 83 percent of t he unbanked earn less t han $25,000 per year.7
People are unbanked for m any reasons, including lack of proxim it y t o a bank, high cost , or personal preference. Som ewhat surprisingly, availabilit y and cost are not t he m ain reasons. Bucks, Kennickell and Moore ( 2006) show t hat in 1995, 1998, 2001 and 2004, t he m ain reason w hy fam ilies did not have a checking account was t hat t hey “ do not writ e enough checks t o m ake it
4 Rauber , K (2006, September 7). “H&R Block Announces Plan to Open 1 Million Bank Accounts for Free And Significantly Cut the Cost of Refund Lending.”
http://www.hrblock.com/presscenter/pressreleases/pressRelease.jsp?PRESS_RELEASE_ID=1459
5 See Robert I. Lerman and Elizabeth Bell, “Financial Literacy Strategies: Where Do We Go From Here?” Networks Financial Institute Policy Brief, 2006-PB-10, April 2006.
6 See Brian Bucks, Arthur B. Kennickell and Kevin B. Moore, “Recent Changes in U.S. Family Finances: Evidence from the 2001 and 2004 Survey of Consumer Finances,” Federal Reserve Bulletin February 2006, pp. A1-A38.
7 See Michael S. Barr, “Banking the Poor: Policies to Bring Low-Income Americans Into the Financial Mainstream,” The Brookings Institution Research Brief, September 2004.
4 wort hwhile” ( 27.9% in 2004) . However, in 2004, fam ilies t hat “ do not like dealing wit h banks” ( 22.6% ) , t he second m ost com m on reason since 1998, and “ do not need/ want an account ” ( 5.2% ) , t oget her exceed t he lim it ed usefulness reason.
On t he ot her hand, cost was t he reason for 11.6 percent who said t hat m inim um balance requirem ent s were t oo high and for 5.6 percent who said t hat service charges were t oo high. Only 1.1 percent of fam ilies gave as t heir prim ary reason t hat t here was no bank “ wit h convenient hours or locat ion.” I n a st udy covering 1995, Hogart h and O’Donnell ( 1999) exam ine t hese sam e reasons t hat lower incom e fam ilies do not hold checking account s, but t hey also break out fam ilies t hat do not use financial inst it ut ions at all.8 Am ong t his group ( i.e. no checking or saving account , or ot her services) t he principal reason given is “ Don’t have enough m oney” ( 32.9 percent ) , followed by “ Don’t writ e enough checks” ( 23.1% ) and t hen “ Don’t like dealing wit h banks” ( 20.2% ) . Cost and availabilit y are less im port ant reasons for t hose who are com plet ely unbanked t han for t hose who use banks but do not have a checking account . Dist ast e for banks is about t he sam e for bot h groups, and lack of funds is m ore im port ant for t he unbanked.
Th e N e w Se n a t e pr oposa l ( S.1 3 2 1 )
On June 28, 2006, t he Senat e Finance Com m it t ee am ended Senat e bill 1321 ( hereaft er S.1321) , “ Telephone Tax Repeal Act of 2005,” a bill t o repeal t he excise t ax on t elephone and ot her com m unicat ions and t o provide great er
financial lit eracy educat ion, t ax preparat ion and financial services access t hrough financial service providers or com m unit y charit ies. The Bill was subsequent ly placed on t he Senat e’s legislat ive calendar in Sept em ber 2006. Essent ially, t he com m it t ee incorporat ed t he t ext of S.832, which provided for t hese new services, int o S. 1321, as a subst it ut e am endm ent , and report ed S. 1321 favorably. The am endm ent , or new com ponent , reads as follows:
( a) Est ablishm ent of Program - The Secret ary is aut horized t o award dem onst rat ion proj ect grant s ( including m ult i- year grant s) t o eligible ent it ies which part ner wit h volunt eer and low- incom e preparat ion organizat ions t o provide t ax preparat ion services and assist ance in
connect ion wit h est ablishing an account in a federally insured deposit ory inst it ut ion for individuals t hat current ly do not have such an account . New Mexico Senat or Jeff Bingam an int roduced t he S. 832 legislat ion, and had t his t o say:
The last sect ion of t he bill [ S. 832] is an issue t hat m y colleague from Hawaii, Senat or Akaka, has been act ively working on for t he last several years. This provision would aut horize t he Treasury Depart m ent t o award
8Jeanne M. Hogarth and Kevin O’Donnell, “Banking Relationships and Lower-Income Families and the Government Trend toward Electronic Payments,” Federal Reserve Bulletin, July 1999, pp. 409-73.
grant s t o financial inst it ut ions or charit able groups t hat help low incom e t axpayers set up account s at bank or credit union. Because m any
t axpayers do not have checking or savings account s, t heir refund from I RS cannot be elect ronically wired t o t hem . The alt ernat ive is t o have t he check m ailed t o t he t axpayer or t o have t he refund im m ediat ely loaned t o t he t axpayer in t he form of a RAL [ refund ant icipat ion loan] . Of course, get t ing people t o set up a checking or savings account for purposes of receiving t heir t ax refund will also have t he benefit of get t ing m any of t hese people t o st art saving for t he first t im e 9
Unfort unat ely, t he Senat e bill was not act ed upon in t he 109t h Congress. I t can be expect ed t o be int roduced in wint er 2007 in t he next session of Congress, however.
N e t w or k s Fin a n cia l I n st it u t e Posit ion
Net works Financial I nst it ut e wholeheart edly support s t he passage of t his
m easure, but caut ions Congress t hat it needs t o be viewed as a sm all st ep t hat t reat s one sym pt om of financial illit eracy.10 I t is crit ical t hat we reach a far deeper underst anding of t he root causes of why people m ake t he personal financial choices t hat t hey do.
I n an at t em pt t o inculcat e sound financial m anagem ent approaches early in life t hrough it s Kids Count financial lit eracy curriculum , NFI int roduces t he key concept s of financial lit eracy t o 3rd- 5t h grade children:
• Goal set t ing
• Earning
• Budget ing
• Saving
• Spending
• Giving
These concept s form t he building blocks of financial lit eracy, and t hey rem ain crit ical t hrough adult hood. I n addit ion, NFI is working wit h a nat ional panel of expert s t o furt her refine it s set of K- 12 financial lit eracy com pet encies int o a set of adult st andards. Legislat ion t hat fost ers t he developm ent of t hese key
concept s, prom ot es age appropriat e nat ional financial lit eracy st andards, and
9 Bingaman, J (2005, April 18). Written statement of Senator Jeff Bingaman upon the introduction of S. 832, the Taxpayer Protection and Assistance Act of 2005. Web site: http://www.natptax.com/s832statement.pdf
10 Since these provisions are embedded in a broader effort to improve economic wellbeing, we should recognize that the telephone tax was passed as a temporary measure in 1898 to fund the Spanish-American War! Support for this component of the bill hardly warrants discussion, but it could be noted that the tax is one of the highest and most regressive excises that low-income taxpayers face.
6 uses t hese st andards t o predict at - risk groups and t o creat e t ailored solut ions st ands t he best possible chance of st em m ing t he rising t ide of financial illit eracy.
Ke y Posit ive I m plica t ion s of S.1 3 2 1
The First Account s program , which began in 2002, provides evidence t hat t he unbanked respond t o program s t o ext end banking services t o t hem .11 S.1321 will go m uch furt her by providing an educat ional base t o effort s t o provide bank access t o t he unbanked. I t creat es an incent ive for t he unbanked t o adopt and use banking services t hrough t he linking of t ax refunds t o bank account s,
especially savings account s and perhaps event ually I RA account s. I n addit ion, a public plan could offer higher rat es of ret urn and lower cost opt ions t han recent ly developed privat e sect or plans. Most im port ant ly, t he bill provides t he incent ive for a fundam ent al shift in t he focus and m ission of charit ies and com m unit y services t oward providing educat ion in developing financial lit eracy and assist ance in t aking up m ainst ream privat e sect or financial services.
First Account s and st at e effort s t hrough Lifeline account s rely on price incent ives t o induce t he unbanked t o t ake up bank services. However, Bucks, Kennickell and Moore ( 2006) show t hat cost is not t he principal fact or account ing for t he num ber of unbanked. Sim ilarly, Doyle, Lopez and Saidenberg ( 1998) show t hat effort s t o lower t he cost of account s t hrough m andat ed Lifeline account s have had “ lim it ed im pact ” because oft en banks already were offering lower cost account s t han t he new m andat ed account s, or because t he unbanked were unresponsive t o price changes.12 According t o Doyle et al, t he unbanked rely on alt ernat ive services t hat provide im m ediat ely available funds m ore rapidly t han banks so t hat check cashing is m ore at t ract ive elsewhere t han at banks, even t hough m ore
expensive. S.1321 does not rely on low ering t he cost of financial services, nor is it a program t hat is focused on paym ent s services. S.1321 shift s focus t o saving and wealt h accum ulat ion and hence has great er long- t erm benefit s for low
incom e individuals and t he unbanked.
The new proposal, S. 1321, also prom ot es access t o elect ronic banking and it encourages individuals t o direct ly t ake up a banking relat ionship. Exist ing
governm ent program s for benefit paym ent s and t ax refunds do not require t hat individuals act ually have bank account s and m any have been able t o avoid t hem t hrough alt ernat ive finance arrangem ent s or st at e governm ent sponsored plans
11 A review of the First Accounts program is contained in David Marzahl, O.S. Owen, Steve Neumann and Joshua Harriman, “First Accounts: A U.S. Treasury Department Program to Expand Access to Financial Institutions,” Center for Economic Progress, published in Federal Reserve Bank of Chicago, Profitwise News and Views, February 2006. Only one round of grants was made in 2002 to create these accounts and no funds have been provided since then.
12 See Joseph J. Doyle, Jose A. Lopez, and Marc R. Saidenberg, “How Effective Is Lifeline Banking in Assisting the
“Unbanked’?” Federal Reserve Bank of New York Current Issues 4, No. 6, June 1998.
t hat receive t he paym ent s and earn incom e from t he float , wit hout benefit t o t he individual.13
The bill also t akes advant age of t he m ost significant and widely accept ed conclusion of “ behavioral finance” research: individuals are m ore likely t o respond t o new saving incent ives if t he default is part icipat ion wit h t he right t o drop out t han if t hey are offered t he opt ion t o j oin. S. 1321 envisions a
fram ework in which t he t ax preparer creat es an account for t he individual t o receive refunds. I ndividuals could lat er close t he account , but given t hat t he funds are safely received and held in t he account , t hey are m ore likely t o keep t he account and use it . I t would be beneficial if S. 1321 were expanded in t he next session of Congress t o provide a different ial incent ive t o creat e and fund a saving- t ype account , especially an I RA or ot her t ax- free or incent ivized account , if t he goal is t o im prove financial lit eracy and long- t erm wellbeing of t he
unbanked.
The key risk of t he new account s proposed under S. 1321 is t hat t here is high reput at ional risk in arranging account s for low- incom e persons. The recent charges against H&R Block for arranging a sim ilar t ype of product could
pot ent ially lim it part icipat ion by charit ies or financial inst it ut ions in t he program . The use of governm ent subsidies could allow bet t er pricing t erm s t o alleviat e som e of t hat risk, t hough ult im at ely t he fact t hat it is a governm ent - sponsored program is probably bet t er insurance against reput at ional risk. I n t he end, t his program could go furt her, t ying t oget her responsible suppliers of personal
financial educat ion and t he unbanked in a program t hat t ransfers t ax preparat ion skills and m anagem ent of personal banking product s t o low- incom e individuals and ext ends banking services along wit h saving and wealt h building program s t o t he unbanked. Such a com prehensive and m ult i- facet ed program is an im port ant st ep in prom ot ing financial lit eracy am ong t he unbanked and not sim ply t rying t o push t hem int o great er access wit h m ainst ream checking account s. We st rongly support t he provisions of S.1321 and t heir expansion as a key st ep in federal effort s t o prom ot e financial lit eracy.
13 Hogarth and O’Donnell (1999) detail the benefits of the trend toward electronic banking and the benefits to low income households.
