At the height of the first Great Depression, President Roosevelt signed the Banking Act of 1933, which established the Federal Deposit Insurance Corp. This was meant to insure account holders and protect them from losing everything in the event of another crash. While the majority of Americans conformed to the new banking system, a smaller percentage did not and instead rely on a cash-based economy – a group that came to be known in the financial industry as the “underbanked.”
Fast forward to 2013 and America’s underbanked population has swelled to some 68 million people. Research from the Federal Reserve Board shows, surprisingly, that the underbanked have adopted mobile and smartphones at a higher rate than the average American. And not only are they more likely to own a cellphone, but because these low-to-moderate income consumers are less likely to have in-home internet access, they rely more on their phones for everyday activities such as paying bills and managing money. Ironically then, it may turn out that the underbanked may have a strong influence in how tomorrow’s mobile payments.
Locked out of mainstream options
Underbanked consumers now represent one in every five American households (and growing). What has fueled the adoption rate of mobile among this population is a lack of service options from traditional banks, which have long viewed them as too risky thanks to their low incomes and poor credit scores. (While this is true for a percentage of the underbanked, it is certainly not the case for all.) They are accustomed to going through great and sometimes costly measures simply in order to accomplish often very basic transactions; collectively the underbanked paid some $78 billion in interest and financial service fees in 2011 alone. This lack of service options has in turn spawned a slew of overpriced check-cashing and remittance-payment industries that prey specifically on the underbanked’s compromised position.
A niche for finance tech – but with risks
This is where mobile is starting to bridge the gap. Young financial tech companies are realizing the potential of this large and underserved market offering better service options – and without resorting to schemes that rely on gouging the underbanked consumer. For instance, QIWI, a financial tech company out of Europe, recently launched a network of self-service kiosks that accept cash and allow consumers to instantly and conveniently pay service providers. The company has since completed a substantial public offering on NASDAQ and now has an approximate $1 billion market value.
There are risks involved in working in this market as well, though. Some critics believe that there is less innovation designed for the underbanked due to their unpredictable nature, which makes it harder for service providers to plan long-term. Another concern is the risk of fraud, although there’s no evidence to say it is more prevalent for channels servicing the underbanked market than it is for fully banked channels. However, many retailers do find the amount of cash that they must accept and process to be challenging from a risk, safety and security perspective. And because the underbanked can be segmented in regional pockets throughout the country, there are challenges in trying to scale quickly as well.
The greater issue, though, for companies trying to enter the market has to do with regulatory burdens. For instance, in addition to the costs and resources required to comply with licensing requirements, companies need to ensure that they comply with money transmitter licensing requirements in each state.
A path to making cash digital
Underbanked consumers are first movers in the mobile wallet space because it has the potential to save them both time and money. Yet a recent digital wallet study by comScore showed that, aside from PayPal, no digital wallet vendor had even 50 percent of general consumer awareness. In order for companies like Google Wallet or Square to attract this early adopter, it’s important that they provide an easy and obvious on-ramp for cash. This means building out infrastructure such as over-the-counter pay locations in areas where the underbanked consumer spends – Wal-Mart, convenient stores, gas stations, and bodegas. (Disclosure: the author’s, TIO Networks, creates products and services for the underbanked market.)
One company that’s done this well is Greendot, a bank holding company. Its MoneyPak is appealing to the underbanked consumer because it works as a cash top-up card. The idea is that it can be purchased easily at retail locations like Wal-Mart, Kmart, and Walgreens and then used to reload prepaid cards, add money to a PayPal account without using a bank account, or make same-day payments to major companies.
Similarly, Square’s model has enabled a large number of low-to-moderate income business owners to accept payments. This could potentially act as a Trojan Horse strategy into the underbanked market, if its wallet were to become accepted in areas where the underbanked consumers are shopping. The reality for the digital wallet space though is that there may not be just one winner, as different aspects of the wallet programs will appeal to different aspects of the underbanked market.
And a recent study commissioned by Mastercard showed the global prepaid market is expected to reach $822 billion by 2017 – crucially, it showed that much of the growth is attributable to the underbanked. Prepaid is attractive to this market because it doesn’t require credit checks or ongoing payments, but it does allow the flexibility of making payments, now that many mobile and web apps accept prepaid cards for payments.
Legislation may stifle opportunities
Innovative financial tech companies are offering underbanked Americans an opportunity for financial inclusion, however increasingly strict government regulations may become a hindrance. New laws like the California Money Transmission Act have imposed onerous costs, lengthy application processes, and huge capital and net-worth requirements, all of which are crippling to start-ups that simply can’t afford the cost of compliance. The spirit of such legislation is well intended but fails in the regulatory hurdles it creates. Luckily organizations like the Consumer Financial Protection Bureau are looking for a balance between solutions that protect consumers while still promoting much needed innovation.
Hamed Shahbazi is chairman and CEO of bill payment service TIO Networks Corp.
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