What Is Underbanked?
Being underbanked describes individuals or households that possess a traditional bank account, such as a checking account or savings account, but still rely on alternative financial products and services outside of mainstream banking to meet their financial needs. This status falls under the broader category of financial inclusion, examining the extent to which individuals have access to and use various financial services. The underbanked often use high-cost services like check-cashing services, payday loans, money orders, or pawn shops for transactions, credit, or other financial needs, despite having a relationship with a mainstream financial institution. This reliance often stems from a lack of access to affordable and appropriate traditional financial services.
History and Origin
The concept of the underbanked emerged as financial regulators and researchers began to differentiate between those completely outside the banking system (the "unbanked") and those who, while having an account, were still poorly served by traditional banks. Early surveys and reports, notably those by the Federal Deposit Insurance Corporation (FDIC), began tracking both unbanked and underbanked populations to better understand financial access in the United States. The FDIC National Survey of Unbanked and Underbanked Households, first conducted in 2009, became a key tool in quantifying this segment of the population and highlighting their continued reliance on non-bank services.5 This ongoing survey revealed that simply having a bank account does not guarantee full financial integration or access to affordable financial tools.
Key Takeaways
- The underbanked possess a traditional bank account but frequently use non-bank financial services for core financial needs.
- This status often results from limited access to affordable traditional banking products, high fees, or insufficient credit score access.
- Underbanked individuals may incur higher costs for basic financial transactions compared to fully banked individuals.
- Understanding the underbanked population is crucial for promoting broader financial literacy and inclusion initiatives.
Interpreting the Underbanked
The presence of an underbanked population indicates gaps in the mainstream financial system's ability to serve all segments of society effectively. When a significant portion of households are underbanked, it suggests that conventional financial products and services may not be affordable, accessible, or suitable for their specific circumstances. For instance, the 2023 FDIC survey revealed that 14.2% of U.S. households were underbanked, meaning they had a bank account but also used nonbank financial services.4 These households may use check-cashing services instead of direct deposit, or opt for high-cost loans outside of traditional banks. Higher underbanked rates are often observed among lower-income individuals, racial and ethnic minorities, and those with disabilities.3 This reliance on alternative providers can lead to higher fees and reduced opportunities for building wealth management or establishing a strong financial history.
Hypothetical Example
Consider Maria, who has a basic checking account with a bank. However, her income fluctuates significantly, making it difficult to maintain the minimum balance required to avoid monthly fees. When unexpected expenses arise, or she needs cash urgently, instead of using her bank's ATM (which might charge an out-of-network fee) or incurring an overdraft fee, she often goes to a local check-cashing service to cash her paychecks immediately. She also uses prepaid debit cards for some online purchases, avoiding potential fees associated with her bank debit card. Although Maria has a bank account, her frequent use of these alternative, often more expensive, services makes her an example of an underbanked individual. She might also occasionally resort to high-interest short-term debt from a payday lender rather than seeking a traditional small loan.
Practical Applications
Understanding the underbanked population is critical for financial institutions, policymakers, and community development organizations. Banks can design more inclusive products, such as low-fee or no-minimum-balance checking accounts, or offer small-dollar loans as alternatives to predatory lending. Policy efforts often focus on encouraging broad financial access and improving financial literacy to help individuals navigate the financial system. The rise of fintech and digital banking has opened new avenues to serve the underbanked, offering accessible and often lower-cost services through mobile platforms.2 However, it is also important to address practices that disproportionately affect underbanked communities, such as cash-back fees charged by some retailers in areas with fewer banking options.1 These efforts aim to bring more individuals into the mainstream financial system, fostering greater economic stability and opportunity.
Limitations and Criticisms
While having a bank account is a step towards financial inclusion, being underbanked highlights persistent challenges within the financial system. A key criticism is that traditional banks may not adequately cater to the needs of lower-income individuals, leading them to rely on more expensive alternative services. High fees, such as overdraft fees or minimum balance requirements, can be significant barriers. This can perpetuate a cycle where individuals, particularly those struggling with income inequality, pay a premium for basic financial transactions, hindering their ability to save or build assets. The lack of robust consumer protection in the alternative financial services sector also exposes the underbanked to risks like excessive interest rates and unfair practices. While fintech solutions offer promise, concerns exist regarding digital literacy barriers and the potential for new forms of exclusion if access to technology is uneven.
Underbanked vs. Unbanked
The terms "underbanked" and "unbanked" describe distinct but related states of financial access. An unbanked individual or household is one that does not have any formal relationship with a mainstream financial institution, meaning they do not possess a checking account or savings account at a bank or credit union. They rely entirely on non-bank methods, such as cash, money orders, or check-cashing services, for all their financial transactions.
In contrast, an underbanked individual or household does have a traditional bank account but still frequently uses alternative financial services for some of their financial needs. For example, a person with a checking account who regularly uses a payday lender for short-term credit is underbanked. The primary distinction lies in the presence (underbanked) or absence (unbanked) of a formal banking relationship, even if that relationship is limited or supplemented by external services.
FAQs
Why are people underbanked?
People become underbanked for various reasons, including the high cost of traditional banking services like monthly maintenance fees or overdraft charges, inability to meet minimum balance requirements, lack of trust in financial institutions, or inconvenient access to bank branches. Some also find that alternative services better suit their immediate financial needs, despite often being more expensive.
What are common services used by the underbanked?
Common services used by the underbanked include check-cashing services, money orders, prepaid debit cards, pawn shop loans, and high-interest payday loans. These services fill gaps left by traditional banking but can come with higher fees and less favorable terms.
How does being underbanked affect personal finances?
Being underbanked can significantly impact personal finances by increasing the cost of basic financial transactions. The fees associated with alternative services can quickly add up, reducing disposable income and making it harder to save, build a good credit score, or achieve financial goals. It can also limit access to affordable credit and wealth-building opportunities.
What efforts are being made to help the underbanked?
Efforts to help the underbanked include initiatives by banks to offer low-cost or no-fee accounts, expand financial education and financial literacy programs, and leverage fintech solutions to provide more accessible and affordable digital banking services. Government agencies and non-profits also work to promote financial inclusion and advocate for stronger consumer protection against predatory practices.