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Requiring Alternative Financial Services Providers to Report Borrowers’ Repayment Histories Would Increase Financial Inclusion

The views expressed are those of the author and do not necessarily reflect the views of ASPA as an organization. 

By Rachel W. Robinson, J.D.
November 6, 2017

Financial Exclusion is a term which refers to the inability to access financial services. This includes lack of access to financial accounts and a lack of financial capability. Financial Inclusion, on the other hand, is the safe, convenient and affordable access to the full suite of financial services to people who have the capability to make informed decisions about how to use them.

A major reason people are financially excluded in the United States is that the alternative financial service providers who serve them do not report their customers’ repayment histories to credit bureaus. As a result, this data cannot be used to provide low-income individuals access to the myriad of financial services which can improve the quality of their lives and even help them escape poverty.

The Federal Deposit Insurance Corporation conducted a survey in 2015 entitled National Survey of Unbanked and Underbanked Households which revealed, in the United States, 66.7 million adults in the United States are financially excluded. That is, 15.6 million adults are unbanked in that they lack access to an insured bank account and 51.1 million adults are underbanked. An underbanked person may own a bank account but they also rely on alternative financial services, such as check-cashing services, payday loans, title loans, pawn shops, rent-to-own agreements and prepaid debit cards. These service providers charge fees that consume a disproportionate amount of their customers’ already low incomes.

Payday loans, title loans and rent-to-own agreements target the people with the least amount of money and yet charge the highest interest rates. Check-cashing services charge exorbitant fees. Pawn shops underpay for goods in hopes of turning a profit if the seller defaults. And individuals who use prepaid debit cards and cash do not have the opportunity to accrue the reward points and cashback incentives that bank debit cards and credit cards offer. This “poverty premium” is a major factor that keeps low-income people from saving their way out of poverty. Payday loans are especially dangerous as explained by Naomi Mannino in her blogpost entitled Can Pay Day Loans Hurt My Credit Score? hosted by CreditRepair.com.

Payday loans are designed to trap low-income borrowers in a cycle of debt. When a borrower fails to repay the entire loan by the due date, the remaining debt is rolled over to the next payment cycle with an added fee. If the borrower does not pay in full for the next cycle, the debt is again rolled over with yet another fee, and so on. Mannino provides a stark example: If an individual took out a $115 pay day loan with a $15 rollover fee, failure to pay for six cycles would result in a $90 fee.

In effect, if enough cycles passed, the person could owe more in fees than the principal on the loan. Somehow this scheme has escaped regulations against loan sharking. But even if a person does not fall into this trap and is able to meet their financial obligations, they still cannot escape the necessity to use payday loans, and other lending vultures, because the financial data reflecting their repayment habits is not reported to credit bureaus. As a result, traditional lending institutions have no way to assess creditworthiness.

Credit worthiness is determined by how likely a person is to meet their financial obligations over time. As mentioned above, alternative financial service providers do not regularly report repayment history to credit bureaus. Therefore, the large swaths of the U.S. population that rely on these services, 66.7 million citizens, remain economically invisible. Policymakers, in addition to continuing to regulate abusive loan practices, should also require alternative financial service providers to record borrowers’ financial data and report it to credit bureaus. Rent and utility payments should also be reported. Only then can low-income individuals establish the credit histories they need to access traditional financial services at regular rates.

In addition to lower cost, traditional financial services provide access to financial guidance and education. Banks, through their tellers and technology, form relationships with their customers and use the data about their spending habits to cross-sell helpful financial products such as savings and investment accounts. They show customers how to manage their finances and provide the tools, e.g., digital and paper account ledgers. By working with traditional financial institutions, low-income citizens can build the financial capability to make decisions that will help them out of poverty.

If policymakers required all financial service providers, not just banks and credit cards, to report the ongoing financial histories of their customers and required credit rating agencies to collect, analyze and report data, the financially excluded who have braved the loan vultures to demonstrate creditworthiness would eventually be able to access traditional financial services at the same low cost as the majority of Americans. This increased access would lead to greater financial capability as they would have access to the guidance of bankers and financial advisors who would guide them to the financial products that the mid- to high-income populations use every day to create and accumulate wealth.

Author: In addition to her work at the St. Louis Circuit Attorney’s Office, Rachel W. Robinson, J.D. is also a faculty member of the Blockchain Research Institute. She holds a BA in Liberal Studies: Comparative Politics and Spanish; an MPA: Leadership and Management; and a JD: Public Interest Law. For lively, interdisciplinary discussions on any topic, you can reach her here: https://www.linkedin.com/in/rachel-w-robinson-j-d-a69922a

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