I’m checking out at Target, my new air fryer bagged and ready to go, but something is wrong. A one-word message I’ve never seen before appears on the POS screen: DECLINED.
The cashier raises an eyebrow, but her tone is polite. Would I like to try a different card? I turn down the offer, leaving the $200 kitchen appliance behind as I excuse myself past the other people in line to make a call. In minutes, I’m talking to Capital One — the very bank that just acquired my tech consultancy — and explaining my situation. Yes, I know my credit limit is just $3,000 but I have money in the bank.
After a complicated divorce, my credit score was down in the low 600s, and even that $3,000 credit limit took time to get approved. The hurdles I ran into during that time were eye-opening and dramatically changed the way I looked at low-credit customers.
Low Credit Scores Aren’t an Anomaly
Fraud flags like the one I experienced exist for a reason, of course. They mitigate risk based on data about low-credit customers. However, they also drive a wedge between customers and their financial service providers. This wedge drives people to exploitative check cashing and payday loan operations to meet their financial needs. These businesses charge the highest rates allowed by state law, anywhere from 5% to 30%. Yet, since twenty-five percent of US households are either unbanked or underbanked, and forty percent of Americans can’t pay for a $400 emergency out of pocket, these operations make a killing. Twelve million Americans use payday loans each year, most taking multiple loans a year to pay for basic expenses while feeding a $90 billion industry.
By letting these customers slip through the financial cracks, banks are missing out, too. With an intelligent, data-driven approach, banks could connect meaningfully with these customers, manage default risk, and earn revenue on reasonable lending rates.
Nearly two-thirds of US adults have bad credit. That’s a lot of customers. Banks that don’t offer financial services to these customers are missing out on a huge segment of the market.
Where Banks Leave a Gap, Fintech Startups Fill In
People with low credit scores are more likely to choose online-only financial institutions over traditional banks. This explains the success of fintech companies like Earnin, which provides interest- and fee-free payday loans based on how much time a user has spent on-location at their job, essentially predicting the earnings that will appear on their next paycheck. Customers are so satisfied that almost all of Earnin’s revenue comes in the form of completely optional tips. Many make the suggested tip of 10%, and Earnin claims to be 95% community supported and operating mainly on these tips.
As for cash flow, popular account app Chime offers immediate access to deposited funds—faster than the usual two-day wait with traditional banks—with no fees. Chime makes a profit through a partnership with Visa. When Chime customers use their Visa debit card, merchants pay a percentage of the sale to Visa, and Chime takes a portion of that percentage. Chime also offers customers high-yield savings accounts and uses those funds to invest in high-return assets.
For customers who feel gouged and ostracized by the risk-mitigation tactics of traditional financial service providers, apps like Earnin and Chime meet a critical need. For millions of people in the US (and billions internationally) who have fluctuating income, high debt, low credit, or are living on government assistance, it can feel like these apps are the only reasonable financial service providers out there—and fintech startups are scooping up that revenue.
It doesn’t have to be that way.
Banks Can Step Up And Mitigate Risk
Yes, the bottom end of the market is risky. People default on loans, deposit bad checks, and misuse credit at higher rates, leading to loss. But banks have one thing startups don’t: the data to minimize their risk. With a more accurate assessment of a customer’s financial situation, banks can offer more favorable lending rates, new subscription-based bundles, and informed financial products at significantly less risk.
Banks already use data to improve services and make lending decisions. Customer insights like income, on-time bill payments, saving habits, spending habits, major life events, and more could be used to expand these practices to more customers and provide reasonably priced financial solutions for everyone.
The top five US banks own nearly half of the industry, so there’s no denying that they possess enough data about customer needs to compete with fintech companies. All it takes is the will to do it.
Following in Fintech’s Footsteps
Where should banks start? I’d say the best place right now, ironically, is fintechs. Top fintech companies experiencing success and opening lots of customer accounts have clearly figured out what at least some of these customers want and need. Banks should examine their brand’s positioning and find ways they are uniquely suited to meet the needs of these customers. Thanks to their size, banks have the ability to watch the market, evaluate demand, and take appropriate action.
Imagine what fair access to financial services could do for customer loyalty down the line. Offering realistic rates to people at every level of financial health is certain to build the kind of trust and long-lasting relationships banks are known for in the current market. With the help of partners, banks can build and execute a digital strategy to reach a broader market.
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This column does not necessarily reflect the opinion of FinLedger’s editorial department and its owners.
To contact the author of this story:
Sandeep Sood: ss@kunaico.com
To contact the editor responsible for this story:
Mary Ann Azevedo at maryann@finledger.com