The Changing World of Retail Financial Services—Capturing the Benefits for All, Avoiding the Pitfalls

1. The Changing World of Retail Financial Services—Capturing the Benefits for All, Avoiding the Pitfalls Presentation by Ellen Seidman ShoreBank and the Center for Financial Services Innovation Community Development Financial Institutions Class Yale Law School March 31, 2006

2. A [Very] Short History of US Financial Services for The Low-Income Population • Pre-1985 • Cash heavily used, for both payroll and transactions • Fair penetration of savings accounts, generally paying very low interest • Few checks, few ATMs, very few credit cards, no debit cards, no stored value cards, no internet • Loans came from independent consumer finance companies, pawn shops and lay-away and informal sources • Low penetration of standard mortgages (less favorable alternatives like land contracts, mobile home leases in use in some areas) ©ShoreBank

3. A [Very] Short History of US Financial Services for The Low-Income Population • 1985-2002 • Employers move to checks and direct deposit; vendors such as utilities reduce direct cash payment opportunities, increasing demand for check cashing and bill payment services • Bank closures and consolidations of late 1980s result in branch closures in low-income neighborhoods; reduce easy access of low income population to neighborhood banks for saving • Wave of immigration makes remittances into big business • Credit scoring makes credit cards available to far broader part of population (often at very high cost), and having a credit card becomes not only a status symbol but also a necessity for such activities as renting a car; ATMs proliferate • Banks buy independent consumer finance companies; rise of payday lenders (informal sources still important) • Mortgage penetration in low-income communities increases substantially, but also increase in sub-prime lending, predatory lending and foreclosures ©ShoreBank

4. A [Very] Short History of US Financial Services for The Low-Income Population • Since 2002 (Part 1) • Rise of payroll cards; $29 billion in 2004, compared to $15 billion in 2003, and growing • Prepaid debit cards and stored value cards take hold. 15 million prepaid debit cards were issued in 2003; in 2004 consumers loaded their cards with over $159 billion, a 24% increase • Some banks beginning to court low-income population with checkless checking accounts, programs such as Get Checking (second chance accounts), tie-ins of savings to tax refunds, but USA PATRIOT Act makes both banks and immigrants concerned about implications of account opening, especially for those without documentation • Retailers and others (e.g., tax preparers) begin offering financial services targeted to lower income customers ©ShoreBank

5. A [Very] Short History of US Financial Services for The Low-Income Population • Since 2002 (Part 2) • Banks begin to have some success in remittance business, driving down prices, but Western Union remittances to Mexico still growing 20%+ a year • Payday lending (and close substitutes, such as auto-title leasing) continue substantial growth; more check cashers and payday lending outlets than McDonalds, Burger King, Target, Sears, JC Penny and Wal-Mart combined • Sub-prime mortgages continue to grow, disproportionately in minority communities • Bankruptcy rates continue upward trend, with mortgage debt accounting for increasing portion of bankruptcy debt • Credit scores become critical to more than credit; recognitions of failings; beginnings of attempts to improve (e.g., PRBC) ©ShoreBank

6. Why Do We Care About Managing and Growing Income? • There’s a large and growing market that isn’t fully served by the mainstream financial services industry, and that is increasingly served by others • Assets matter – and financial services are a key means to that end. • Research shows a strong correlation between having a bank account and owning other assets. • Growing wealth gap and increasing awareness of unbanked demonstrate disconnect between supply and demand of financial services for the lower end of the market. ©ShoreBank

7. Market Snapshot • As many as 22 million households – 20% of U.S. households – are unbanked • At least 53% of Mexican immigrants are unbanked • $500 billion in payroll checks issued annually to unbanked employees • $55 billion in checks cashed at check cashers annually • Up to 40% of U.S. households do not have an unsecured credit card • The combined unbanked and subprime credit population may be 30-40 million households Unbanked consumers spent at least 2% of income on basic financial services. That translates into a $4B-$9B market. ©ShoreBank

8. Financial Services Survey • 21 low- and moderate-income census tracts in each of Los Angeles, Chicago and Washington DC • 1532 respondents, 48% response rate • Survey available in English and Spanish, and 10% took it in Spanish • One-third conducted in person and two-thirds by phone • Field work done between September 2003 and January 2004 ©ShoreBank

9. 70% of the Population is “Banked” ©ShoreBank

10. But the Banked/Unbanked Dichotomy Is Incomplete Almost two-thirds of the banked survey population use non-bank services as well Half the unbanked survey population were formerly banked Banked (70.4%) 20.2% receive income in cash 38.1% of those with checking accounts pay rent with cash or by money order 25.9% of those who cashed checks did so at a non-bank Unbanked (29.6%) 47.8% have had a checking or savings account in the past 25.5% of those who cashed a check did so at a bank Use banks exclusively (35.6%) User of non-bank services (64.4%) Formerly Banked (47.8%) Never banked (52.2%) The unbanked population is disproportionately lower income, with less education, and are: foreign-born, households with more kids, younger, and black or Hispanic ©ShoreBank

11. Summary: Survey Key Findings • Banked/Unbanked dichotomy incomplete • Informal networks important for payments and credit; substantial savings in cash and other non-formal forms • Limited use of alternative credit sources • Saving matters—savers have more assets, asset-based debt, more insurance and seem to save in the face of life setbacks ©ShoreBank

12. Who are the Underbanked? • Segmentation is a market analysis technique that divides a target market into groups of useful size that have maximum internal similarities and maximum differences between them • We segmented the survey population on the basis of demographics, usage and attitudes • The results are an important reminder that this group is diverse, and needs to be served in diverse ways ©ShoreBank

13. Segments • Never Banked Natives (6.9% of the population, median income $7,922): low-income, young and middle-aged single parents, very few save and 30% have outstanding loans, mainly for cars • Formerly Banked (14.1%, $13,726): 30% Latino, mainly young and have children, 60% were satisfied with their bank accounts, 90% would like to open an account within the next five years • Nuevo Latinos (8.5%, $14,482): low-income, young mostly foreign born, half send money home, least educated, but 60% are employed for salary and 6% self-employed, not banked, use pawn shops • Settled In (14.3%, $23,358): 13% born in US, 84% have checking accounts, 57% send money home (almost entirely via non-bank providers), 70% have children at home, many are married or living with a significant other • Older Margin (18.1%, $13,746): primarily African Americans, 42% of households have no one working, 82% have checking accounts, but 32% use money orders (primarily from a non-bank) • Older Core (7%, $33,494): US-born, educated retirees, few work, most receive benefits, 92% are homeowners, almost all have checking accounts, 75% have savings accounts ©ShoreBank

14. More Segments • Young Families (8.4% of the population, $23,490 median income): young African Americans with some post-high school education, 60% have saved in last month, 39% have credit cards, heavy users of money orders • Core Customers (7.7%, $32,967): young professionals, 40% have children, 30% married or in relationship, use both checking accounts and credit cards, 2/3 have savings accounts, 70% have saved during last year • Up and Comers (10.7%, $46,376): young and diverse, 29% have college degree and 16% more have some graduate school, 91% have checking accounts but 31% still pay some bills with money orders, heavy credit users • Making It (4.5%, $72,586): US-born, well educated, savers, 69% own homes, wide relationship with financial institutions, both banks and insurance companies ©ShoreBank

15. Segments and Median Incomes

16. Race Defines Some Segments, Not All

17. Checking Accts and Money Orders — Side by Side

18. UP AND COMERS Nearing Success MAKING IT YOUNG FAMILIES Working Their Way CORE CUSTOMERS NUEVO LATINOS Immigrants SETTLED IN NEVER BANKED NATIVES FORMERLY BANKED Struggling OLDER MARGIN OLDER CORE Older Natives Clusters and Pairs • Ten “clusters” in data • Distinguishing features • Demographic characteristics • Product usage • Preferences • Suggestions of appropriate products • Three cluster pairs similar in characteristics other than age and/or education. • Older/better educated cluster uses more sophisticated / more profitable bank products, • suggests develop opportunity for younger / less educated cluster ©ShoreBank

19. Opportunities • By recognizing these segments, banks and other financial services providers can increase their service and profitability in this sector • Consumers benefit from outreach by mainstream financial services sector • access to more cost-efficient products and services • additional asset-building opportunities • These consumers are likely to become long-term customers, whose increasing financial health and stability will continue to enhance the value of their relationship to both customer and provider. ©ShoreBank

20. What are Some of the Barriers Providers Need to Overcome? • Economic barriers • Lack of liquidity to carry account balance • High fees, especially for bounced checks • Structural barriers • Lack of sufficient identification to open account • Bad prior experience (ChexSystems) • Experiential barriers • Unfamiliar with banks • Lack of account transparency • Distrust of banks ©ShoreBank

21. Key Challenges for Banks and Credit Unions • Cultural barriers • Inadequate market data • Finding volume • Finding partners • Regulatory issues ©ShoreBank

22. Banks and Credit Unions Federal (and frequently state) supervision Regular examinations Non-appropriated funding for most part Some consistency among regulators Emphasis on fixing problems, not suing, but regulatory enforcement can be strong and effective Limited private rights of action Non-depository Institutions Primarily state regulation (although HUD and FTC involved) Complaint-based system; no regular examinations Appropriated funding, generally limited Limited state-to-state consistency Philosophy generally oriented toward enforcement, not engagement Private rights of action in general not limited by regulatory jurisdiction or organizational structure The Regulatory Dynamic ©ShoreBank

23. Overcoming the Barriers: Promising Innovations ©ShoreBank

24. Process Improvements: Alternative ID • Matricula consular is official Mexican ID; other countries like Guatemala, Argentina and now Colombia have developed similar documents • 350 U.S. banks accept the matricula for account opening; the USA PATRIOT Act does allow it • Bank regulators - after extensive public comment and review of their procedures – have confirmed their decision not to prohibit financial institutions from accepting foreign-issued identification cards, such as the Matricula card. • Individual Taxpayer Identification Numbers are issued by IRS for non-citizens in order to pay taxes • At least 18 banks are making mortgages with ITINs; MGIC is providing PMI; secondary market is considering purchases ©ShoreBank

25. Process Improvements: Second Chance Accounts • The majority of U.S. financial institutions use credit scores and/or databases of customer banking history to determine whether to open a bank account, effectively barring millions from banks, credit unions. • These tools are not adequately calibrated for the un/derbanked. • Financial institutions don’t adequately tailor how they use the tools. • In the last five years, hundreds of depositories have reengineered the use of these risk management tools and developed alternative pathways for re/entry. • Get Checking: eFunds-sponsored effort that offers a second chance to customers with ChexSystems problems. • Result: 10,000 graduates, 95% of whom have maintained accounts in good standing for a year. ©ShoreBank

26. Product Improvements: Checkless Checking • Checking accounts are not well designed to meet the needs of un/derbanked consumers. • Lack of liquidity • Lack of pricing transparency • But banks and credit unions are tied to account-based systems, even for their new remittance platforms. • The rise of debit cards has provided a range of new “checkless” solutions. • Account based • Prepaid ©ShoreBank

27. Partnership Improvements: Tax Time • Tax time is a potentially powerful moment for reaching underbanked consumers with financial services • In 2002, 70 million tax filers with incomes under $30,000 received more than $82 billion in federal tax refunds • Financial institutions and community groups have begun to take advantage of this, usually in partnership with both free and commercial tax preparers • H&R Block and city governments • JP Morgan Chase and VITA sites • Alternatives Federal Credit Union • New refund splitting option (in 2007) raises the stakes ©ShoreBank

28. Who is Succeeding In Outreach and Financially? • Union Bank of California • Cash & Save • Wells Fargo • Matricula Acceptance (Mexico, Guatamala, Argentina; just added Colombia) • Legacy Bank • Get Checking • El Banco de Nuestra Comunidad • Latino Community Credit Union • Alternatives Federal Credit Union • Alternative RAL • North Carolina State Employees Credit Union • Salary Advance Loan ©ShoreBank

29. Who Else is Working At It? • Citibank • Access Account • Washington Mutual • Essential Bank Account • KeyBank • KeyBank Plus • US Bank • Second Chance Checking • Bank of America • SafeSend, Keep the Change • Central Bank of Kansas City, University National Bank • Stored Value Cards • Northside Community Credit Union • Payday Alternative Loan • LaSalle Bank • Emergency Credit product ©ShoreBank

30. And Who Is Catching Up Quickly? • From transactions to mortgages • In-store bank partnerships – some private labeled • A bank charter on the horizon? • Increases store visits • Vcom self-service financial kiosks • 1,000 stores • $20 million in R&D costs • Promotes convenience • Tax prep + wrap-around financial services • IRAs, mortgages, checkless accounts • Just received bank charter • Increases loyalty ©ShoreBank

31. For More Information • Center for Financial Services Innovation (CFSI) • Key topics: workplace as distribution channel; alternative data sources for credit reporting; enhance functionality of prepaid cards for asset- and credit-building • www.cfsinnovation.com • Retail Financial Services Initiative report: From the Margins to the Mainstream • www.ncif.org/services.php?mainid=3&id=41 • KnowledgePlex Chat series • Next one (on tax prep) April 5 • www.knowledgeplex.org/xchat.html • Underbanked Financial Services Forum • June 8-9 in Chicago • www.sourcemediaconferences.com/conferences/CFSI06/ ©ShoreBank

32. For more information contact:Ellen SeidmanShoreBank 7054 S. Jeffery BlvdChicago IL 60649(773) 420-4920ellen_seidman@sbk.com