Bashing the bankers has made for big headlines. But the banking system actually needs more customers.
The still yet unaddressed problem of the 2008 financial crisis is the need for fuller participation in the banking system.
As the crisis of the last two years makes clear, a strong and well-functioning financial system is key to a growing economy. The financial system provides for the efficient transfer of household savings to business investment. With investment, an economy increases productivity and raises standards of living.
Banks are crucial to this process. Large companies like Micron Technology go to the stock or bond markets to get needed capital for investment in plants and equipment, but smaller businesses, the largest group of employers in the U.S., go to their local banks.
Banks also reduce risk for consumers. Without a banking system, individuals must carry more cash for regular purchases. This is not only inefficient but puts everyone at a higher risk of loss.
In response to regulatory changes and increasing competition over the past three decades, banks pursued higher profitability in nontraditional banking activities, such as initiating mortgage loans and quickly selling them in the bond market. One important reason for the competitive changes in the banking industry was a decline in the lowest-cost source of funds for banks – standard checking and savings accounts.
In the 1970s banks obtained nearly 60 percent of their funds from these traditional accounts. Today, banks get only 7 percent of their capital from them. If the banking system is to return to health and get back to its traditional support role in the economy, there need to be more households using standard bank services — specifically, savings and checking accounts.
The Federal Deposit Insurance Corp. is leading initiatives to bring more people into the system. In late 2009 the FDIC released a study measuring the percentage of the U.S. population that does not use the banking system.
The FDIC estimates that nearly one fourth of U.S. households are unbanked or underbanked. Just under 8 percent are unbanked – households without a checking or a savings account. Underbanked refers to households that have a checking or savings account but use nonbank financial services frequently. These relatively costly services include money orders, check-cashing services, rent-to-own agreements, pawnshops, or the very costly payday loans.
For households in Idaho, the nonparticipation rate in the banking system is near the national averages. In Idaho, 6.7 and 19.7 percent of households are unbanked and underbanked, respectively.
An important recommendation from the FDIC is for banks to reach more of the unbanked and underbanked by working with employers to increase payroll direct deposits. Direct-deposit programs increase participation in the banking system because they provide immediate availability of funds and remove the high fees associated with check cashing.
A related and promising program is a payroll card. With payroll cards, employers need not write payroll checks. The bank issues a debit card for an employee that can be used immediately to purchase goods and services. However, the financial regulation bills currently under consideration in Congress call for limits on the fees banks can charge for debit-card transactions, discouraging banks from helping the underserved groups.
As with many problems, more education will help, bringing the unbanked and underbanked into the financial system. The Idaho Financial Literacy Coalition provides education and training in personal finance for public and private school teachers to improve both the quantity and quality of personal-finance information available to Idahoans. The Idaho Bankers Association also provides financial education for students and consumers.
Increased banking system participation can increase bank profitability and reduce risks, improving the economy for everyone. Innovative payroll programs and increased financial education should help bring the nearly one quarter of U.S. households and more than 26 percent of Idaho households bank in the fold.
Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.